The Federal Reserve Chairman Jerome Powell reiterated the central bank's stance on curbing inflation at his re-appointment hearing on Tuesday. He said the Fed would raise interest rates if inflation lingers longer than expected. Such a stance continued his previous argument and did not surprise the markets. However, it also dispelled various concerns from investors, which played a crucial role in calming the markets.
Subsequently, the three major U.S. stock indexes rebounded, with technology stocks among the top gainers. After a sharp sell-off in U.S. technology stocks at the beginning of the year, the markets experienced a four-day losing streak. However, there are still many variables that could derail technology stocks in the future. Therefore, this will be a challenging year for high-growth technology companies.
The Tech sell-off may be coming to an end
Last Wednesday, the Fed's December meeting minutes showed that the pace of shrinking the balance sheet could exceed the previous shrinking cycles and that interest rates may be raised faster than expected. Subsequently, the swap market is expected to show an 80% probability of the Fed raising interest rates in March. With more hawkish signals from the Federal Reserve, interest rates could head higher in the not too distant future, posing a significant risk to tech stocks with valuations at all-time highs.
U.S. tech stocks have been under selling pressure since the year started. Jason Gopfer, the research director at Sundial Capital Research, said that most tech stocks had experienced declines of varying degrees, with about 4 out of 10 companies in the Nasdaq having lost nearly half their market value from their 52-week highs.
Morgan Stanley believes that the sell-off triggered by the interest rate adjustment is nearing an end. Many of the big banks have a similar view. Although the interest rate shock has put significant pressure on richly-valued technology stocks, it is expected that the pace of monetary policy tightening will be gradual, with the markets having time to digest each change. I believe that risk assets can bear with the changes. Therefore, the Fed's next policy decision is crucial to the prospects of technology stocks.
In addition, the 10-year U.S. Treasury yields have fallen recently, easing the pressure on the future earnings of high-growth technology companies, supporting the rebound in technology stocks. But is such a rebound temporary?
Tech stock valuations are at all-time highs
Because interest rate fluctuations mainly affect the discount rate of a company's future profits, high-valued, unprofitable tech stocks tend to take a bigger hit when bond yields rise.
The valuation premium for technology stocks as a whole is still at an all-time high relative to the S&P 500. Furthermore, the data shows that after excluding the two technology giants, Apple and Microsoft, the expected price-to-earnings ratio of the technology sector is 25.1 times, while the S&P 500’s is 21.1 times. Therefore the above shows that technology stocks are severely overvalued by the market, which has not changed.
The software and electronic equipment industries have the highest valuations among technology stocks. Some analysts predicted earlier that under such circumstances, the valuation of the fastest-growing software stocks might shrink by more than 20% this year.
Earnings season is coming. Will tech stocks remain under pressure?
Speculation is mixed for the upcoming earnings season, with tech and bank stocks under the spotlight due to expectations of rising interest rates. Looking back at the performance during the first half of last year, the main reason for the sharp jump in the profits of US companies was the impact of the low base during the 2020 pandemic. As the pandemic becomes normal, the results set to be announced may be lower than last year’s. However, some market analysts believe that if the fourth-quarter earnings show that a company's profits were higher than analysts expected, this could push up its stock price, thus reducing its valuation.
As the results for Q4 2021 start streaming in, investors should pay attention to three key points, namely the potential risks to the economy from the COVID-19 variants, the labor shortage in the job market triggered by rising inflation, and the faster interest rate hike cycle. In the short term, high inflation in the United States will continue to persist, and labor costs will keep rising, which has also exacerbated the market's concerns about the profitability of companies in the first quarter of 2022. In addition, facing the impact of future interest rate hikes, the profitability of technology companies may suffer as it becomes more difficult to grow earnings.
It is also important to note that U.S. stocks outperformed the stock markets in the rest of the world last year due to the performance of large technology stocks. This year, various policy factors have put significant pressure on technology stocks. Whether US stocks will lose their strong upward momentum this year is a question that worries the market.