The bull is back in big-cap US tech. Or was back. And could be back again soon. Or not.
In early trading this week, the Nasdaq 100 was briefly up 20% from the June lows, as tech shares looked to build on three straight weeks of gains.
Editorializing around the achievement of imaginary milestones is difficult because they often prove fleeting. The figure (below) is a snapshot in time from Monday morning.
I mention this not just for the novelty value (this is still a bear market), but rather because it’s a poignant illustration of how rates-dependent US equities really are.
Of course, valuing stocks entails inputting a risk-free rate. My point here isn’t to recap your first semester of business school (when you’re forced to actually learn the basics you pretended to learn in undergrad), but rather to underscore a familiar talking point about duration sensitivity.
The US equity market is highly levered to growth stocks. Most are good companies. Some are great companies. A few are, arguably, the best companies the world has ever known. But that doesn’t shield them in a rising-rates environment. They’re sensitive to yields and more prone to oscillations when set against a backdrop of elevated rates vol.
“The more expensive you are, the more the volatility in the discount rates feeds through to the share price, and the most expensive stocks with the highest growth expectations are now indeed amongst the most volatile stocks in the US market,” SocGen’s Andrew Lapthorne said Monday.
This conjuncture has precipitated the largest overshoot for growth stock volatility relative to value stocks since the dot-com bust (figure above). Growth shares are 50% more volatile amid the tumult in rates and bonds.
You should consider this in the context of the Nasdaq 100’s double-digit July gain, which was propelled, in part anyway, by falling bond yields. As discussed at length on Monday morning in “Bears, Bulls And The People In-Between,” assigning a higher multiple to rising profits is one thing, but tech earnings are seen receding in aggregate. This rally is, in some places, the product of investors paying more for every dollar of shrinking profits.
“We understand the discounted cashflow logic of re-rating stocks whose profits are resilient to an economic downturn as bond yields decline, and this type of investor behavior has been a defining feature of equity markets during the QE era,” SocGen’s Lapthorne remarked, in the same Monday note mentioned above.
But this isn’t the QE era. We’re not in Kansas anymore. And Lapthorne was keen to reiterate as much. “We are not so sure it applies in an era of QT and rising interest rates,” he said, calling growth stock profits “somewhat fragile.”
Some growth stocks are actually cyclicals in disguise as well. Tech hardware for instance. And B to B software in a slowdown could get hurt badly too. The narrative can change that is for sure. Be careful out there.
I’ve been thinking about the US economy and the US equity markets this way, for the past week or so… If we DON’T have a proper (full-fledged) recession, and if we DON’T tumble to dramatic new lows in SPX et al., just imagine the resiliency our economy and markets will have demonstrated after all that has been thrown at them, year-to-date.
It would truly be remarkable, no?
But, having said all this, certainly not the most likely outcome.
I’m still having trouble envisioning how we’re already past all the worst of it, having turned the corner and now on the path of progress (so to speak).