There is a theory floating around that as the 10-year Treasury yield continues to rise, more pain will be inflicted on the Nasdaq and tech sector. I’m not so sure about that.
The chart below depicts the correlation between the 10-year Treasury yield and the NASDAQ 100 (ticker: QQQ). Green indicates a positive correlation and red a negative one. It went negative super-fast a few weeks ago, but now it appears to be moving the other direction just as quick.
It seems to me that either:
- There is no consistent relationship between the two, and therefore, the 10-year rising is probably not, on its own, a dark omen for the Nasdaq
- OR there is a relationship and this reversal (if it sticks) could look a lot like Nov/Dec of last year in the coming months (this could be good for the Nasdaq)
What I am far more certain about is that the 10-year yield has little negative impact on the fundamentals of tech companies and other constituents in the Nasdaq. Tech isn’t overly reliant on debt, the 10-year yield does not materially impact revenues for the sector, and I doubt Stanford grads will bypass tech to work on oilfields because the 10-year could hit 2% by year-end.
If it’s not the fundamental side of the equation, then recent weakness stems from valuation. There are two prevailing explanations as to why tech valuations have gotten hit.
The first is a rising 10-year yield lowers the value of future cash flows of tech companies. That’s too technical of an explanation for 2021. Don’t forget that this is the same year a pair of sneakers sold for $33,400, so I doubt discounted cash flow analysis is top of mind for buyers these days.
The second explanation is a rotation from growth to value/cyclicals. Last month, a slowly rising 10-year yield seemed to indicate that traders were selling Treasury bonds (prices fall when yields rise) to buy stocks as the data around COVID began improving (signaling a stronger economy on the horizon).
But since tech ripped last year, the buying was more concentrated in cyclical sectors that didn’t start recovering until late last year (energy, financials, etc.). Theoretically, cyclical sectors should benefit from a rising economy, so this sort of makes sense.
This probably spooked Nasdaq/tech-heavy traders into thinking a rotation from growth to value was underway (the 163rd time they’ve thought this since 2016) so they panicked. It didn’t help that a lot of the Nasdaq looked expensive at the time (some argue it still does), so tech and other growth sectors that were at risk of a correction got one.
However, much of this rotation seems more like a junk rally or “catch up” trade in disguise. For example, energy, consumer cyclicals, and financial stocks have taken off lately, but I refuse to believe for a millisecond that it’s because all of the innovation, earnings growth, and cash flow generation from tech is somehow rotating to these sectors. Seriously, how can anyone with a straight face argue that innovation in oil drilling or loan creation will change the world over the next decade?
If this is mostly a catch up trade, that means those who left tech for greener pastures could eventually realize that they own some low growth sectors that are no longer as cheap as they used to be. After a few earnings reports in tech get announced, they may remember that monopoly profits are just slightly more attractive than razor thin margins and debt-laden balance sheets. If so, these same investors may flock back to tech.
I think this will happen, but I don’t know when.
I do know that I want nothing to do with this catch up trade because I view it as being riskier than doing nothing at all. You have to sell out of tech, pay taxes, ride the cyclical wave higher, then shift back to tech (paying taxes again). But that’s not even the hard part. You then have to nail the timing or else.
There’s no question that parts of tech/Nasdaq are still expensive, but these corrections along the way fix that. Expectations cool while earnings and cash flow keep growing, and this cycle creates the foundation for the next wave of growth.
Lastly, cyclicals may benefit from a rising economy, but I’d argue that tech could benefit even more since it’s become so critical to every other sector in the economy.