Shares in U.S. technology companies are getting the worst start in a year since 2016, as fears of runaway inflation threaten the intoxicating valuations left by the market’s rise over the past few years.
After several failed attempts this week to rally sharply, investors remain hesitant to plow sharply back into equities in growth stocks, and there is still no significant sign that the pressure on technology companies will soon subside.
The Nasdaq 100 index, which includes some of the country’s tech giants, has fallen more than 4 percent this year, even after a jump late Friday that erased its losses from earlier in the week. The broader Nasdaq Composite Index fell for the third week in a row.
High-flying growth stocks have been particularly hard hit by the growing belief that the Federal Reserve will soon begin withdrawing the massive monetary stimulus that has kept the financial system flooded in cash since the pandemic hit.
Concerns about rising rates were driven by data this week, which showed that US consumer prices rose last year with the biggest since June 1982, while US retail sales fell in December by the most in 10 months, indicating that higher prices may deter consumers. It threatens to put further pressure on tech stocks with valuations based on future profit growth, as higher interest rates reduce the present value of expected earnings.
“Nasdaq has stumbled out of the gate by 2022,” said Douglas Porter, chief economist at BMO Capital Markets in a note to customers. Although he said these high-flying companies have enormous long-term potential, these distant earnings prospects face “the cold calculation of being discounted at current interest rates, so the Fed’s sudden turnaround is a clear headwind for high valuations.”
The market largely expects the Fed to start raising interest rates in March and start reducing its stock of bond holdings in the second half of the year, removing a source of support for the government bond market. Fed Chairman Jerome Powell told the Senate Banking Committee this week that he is prepared to raise interest rates more than expected if necessary to bring inflation under control.
“Inflation has been really high, to highs for decades, and it’s really become a problem for the market,” Randy Frederick, vice president of trading and derivatives for Charles Schwab & Co., said in an interview. “We’ll get a rate hike in March, but it’s still a resort and the market could continue to struggle if inflation remains high in the meantime.”
Even with the recent volatility, the technology sector remains, by and large, a long-term outperformer relative to the overall market. The Philadelphia Stock Exchange Semiconductor Index has risen nearly 40 percent since the start of 2021, while the S&P 500 information technology index has risen 27 percent. The overall S&P 500 index has risen about 24 percent over the same period, with names like Apple Inc., Microsoft Corp. and Alphabet Inc. all perform better than the benchmark index.
An exception is the software industry, which has experienced some of the greatest pressure as investors rotate out of high-value growth stocks. Since peaking in November, the iShares Expanded Tech-Software Sector ETF has been on a marked downward trend with declines over the past three weeks, driving it back to where it was at the end of 2020.
Big tech stocks like Apple and Microsoft, for example, have strong balances, and larger, established, dividend-paying companies can hold up well if there is a movement among investors toward quality stocks, according to Frederick. But this is not so likely for microcapital stocks, which have typically been more volatile and less liquid than stocks in larger companies.
“We need to see a stabilization in rates and more certainty about what economic data looks like in general before you will see people move back to these growing names,” Frederick added. “The rating has dropped a lot, but it may take some time before they come back.”
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