Hello Benchmarkers!
Happy to have you on board! Today, we provide you with an analysis on the state of the markets.
👉 Want insights only? Jump to “The Bottom Line”
You want to be the first one to know about under-hyped businesses? Get these in your inbox 📩
Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.
🔦 THE INTRO 🔦
Stimulus packages unlocked by governments, technological advances spurred by lockdowns and supportive central banks are a boon for technology stocks. Flooding the market with cheap money and sending valuations to new heights.
Optimism around the recovery have sent yields on an upward path and these have reached their pre-pandemic levels
A rise in interest rates could negatively affect technology, growth and innovation stocks by deflating their multiples
“If rates were to take a sharp turn up, then we would see a valuation reset and our portfolios would be prime candidates for that valuation reset of course,” Cathie Wood (CEO ARK Invest) by David Randall and Lewis Krauskopf for Reuters
💸 MASSIVE STIMULUS 💸
The COVID-pandemic forced businesses to close across the world. Increasing jobless rates and decreasing output. In response, to the economic fallout, governments have distributed checks, increased unemployment benefits and paused down debt repayments.
The FED also stepped in, providing over $ 2.3T in lending to support employers, households, financial markets and governments
“We are deploying these lending powers to an unprecedented extent, enabled in large part by the financial backing and support from Congress and the Treasury. We will continue to use these powers forcefully, proactively, and aggressively until we’re confident that we are solidly on the road to recovery” Transcript of Chair Powell’s Press Conference April 29, 2020
The FED cut its target for the federal funds rate by 1.5% since March, brought it down to a 0% to 0.25% range and signalled its commitment to support the broader economy until inflation hoovers back over 2% and the employment market has been restored
“In light of these developments, the Committee decided to lower the target range for the federal funds rate to 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals. This action will help support economic activity, strong labor market conditions, and inflation returning to the Committee's symmetric 2 percent objective.” Federal Reserve FOMC statement
Finally, the FED also used a range of tools to supply liquidity to financial markets, provide loans to banks and major corporations and temporarily relax regulatory requirements
Democrats are now seeking to pass a $ 1.9T relief package that would include stimulus payments, jobless benefits and vaccine funding. The could push the economy forward and bring down real unemployment rates (estimated a 10% by the Federal Reserve).
📈 RISING YIELDS 📈
The yield on the 10-year Treasury note touched a low of 0.52% on the July 31, 2020 as a spike in new cases diminished the prospects of a quick recovery and labour market comeback.
“Today’s jobless claims are an ominous sign that many Americans are unable to get back to work after the coronavirus lockdown of the economy earlier this year, […] There aren’t enough dollars flowing through the economy to help keep it growing if the government stops its support.” Chris Rupkey, chief economist at MUFG in New York by Lucia Mutikani for Reuters
In recent months, the massive government support, decline in infections, strong corporate earnings and hopes linked to the vaccine have been able to turn the narrative around. Increasing inflation expectations are sending the yield on the 10-year Treasury note above the 1.36% mark.
“the 10-year Treasury note yield has risen to around 1.36%, marking its highest level in a year, compelling investors to reconsider the value of owning speculative tech stocks versus risk-free assets like bonds.” Mark DeCambre for Dow Jones
Investors are now expecting increased consumer spending as the economy opens up. This would further increase inflation expectations and the FED has repeatedly voiced its support for higher inflation.
This in turn, would increase rates as investors start pricing in expected rises in rates, betting that the FED will have no other choice than rising rates in the coming months to prevent the economy from overheating
“A sustained rise in rates is probably reflective of improving economic conditions, so that in and of itself isn’t necessarily a bad thing for stocks, […] Where it does get tricky for stocks is how fast they are rising.” Willie Delwiche, investment strategist at Baird in Milwaukee by Lewis Krauskopf for Reuters
🔥 VALUATION RESET 🔥
In the words of Cathie Wood, members of its ETFs could suffer a “valuation reset” would rates increase further. At best, this would be exemplified by a downward pressure on stocks.
Technology, growth and innovation stocks have attracted large inflows of capital in the last year as work-at-home policies and lockdowns have increased demand for their products and services
Combined with the rise in liquid assets across markets, these stocks are now trading at significantly higher multiples than their pre-pandemic levels
A prime example of the rise in demand for technology stocks are Cathie Wood’s ETFs, which have seen a fivefold rise in Assets Under Management from March 2020 to December 2020
💸 FOLLOW THE MONEY 💸
Most technology stocks aren’t profitable yet and rely on external cash inflows to subsidise their growth. Historically, rates have been declining and handsomely rewarded investors who favoured growth over dividends.
When money is cheap, their valuation rises and they are able to issue new shares (e.g. Twilio and Shopify) and raise debt relatively more easily
This also led financiers to raise capital and take private companies public through Special Purpose Acquisition Companies
Yet, in the short to medium term, investors could be facing a rising rates environment once again. Driven by the massive government stimulus and dovish central banks.
“Shares of financial companies, which benefit from higher rates, are up 5.14% this year, using the S&P U.S. Financials index, outpacing the S&P 500 index, which is up 3.71% over the same period.” Kate Duguid for Reuters
How do banks benefits from higher rates? A rise in yields increases the spread between the federal funds rates and the rate the bank charges its customers. At the same time, the spread between long-term and short-term rates also expands (given investors are optimistic about growth prospects). These drive up the bank’s margins and net income.
⚡️ THE BOTTOM LINE ⚡️
The pandemic has pressured the economy and required institutions to close the output gap with large support measures
This massive influx of liquidity has partially found a home in technology stocks which led the market recovery during the pandemic and reached new heights
Investor optimism around the reopening, vaccinations and inflation expectations have led yields to rise
Rising yields could pressure the valuation of richly valued stocks while boosting earnings of financial firms
Sources and credits
Reuters
Federal Reserve
Brookings
CNBC
Wall Street Journal
Morningstar
Dow Jones
Barron’s
MarketWatch
Picture by Sharon McCutcheon
Disclaimer
Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.
Disclosures
The author has no business relationship with any company mentioned in this article and the author is not receiving any form of compensation for this article other than contributions from paying subscribers.