Editor's note: This Weekend Edition, we're taking a break from our usual fare to cover this week's decision on interest rates. In this piece – first published yesterday in Chaikin PowerFeed – Pete Carmasino joins us from our corporate affiliate Chaikin Analytics to explain what the Fed pause means for stocks... especially the already-soaring technology sector.
I'm sure you've seen the headlines by now...
Federal Reserve Chairman Jerome Powell said Wednesday that the central bank is taking a breather. It decided not to raise interest rates – this time, at least.
That's a big deal, folks...
Since March 2022, the Fed has raised rates 10 times.
This aggressive campaign jacked the federal-funds rate from near-zero percent all the way up to more than 5%. And the markets reacted big time – especially tech stocks...
We all remember the "tech wreck" last year. The tech-heavy Nasdaq Composite Index lost roughly 35% from its November 2021 peak through the end of 2022.
It might seem crazy, but the current rate environment is significantly better for tech stocks.
In fact, despite Powell's warning that the Fed could resume its rate hikes later this year, the tailwind behind tech just got stronger. It all comes down to what rates mean for tech...
You see, tech stocks are especially sensitive to interest rates. We refer to this sensitivity simply as "interest-rate risk" in the financial industry.
One reason is that tech companies rely on borrowing to fuel their growth. So when rates rise, borrowing becomes more expensive. In turn, these companies' costs go up.
And as their profits decline, these stocks become less attractive to investors.
But tech stocks also rely on growth to fuel investor interest. When rates rise, their future earnings become worth much less than their current value. And since current rates are significantly higher than they've been in the past 15 years, the path of tech stocks changed dramatically.
Let's use the NYSE FANG+ Index to see the bizarre path that tech stocks took...
This index holds the mega-cap tech stocks. Most investors know these 10 names. Here's the full list...
Next, let's look at the chart of the NYSE FANG+ Index over the past five years. And in the bottom panel, we'll look at the 10-year U.S. Treasury yield. While this rate isn't directly controlled by the Fed, it is responsive to rate hikes – and it's a useful way to track interest rates...
Back in 2020, the 10 stocks in the NYSE FANG+ Index were all the rage...
The COVID-19 lockdowns forced almost everyone to work from home. And these companies thrived for obvious reasons. In response, this index rallied to an all-time high by late 2021.
But again, the bottom panel shows the yield on the 10-year U.S. Treasury note. You can clearly see that when rates soared throughout 2022... these 10 tech stocks crumbled.
The downturn began when the Fed hinted that rates would need to rise dramatically to curb inflation. I've drawn two arrows on the chart to reflect this period of "negative correlation."
The opposite is true today...
As you can see on the chart, interest rates are cooling again. That's good news for tech stocks.
Now, rates are only cooling slightly so far. But even that has injected a burst of much-needed optimism into the market. It signals that "things are getting better from here."
Of course, the world could face another calamity. And the Fed is still trying to fight inflation. No one truly knows what tomorrow will bring.
But for now, rates are easing. And that's strengthening the tailwind behind tech.
Good investing,
Pete Carmasino
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