Rising rates are Tech stock kryptonite! So claim many pundits, supremely sure rising long-term interest rates will upend the giant sector’s bull market leadership. But there are several problems with that theory: Historically, Tech actually has outperformed the broad market more often than not as rates rise. Now? If rates’ recent climb proves lasting—a big if—Tech should still lead, due to myriad drivers favoring it. See claims of Tech’s looming demise for what they are: sector pessimism, a sign Tech’s run isn’t done.
Linking Tech to yields stems from a correct but myopic theory misapplied: Higher rates theoretically shrink what investors will pay for a firm’s future profits. True. They reduce the net present value of cumulative future earnings and increase bonds’ relative appeal. Since Tech’s sparkly profit projections underpin its premium valuations, pundits argue rising rates dent them more than other stock categories. They tout lower-valuation, economically sensitive “value” companies in such environments.
Nice theory. But oversimplified to the point of error. Rates are just one of myriad forces dictating style dominance at any time. Years of data prove the notion rising rates automatically crush Tech is blatant bunk. Since 1973, Tech stocks outperformed world stocks over half the time when 10-year Treasury yields rose. Some industries within Tech, like hardware, outperformed much more often.
Today’s Tech composition by industry differs from decades past—less hardware, more software and services. But Tech still frequently bucks rising rates. Consider: From July 5, 2016 through November 8, 2018, 10-year Treasury rates jumped from 1.37% to 3.24%. Global Tech soared 69.4% over that stretch, trouncing world stocks’ 26.6% gain. Why? The economic expansion matured and growth slowed, favoring stocks that could grow in a low-growth economy—Tech.
Also, short rates’ climb paralleled long rates then—three-month Treasury yields rose from 0.27% to 2.36%—keeping the spread between them tight. Banks borrow at short-term rates to lend long term, so the gap between them (the “yield curve spread”) approximates new loans’ profitability—and banks’ future willingness to lend. Slim profits made banks loath to lend eagerly to typically lower credit quality value firms. Growth firms, which can tap varied financing sources or internally fund growth, excelled.
Today’s yield curve spread is about where it was in 2016—as big a headwind for value versus Tech and growth stocks now--as it was then. This is why, as I wrote here in September last year, value stocks’ typical early bull market outperformance isn’t all about rates. That is as much or more about sentiment—a relief rally when widening spreads encourage lending.
Further to the point, the rise in long rates from August’s lows to now has been tiny—insufficient to turbocharge lending and propel credit-sensitive value stocks to lasting leadership. They have already retreated some—no shock, considering early autumn’s rise was simply about sentiment. For example, the Fed’s months-long telegraphing about tapering its “quantitative easing” (QE) bond-buying programs likely stoked some selling, pushing yields higher. As Fed officials’ statements made November 3’s taper announcement ever more clear, rates’ climb cooled. Markets were done pre-pricing that move.
Little remains to boost rates. Foreign demand for Treasurys remains strong and will rise with rates. Elevated inflation, supply chain snarls and Fed rate hikes in 2022? Too widely watched not to be near-fully pre-priced. Higher long rates require further and lasting inflation pressures exceeding what markets already priced. Unlikely since inflation fear is so widely broadcast. Headlines shriek of sky-high inflation doom, sapping surprise power. Less noticed: In Q3, S&P 500 earnings reports showed firms’ gross profit margins—especially Tech and Tech-like stocks in the Communication Services sector—remained just as fat as in Q2. They are coping well with higher costs.
Then, too, price pressures will wane. Energy? Global oil and gas producers are upping output, while Asian coal prices have plummeted. Europe’s recent wind woes are abating, cooling rates’ climb. European natural gas prices are down over 40% since their October peak.
Moreover, economic growth is slowing, which helps firms that can grow despite tepid economic activity. That is doubly true if supply and labor constraints persist. These complications favor firms less labor intensive—but with the capital and clout to dictate supplier and shipper terms—as well as digital service provides that ship few physical goods. That points to fat-margin businesses that ride longer-term trends—like Tech and other big growth companies.
Remember, too: Sectors aren’t binary decisions. Their industries feature varied drivers. Hardware and semiconductor firms’ economically sensitive nature helped them top world stocks in two-thirds of years when 10-year US Treasury yields rose since 1973. Thank Moore’s Law and semiconductor commoditization. Hardware also beat software firms 82% of years rates climbed.
The notion long-term (or short-term) interest rate wiggles alone mean a darned thing for Tech—or any sector—presumes one liquid capital market knows better than another, a common but always hugely ridiculous notion. Interest rates move on the same fundamentals and sentiment as stocks, both in real time. Nor do today’s fluctuations determine tomorrow’s. So don’t overrate short-term swings (pun intended). See the rates-kill-Tech fears for what they are: A sign Tech’s fundamental strength is currently underappreciated—which is bullish.
