Meanwhile, In Tech: ‘Hey, I Bought Stuff That’s Going Down’

“Interest rates are a central focus of equity investors,” Goldman’s David Kostin said, in a note out late Friday.

It was an understatement. The market is now staring down the daunting prospect of four rate hikes and the onset of balance sheet runoff in 2022. Historically, Fed tightening cycles are disruptive. And each time, the pain threshold seems to be lower.

Conceptually, this isn’t a particularly complex dynamic. The longer price discovery is impeded by extraordinary monetary accommodation, the further away from fair value prices drift and thus the more sensitive risk assets become to policy tightening.

10-year US reals ended the week at a “lofty” negative 66bps — not exactly onerous. However, they were 31bps more negative on January 3. It’s thus no surprise that US equities are down 2% over the first two weeks of the new year.

The figure (below) is updated through Friday. Over time, lower and lower real yields are required to keep stocks buoyant.

Whenever reals rise “too much” over a compressed time frame, stocks swoon.

Arguably, the more concentrated the index becomes vis-à-vis mega-cap tech (i.e., the larger the share of market cap commanded by the FAAMG cohort, Tesla, etc.) the more acute this situation will get given the disproportionately deleterious impact of rising real rates on growth stocks.

Note that the Nasdaq 100 is down twice as much as the S&P in 2022, although the FANG+ index has held up better. Clearly, there are quality considerations to account for when drawing comparisons with the tech bubble, but nevertheless, tech companies whose long run growth prospects are otherwise bright, face “the cold calculation of being discounted by current yields,” as BMO’s Douglas Porter put it. “The Fed’s sudden turn is a clear-cut headwind for lofty valuations,” he added.

So, what’s the saving grace? Or is there one? Well, according to Goldman, the important consideration is that “growth stock valuations look much less demanding today than they did in 2000.”

The bank’s Ben Snider noted that “at the peak of the Tech Bubble, the nominal 10-year US Treasury yield was above 6% and the real yield exceeded 4%.” That meant growth shares traded with an earnings yield below nominal Treasurys and “with a scant 100bps yield premium on a real basis,” he went on to say.

As the figure (above) shows, the situation is markedly different today. “The gap between the growth stock EPS yield and Treasury yields is far wider on both a nominal and real basis,” Snider remarked.

Still, caution is warranted. And angst is showing up in predictable places. For example, Cathie Wood’s flagship fund saw more than $350 million in outflows in a single day this week, the most since March of last year, when the wheels first began to come off the Ark amid a similarly acute rise in rates.

The figure (above) is updated with this week’s loss, which summed to almost 5%.

“There’s fear,” one PM told Bloomberg’s Vildana Hajric, who, in a piece out Friday afternoon, asked whether dip-buyers in tech currently exhibiting “lion-like courage” might soon be mourned as “sheep to the slaughter.”

That fear, the same PM remarked, isn’t necessarily related to the economy. Rather, it’s “fear about, ‘Hey, I bought all this stuff. It’s going down.'”