Why Tech Stocks Hate Interest Hikes

Hey Traders,

Like we talked about recently, market breadth has been horrible as of late.

Over the past six months or more, a majority of the entire market’s gains has been powered by a few big-name tech stocks, like Meta (Ticker: FB), Nvidia (Ticker: NVDA), Microsoft (Ticker: MSFT), Apple (Ticker: AAPL) … you get the picture.

The “big names” in tech …

But unfortunately, these mega cap’s moments in the sun may be coming to an end …

Especially if J.Pow throws a triple-rate-hike at us in 2022 …

Here’s why tech giants hate rate hikes.

Higher Rates = Lower Earnings

Many of the biggest names in tech are among what are considered “high growth” stocks … stocks whose values are based on their potential to outperform the market in the future, rather than their actual performance right now.

In fact, some of the biggest names on the market aren’t actually profitable at all (yet), and their stock value is actually based on terminal value … or the estimated value of a company based on the forecast of future earnings.

Now … this presents several problems when interest rates go up.

First, many high growth companies rely on outside money to finance their operations.

They use loans to fund growth … or just pay to keep the lights on.

When interest rates go up … the cost of borrowing this money gets much more expensive.

And when you’re burning cash like it grows on trees …

Paying more for said cash is a problem.

Obviously, not great news for high-growth companies that depend on huge loans to fund their operations, and therefore can’t stop borrowing.

And even companies that don’t rely on loans to survive often seek to borrow funds to grow their business.

Now, another way to view this is that when interest rates rise, the value of high growth companies’ debt also rises.

Which isn’t looked on favorably by a market trying to determine their valuation!

That’s not the only way higher rates also affect the valuation of these companies. 

The future earnings, and therefore valuation, of these companies are calculated using the current interest rates.

So when interest rates go up, the future value goes down.

So now you’ve got higher debt, paying more for higher debt, and lower future earnings …

Not exactly a recipe for success.

Finally, just like producers pass on inflated costs to consumers, higher interest rates also find ways to trickle down to consumers, in the form of better yields in savings accounts and bonds.

This entices consumers (and businesses) to put more money into these investments.

That’s great for savings rates …

But not so great for discretionary spending!

While this is beneficial for cooling inflation (since the market isn’t being flooded quite as much cash), it’s not beneficial for companies that depend on consumers spending plenty of money to buy their products (like the latest smartphone), or companies that depend on other businesses to purchase their products.

Higher interest rates also divert investor’s money away from high growth (and high risk) investments in favor of low-risk, guaranteed-return investments.

In other words, investors are less inclined to invest in high growth stocks, because the risk/reward isn’t as favorable when low-risk investments now offer a higher reward.

So where should you look to invest during times of higher interest rates?

For one, banks.

Banks will make money off of higher interest rates, as they will get paid more to loan out money.

“Value” stocks, or stocks that are relatively lower priced compared to their actual performance (versus growth stocks, which are higher priced compared to their actual performance) are also a good pick. Many consumer goods, banks, and oil names are among those considered “value” stocks.

However, this doesn’t mean it’s time to close out of tech altogether. Far from it, actually.

But it may be time to reevaluate just how much you have allotted to high growth names, and how much of a storm you are willing to weather with them.

Your Only Option,

Mark Sebastian

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