Technology stocks are officially in correction territory after yesterday's late Wall Street selloff. The tech and growth focused Nasdaq 100
(NDX) (NASDAQ:QQQ) fell more than 1% in the previous session, bringing the decline from its high to 10.2%, the typical definition of a correction. The S&P Info Tech sector
(NYSEARCA:XLK) is down 10% from its high, with key component Apple
(NASDAQ:AAPL) falling below its 50-day moving average for the first time since October. The VanEck Vectors Semiconductor ETF
(NASDAQ:SMH) is down 10.6% from its high. By comparison, the S&P 500
(SP500) (NYSEARCA:SPY) is down 6%, despite some recent weakness in cyclical sectors.
Bubble or wall? The market's reliance on tech stocks and other megacaps for broader gains has brought comparisons to the 2000 Dot-com Bubble. If these high-valuation stocks buckle, lower-weighted sectors will have a very tough time picking up the slack. Morgan Stanley says there's also concern about stocks under the surface, comparing the valuation of the median S&P 500 stock today to that of the Tech Bubble.
But ARK Invest's Cathie Wood, whose active funds have been hit hard by this selloff in higher-multiple names, says the bubble lies in value stocks. "In our view, the wall of worry built on the back of high multiple stocks bodes well for equities in the innovation space," Wood says in ARK's Q4 report. "The strongest bull markets do climb a wall of worry, a fact that those making comparisons to the tech and telecom bubble seem to forget. No wall of worry existed or tested the equity market in 1999. This time around, the wall of worry has scaled to enormous heights."
Getting real: One of the biggest factors putting selling pressure on tech stocks is the rapid rise in real yields seen since the start of the year. The real 10-year Treasury yield
(NYSEARCA:TIP) as measured by the inflation-protected securities now sits at -0.64%, 40 basis points higher from where it closed out 2021. The correlation between Nasdaq 100 performance and the change in the 10-year real yield is -0.5, "about as low as it's gotten in this post-covid recession period," Wilson says. "In other words, changes in yields are currently a significant explainer of NDX returns."
But Wilson does think they will become less of a factor as earnings revisions take more prominence in stock performance over the next few weeks. "At a sector level, we expect continued volatility in the technology sector, but the pressure on the sector from higher yields to abate in the months ahead," UBS says. "While we see 10-year (nominal) yields climbing modestly higher, from 1.89% at present to around 2% by June and 2.1% by the end of the year, we do not expect a further sharp rise. We think the 2-year Treasury has moved too aggressively in pricing in Fed tightening, and we expect the yield curve to steepen."
"It's also worth keeping in mind that historically stocks have performed well in the months leading up to the Fed's first rate hike. Since 1983, the S&P 500 has risen 5.3% on average in the three months ahead of the start of the rate hiking cycle and by a further 5.3% on average in the six months thereafter." Markets are currently pricing in a first Fed hike in March.
Next stop? Wall Street remains at a historically large split on the direction of the broader market. Stifel is looking for a drop in the S&P to 4,200 as early as Q1 this year, pointing to the impact of real yields.
"Equity Risk Premium (We use a CAPE Operating EPS earnings yield minus 10Y Treasury TIPS real yield) may fall in 2022, which is a bullish offset, but that is likely overwhelmed for Growth stocks by the negative 'convexity' of a rising real 10Y TIPS yield (-1.1% at year-end 2021, -0.65% now) pummeling Growth P/E ratios," Stifel says. Credit Suisse is looking for the S&P to end this year at 5,200 and suggests it may be time to embrace inflation. "Historically, earnings and stock prices have moved directionally with inflation," strategist Jonathan Golub writes. "Over the past 4-1/2 months, stock prices have risen an average of 32 bps on days when inflation expectations rise, and fall -41 bps on down inflation expectation days." (
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