Bringing fundamentals back into focus is no bad thing
The rise in US Treasury yields in reaction to the government's $1.9tr stimulus package has prompted a shift in equity markets away from highly valued tech stocks that may do less well if interest rates rise as a result of higher inflation. But if the switch means investor portfolios reflect the wider economy, that is a positive development.
The tech-heavy Nasdaq 100 fell by 10.9% from its most recent peak on February 12 to Monday's close, an official market correction; the less techy S&P 500 was down 3% over the same period and the Dow Jones Industrial Average was up by 1%.
Higher rates also mean bonds become more attractive compared to stocks as yields track rates while they also mean higher financing costs for tech companies, which could struggle to continue to issue debt to finance growth or share buy-backs, putting pressure on lofty valuations. Meanwhile, future revenue projections will be discounted at higher rates, which would also mean a lower valuation.
Nevertheless, equity investors have not abandoned stocks completely. They appear to be buying cyclical companies instead, in line with the growth expected to stem from stimulus package and economic recovery.
One of the hardest hit stocks over the last month was Tesla, the electric car company that saw its equity value rocket 700% in 2020.
Tesla lost a fifth of its value from the middle of February but even after this fall is still trading at over 900 times its earnings. Amazon and Apple fell by nearly 10% in the same period and Netflix by a similar amount.
Some of the best performers over the past month in the US have been television companies like Discovery, which is up over 30% since mid-February; Fox Corp, up 25% and Viacom, up over 30%.
Other traditional businesses have also performed well over the last month. JP Morgan is up over 7%, insurer AIG over 13%, Ford up over 11% and American Airlines has risen by around 20% since mid-February.
While the rotation has been mostly focused on the US, it is a similar story in Europe.
On the Amsterdam exchange for example, tech darlings Adyen and Prosus were down 10% and 7% respectively from their mid-February peaks while ABN Amro has risen by over 11% over the same period.
In the UK, e-commerce firm The Hut Group, which was listed in London last September, has fallen by 10% from mid-February while Barclays has risen by around 17% and Marks & Spencer by about 15%.
On Tuesday the Nasdaq 100 recovered some of its losses in a sharp rally but as of Thursday it was still down 7.65% from its February high.
A dip in momentum for tech stocks is clearly painful for many investors but should be no cause for alarm.
Despite the recent repositioning, the tech bull run has not lost steam and firms like Amazon, Apple and Google remain profitable giants of the global economy. This is by no means yet a bubble-bursting event like the dotcom bust of the early 2000s.
Nevertheless, after years of concern about the huge valuations of various tech unicorns and their outsized weightings in indices, a more balanced equity market should be welcomed.
Future growth is a great thing but in the long term, a track performance of profits is even better. Investors should have space in their portfolios for today’s business titans as well as tomorrow’s.
In the short-term, rotation may mean a harder time for tech in secondary equity markets and in primary ones, with investors perhaps unwilling to commit capital to companies when they are uncertain about sector valuations in the short-term.
However, good equity stories should still gather support, especially among long-only investors keen to commit to the sort of long-term rewards that growth tech-stocks promise.
For the moment though, companies that make money today may finally be able to jostle for investor attention in the equity capital markets.