· What is your outlook for the NASDAQ as we see treasury yields surge?
In our view, the Tech-stock-heavy NASDAQ index is likely to correct -16% from its 2/12/21 level of 14,095 to test its 8/1/21 of 11,775 for the following reasons:
1) Earnings Growth Is Slowing: Indications are that consumers coming out of the pandemic are planning to spend on categories of goods & services that were effectively shut down due to COVID. For example, Google searches for “Restaurant” have outstripped “Netflix” which shows that consumers wish to be out and about. As changes in demand are a precursor to what financial performance will results, the apparent shift away from the technology products and services consumers and businesses have come to rely on during the past year of pandemic-driven lockdown will clearly serve to diminish Tech companies earnings growth prospects from here as the broader global economy re-opens.
2) Vaccination Distribution Efforts Are Accelerating: In the U.S. and hopefully soon elsewhere, the approval of additional COVID vaccines and collaborative developments to boost their production are serving to bring forward the expected dates by which the adult population will have been fully vaccinated thus allowing the reduction of the public health safety protocols that have been in place since 2020. Note that the emergence of new COVID mutations poses an ongoing threat to global socio-economic re-opening, but present efforts are proving to be successful at an accelerating rate. Nevertheless, all of these developments serve to underpin the re-opening that will allow consumers and business to reallocate time, attention and spending the COVID-supressed activities and away from the technology goods and services on which they have relied so heavily over the past year.
3) The Yield Curve Is Steepening Due To Expectations Of Accelerating GDP Growth And Possible Inflation: As re-opening prospects improve the fixed income market has anticipated the rise in GDP by a rise in long-term interest rates. At the same time, embedded inflation expectations as measured by the spread between 5-year and 10-year Treasury Inflation Protected Securities and their normal non-inflation-protected counterparts have risen above the 2% threshold that the Federal Reserve has set as its average inflation target, with 5-year inflation expectations actually surpassing the 10-year, an unusual occurrence and one indicating concerns that near-term inflation is breaking out to the upside. The negative to tech stocks is that given their high P/E multiple valuation and low dividend yields they are in effect high duration securities therefore quite sensitive to interest rate changes. For an example of interest rate sensitivity, please see the table below which sets out how the share price of Apple might respond to an increase in the 10-year interest rate:
4) Technology Companies Now Confront Greater Risk Of Regulation: The change in administration in Congress will lead to the anti-trust hearings begun during the previous session to move forward. Given that large-cap tech companies such as Facebook and Google are effective monopolies as the anti-trust nature of the hearings confirms, look for the result to veer towards the break-up of these entities which poses a risk that investors will need to discount.
· Is now the time to move out of tech stocks?
Yes, to generate superior returns relative to the market, investors need to turn their attention to those sectors of the market that will most benefit from the re-opening, namely energy, financials and industrials as well as small- & mid-cap companies. The table below highlights the returns that have been realized over the first two months of 2021 and confirm that a rotation to these areas and away from tech stocks has been unfolding.
Or is there opportunity in the sector?
There are always opportunities in any sector and at present in tech it appears that PC hardware companies (e.g. Apple, Dell, Hewlett-Packard) have continued to see strong demand based on a historical analysis of Google searches that show continued growth in 2021 over 2020 levels, something we attribute to the likelihood that “work from anywhere” will be a distinct feature of the re-opened economy.
· Which tech stocks do you like right now? (Do you, your family, firm own these stocks)
The shift to “work from anywhere” serves to underpin the PC hardware companies (AAPL, DELL, HPQ) and their related suppliers, so those are names we are inclined to consider on the long side. At the same time, the distinct shortages seen in semiconductor chips also serves to support that sub-sector quite positively.
· Which tech stocks don’t you like right now?
Based on the previous discussion of regulatory risk, we try to stay away from companies such as Facebook (FB) and Alphabet (GOOGL) that have the eyes and crosshairs of Congress on their backs. Better to watch in this case and see where the chips fall.