Zacks Investment Management

Darrin A. from Red Lodge, MT asks; Good Morning Mitch, I’d like to hear your thoughts on rising interest rates and technology stocks. All signs point to interest rates rising and tech stocks falling in the future, as far as I can see. Do you share this view? If not, what are your thoughts? Thank you.

Mitch’s Response:

Thank you for emailing your question, Darrin. It’s a great question, and one that I think has a few different answers.

Let’s start with the basic premise of rising rates, for which we’ll use the 10-year U.S. Treasury bond as a proxy. The pandemic response pushed the 10-year to a record low (chart below), and rates have started to move higher of late, albeit at a relatively slow pace. By historical standards, long-duration Treasury bond yields are still very low.

The Federal Reserve has increasingly indicated their intent to gradually reduce QE purchases, which I think is fair to say will put a little upward pressure on long-duration bond yields. Inflation has run longer and hotter than many Fed officials expected, though in their view – and in mine, I should add – these inflationary pressures are likely to abate in the near future. Even still, reducing QE purchases, while the economy is simultaneously expanding, could see the 10- and 30-year US Treasury bond yields move higher – but not in the sustained and rapid manner as many people fear.

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Your question is whether higher yields are bad for tech stocks. Conditions today are different than they were 10 or 20 years ago, but the first thing I’d like to point out is that historically, rising rates have not necessarily been bad for tech stocks. In the two periods I highlight below with green arrows, yields were rising while technology stocks were performing very well. In the 2016 to 2018 period, technology stocks significantly outperformed the broad S&P 500 index, while the 10-year U.S. Treasury yield was also moving up.

10-Year U.S. Treasury Bond Yield

Now, a counter-argument to my point would be that today, many tech valuations are far more stretched than they were five or ten years ago. Fair point. When yields are low, investors are more willing to buy growth stocks and pay premiums for doing so, meaning that many tech stocks were bid up to relatively high multiples. Since rising rates generally benefit value-oriented companies, a higher rate environment could result in a rotation away from growth toward value, which could mean selling pressure in those high valuation tech names.

I believe that is the premise of your question, Darrin, and I think you have a good point. I would counter, however, by saying that a portfolio response should not be to sell out of tech – a better response would be to apply critical fundamental analysis to your portfolio holdings, and think about what valuations are fair relative to expected future earnings and which valuations are maybe too steep.

In other words, it’s a good time to be very careful in-stock selection within the technology sector, but not bearish on the sector overall, in my view. Many technology companies are not facing the same price pressures and supply chain issues as other companies in the economy, and they still post accelerating earnings and rising gross margins. Slightly higher rates should not materially alter the profit outlook for these companies, which is the main reason investors should consider owning them in the first place.

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