Just As Wall Street Piles In, Tech Stocks Are Facing Another Interest Rate Storm

(Bloomberg) — Jerome Powell’s latest aggressive mission threatens to open a new front in the ever-furious battle between tech stocks and Treasury yields — potentially hurting money managers who have just plunged back into U.S. megacaps in droves.

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The Nasdaq 100 posted its biggest drop since the week ended June 10 after the Federal Reserve chairman signaled on Friday his steely resolve to raise interest rates in restrictive economic territory to reduce inflation at decade highs.

Portfolio managers, including long-term bulls in the sector, see the risk of further losses for interest-sensitive technology stocks — as all signs point to Powell making good on his policy threat as prices for goods and services continue to are stubbornly high on the globe.

Read more: Powell talks tough, says rates likely to stay high for some time

The rapid rise in the yield on the 10-year note this month has already rattled so-called growth stocks while sparking an asset cross selloff following the stock’s recent $7 trillion rally.

Wall Street worries are now bracing for the benchmark Treasury to retest the high of nearly 3.5% hit in June or rise even higher to 4% – threatening fresh losses for blue-chip companies after the group recovered more than 20% from the bear market nadir.

“If yields jump to 3.5%, that will shake the markets and be particularly painful for tech stocks,” said Nancy Tengler, chief investment officer at Laffer Tengler Investments. “If we get to 4%, the whole stock market will change and recalibrate.”

All of this threatens to catch hedge funds by surprise after the cohort in industry data tracked by Goldman Sachs Group Inc. raised tech bets last quarter to the highest since the start of the pandemic on the belief that an economic slowdown would revive megacap security trading.

Another wave of volatility hit Wall Street on Friday, following Powell’s jaw-dropping speech at the Jackson Hole symposium as he warned of tightening policy “for some time,” given that history “strongly warns of premature policy easing.” Futures referring to the Fed’s September policy meeting saw 64 basis points of tightening at one point on Friday, compared with 59 basis points before the speech. But the stock market bore the brunt of Powell’s message that rate hikes could dampen economic growth as the tech-heavy Nasdaq 100 fell 4.1 percent even as the 10-year yield was broadly flat.

In general, tech companies are particularly vulnerable to fears of rising interest rates because many of them are valued based on projected earnings to be delivered years into the future. The present value of these future earnings is worth less as returns rise.

Read more: Stock Bulls’ Swagger deflates as Powell issues a warning

Rising interest rates also make financial transactions more expensive. This is not a problem for companies like Apple Inc. and Microsoft Corp. that are flush with cash, but it increases the risks for younger companies that are burning through cash in pursuit of rapid growth.

The yield on the 10-year U.S. Treasury note hovered around 3 percent on Friday, down from about 2.57 percent in early August.

“Investors are grasping for a pivot, but they’re not going to get it until inflation comes down — it’s certainly peaked, but it needs to come down substantially,” said Sean Sun, portfolio manager at Thornburg Investment Management. “If the Fed needs to raise rates even more aggressively to get there, then we could see the 10-year back to around 3.5%. This transition will hardly be painless for tech stocks.”

Money managers with a long-term focus are famously reluctant to unload technology exposures because of the cohort’s reliable profit generation, healthy balance sheets and ability to follow deflationary trends.

For investors looking to maintain exposure to technology companies, Sun recommends clients buy shares of IT services companies while avoiding unprofitable, long-term plays such as early-stage software companies.

Tengler at Laffer Tengler sees technology issues in the near future, though she favors the cohort for the next three to five years. He sticks with cybersecurity stocks and companies investing in cloud services such as Amazon.com Inc., Microsoft and Google parent Alphabet Inc., while avoiding struggling social media companies such as parent Meta Platforms Inc.

Meanwhile, electronics prices in the Adobe Digital Price Index, an alternative measure of consumer price trends, fell 9.3 percent in August from a year ago, which may signal lower inflation in the coming months. according to Jim Paulsen, chief investment strategist at The Leuthold Group.

This is one reason why it is a bull in the field.

“The real issue for long-term investors is whether this is the 1970s, where we have permanently higher inflation for a longer period of time? If it is, then you don’t want tech stocks,” Paulsen said in an interview. “Or is this just a cyclical spike in inflation? The odds strongly favor that we will eventually return to deflation.”

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