Why are NASDAQ’s tech stocks crashing for the past few weeks?

Why are NASDAQ’s tech stocks crashing for the past few weeks?

According to a recent Bloomberg article, 40% of the NASDAQ stocks have fallen by 50% from one-year highs. Palantir for example is down 36% in the past 12 months and there are plenty of other examples out there.

If your thesis hasn’t changed and you’re investing for long term you should be happy with this buying opportunity. This is a chance to buy more at a reduced price. The only scenario where this is bad for you is if you were trying to swing trade this stock while pretending to be long term.

But is now a good buying opportunity or should you wait?

That would depend on what you think the FED will do in 2022 and 2023. If you think the FED will follow through with the current plan to raise interest rates to about 1% in 2022 and 1.5% in 2023, than this is the bottom since this is already priced in and you can expect a bullish pattern on these tech stocks going forward.

However, if you think the FED will have to adjust the interest rate increases higher than that, you can expect a lower bottom in the middle of 2022 when the FED announces its updated policy guidelines, since anything about 1% this year and 1.5% next year is not yet priced in.?

Inflation is at 7% for 2021. May not sound like a lot, but if context, its actually quite alarming. In 2020 inflation was 1.2%, so a 600% increase in inflation in one year is definitely a cause for concern. This is the highest inflation numbers we had since the 1980’s and this will require an aggressive response from the FED.

So, is the 1% and 1.5% in the next 2 years is enough? According to the Taylor rule, named after John Taylor, interest rates rise 1.5 times as much as inflation. So if inflation rose from 1.2% percent to 7% percent, interest rates should rise by 8.7%, that is before adding in the 2% for inflation target and 1% for long term real rate of interest, so with our current inflation figures, the FED needs to raise interest rates to anywhere between 9% and 12%, which is very close to the interest rates we had in the early 1980s.

The big problem for the FED is that it holds a double edge sword. One the one hand, raising interest rates is needed to reduce inflation, on the other hand, raising interest rates will have destructive impact on the US federal debt. Raising interest rates is essentially increasing the cost of the US federal debt, but here is the problem, the US federal debt has spiraled out of control in the past?40 years. In the 80s the debt was about 25% of the GDP, and as of 2022, we are at 100% of the US GDP and its not coming down any time soon.

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The problem is that raising interest rates to 12% would mean a 2.7 trillion dollar increase in us debt payments, so the big question is where is this money going to come from? 1)reduce government spending 2)increase tax revenues 3)borrow more money or 4)print more money: Printing money is just going to increase inflation, borrowing more money will mean even higher interest payments, so we are left with reduced spending and increased tax revenues. Without that, increased interest rates will achieve nothing.?

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Reduced government spending is quite simple to understand but cant you just increase tax revenues by raising taxes? Not really. Beyond a certain optimal point, increasing rates only reduced tax revenues to avoidance evasion and mobility incentives. Based on the OECD data, 20% is the optimal corporate tax rate and the US is already there.?

So what can be done?

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If you increase GDP you can create more tax revenues without raising tax rates, but for that you would need significant reforms, reduction in government spending and a reduction in nominal tax rates for corporations, exactly everything this government is not likely to do.

Alternatively, there is another solution in the horizon. The reason the US is in this situation to begin with is greed. The US debt is so sensitive to interest hikes because its mostly rolled over short term debt. In this type of loan, you get a cheap adjustable interest rate,?but when interest rates spike, you pay for it in full. However, if the US would have issued long term debt at a fixed rate, the rate would be higher initially, but would have no sensitivity to interest rate increases. So changing over from short term to long term fixed debt will solve this problem.

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If this works, we would need the Fed to cause a recession, and to stick with the high rates despite public outcry. While the government will have to deal with backlash from pulling money away from important infrastructure, education and healthcare projects and reducing corporate tax rates – It will be a political death sentence to everyone involved but it will be the right thing to do for the economy, will they do it?

Nobody really knows, but I’d like to think that if push comes to shove the politicians will do the right thing, if anything, just to keep their legacy and name not attached with causing hyperinflation.