By the end of September 2021, tech stocks were rolling, as a summer rally suddenly deflated. Market pundits and investors cited a long list of causes for the selloff, but one reason seemed to make the rounds more than others: A jump in Treasury bond yields led investors to dump tech stocks.
“It doesn’t matter what Nasdaq stock we’re talking about,” said a well-known TV market expert. Every time Treasury yields rise, tech stocks fall, he and others have argued. “The connection is so clear,” he said.
But is it true?
This is not the case.
It turns out that when the numbers are calculated, over the past 15 years there has been only a small inverse correlation between tech stocks and bond yields. In other words, when bond rates rise, tech stocks have a slight tendency to fall.
This was also the case during the last interest rate hike by the Federal Reserve, from late 2015 to late 2018.
That’s not to say there’s no connection between tech stocks and interest rates. Rates are an important variable when setting valuations for technology stocks and other fast-growing companies. But when it comes to real-world stock prices, there’s not really a connection.
We will start with the interest rate situation.
Although yields on longer-term Treasuries have risen this year as the economy recovered from the lows of the pandemic recession, by historical standards yields are still relatively low. Meanwhile, the Fed has kept official interest rates low, with the fed funds rate essentially at zero and expected to remain so into next year.
Let’s explore until 2021.
Early in the year, yields rose sharply as the US economy recovered from the pandemic recession, until the delta variant spread and expectations for the economy began to cool. However, at the beginning of September, inflation fears were growing and bond yields jumped 21 points.
Tech stocks, meanwhile, started the year with a rally even as bond yields began to rise. After a few seesaw moves through the remainder of the first half, the tech sector soared. In early September, the Morningstar US Technology Index was up 15.7% year-to-date, but during the month it fell 5.8%.
On the surface, it is possible to see that there could be a correlation. But what is its strength?
We analyzed correlation data between the Morningstar US Technology Index and the yield of US 10-year Treasury bonds in Morningstar Direct. We have added short-term rates in the form of Treasuries as well as the broader Morningstar US Market Index. A reading of 0 indicates that stocks and returns move unrelated, 1 means gains or losses in perfect unison, and minus 1 means gains or losses occur in the opposite direction.
With a negative correlation of 0.33 between tech stocks and 10-year Treasury yields over the past 15 years, the inverse relationship is relatively weak. When it comes to treasury bond yields, there is almost no relationship.
Maybe it’s only relevant when rates go up? We looked at correlations over the period of the last Fed rate hike and found even less of a relationship between tech stocks and 10-year Treasury yields.
In fact, during this period, tech stocks have outperformed the broader market.
Brian Colello, director of technology for Morningstar, notes that in theory there should be a strong inverse relationship between interest rates and tech stocks that relates to how investors assess a stock’s value. . It starts with the fact that most of the profits of a fast-growing technology company will occur in the future. In order to determine the present value of a stock based on these future earnings, an investor must discount the value of these future earnings. Higher interest rates translate to higher discount rates, which lowers the value of future cash flows and lowers the value of stocks today. “All other things being equal, tech stocks with more earnings going forward will be more impacted by higher interest rates than mature companies where more of their earnings are short term or short term” , said Colello.
Why doesn’t this seem to be playing out in the markets? Colello offers several theories. The first is that because rates have been particularly low for a long time, any of the minimum increases may have been too small to matter much.
Another theory is that the technological expansion over the past 10 to 15 years has been exceptional and capable of more than overcoming any rise in interest rates. “The rise of the smartphone, the Internet of Things, cloud computing and software as a service has been a powerful secular tailwind within technology, and adoption has occurred during the good times and bad times,” Colello said. “Even at the height of the COVID-19 pandemic, companies have been rushing to upgrade their PCs and servers, while buying a host of remote working software tools, such as those offered by Zoom. (ZM)DocuSign (DOCU)and Shopify (STORE).”
Finally, “tech stocks may have just been due to pullback,” Colello said. “Tech was one of the strongest sectors in 2020 during the pandemic and generally outperformed the broader market. This led to many overvalued stocks at the start of 2021. It is possible that the latest pullback is simply healthy breathing.”
Disclosure: Morningstar, Inc. licenses indices to financial institutions as tracking indices for investable products, such as exchange-traded funds, sponsored by the financial institution. License fees for such use are paid by the sponsoring financial institution based primarily on the total assets of the investable product. Neither Morningstar, Inc. nor its investment management division markets, sells, or makes any representation regarding the advisability of investing in any investable product that tracks a Morningstar Index.