Why Rising Rates Don’t Doom Tech

Rising rates are Tech stock kryptonite! So claim pundits, supremely sure rising long-term interest rates will upend the giant sector’s bull market leadership. Recent days’ Tech weakness buoys that sentiment further. But there are myriad problems with that theory: First, Tech has outperformed the broad market historically more often than not as rates rise. Now? If rates’ recent climb proves lasting—a big if—Tech should still lead, due to other drivers favoring it. See claims of Tech’s looming demise for what they are: pessimistic sector sentiment building a solid base--a sign Tech’s run isn’t done.

Linking Tech to yields stems from a singularly valid but myopic idea: Higher rates theoretically shrink what investors will pay for a firm’s future profits. They reduce the net present value of cumulative future earnings and increase bonds’ relative appeal. Since Tech’s sparkly profit projections underpin its premium valuations, the sophomorically wise fallaciously argue rising rates dent it more than other stock categories. They tout lower-valuation, economically sensitive “value” companies in such environments.

Nice theory. And sometimes it’s right and other times wrong.?And, it’s fully valid if all other things are equal; but they never are. And the theory is oversimplified to the point of error.

Rates are just one of myriad forces dictating style dominance. Decades of data prove that rising rates automatically crush Tech is blatant bunk. Since 1973, Tech stocks outperformed world stocks over half of all quarters when 10-year Treasury yields rose—and overall in 10-year rate runs upward. Some sub-sectors, like hardware, outperformed much more often than that when rates rose.

Today’s Tech composition by industry logically differs from decades past—less hardware, more software and services. But, still, Tech still usually has bucked rising rates. Consider one recent rate run upward: From July 5, 2016 through November 8, 2018, 10-year Treasury rates jumped from 1.37% to 3.24%. Global Tech soared 69.4% over that stretch, trouncing world stocks’ 26.6% gain. Why? The economic expansion matured and growth slowed, favoring non-cyclicals with fat gross profit margins that could grow robustly in a slow-growth economy—Tech.

Also, in that run, short rates climbed, paralleling long rates—three-month Treasury yields rose from 0.27% to 2.36%—keeping the spread between them tight. Banks borrow at short-term rates to lend long term, so the gap between them (the “yield curve spread”) parallels and largely predicts the profitability of new lending and, hence, banks’ future willingness to lend. Meager loan profitability made banks loath to lend to typically lower credit quality value firms. Growth firms, which can tap varied alternate financing sources or internally fund growth, excelled.

Today’s yield curve spread is about where it was in 2016—a marked headwind for much of the value universe, as it was then. This is why value stocks’ typical early bull market outperformance isn’t all about rate direction. That is as much or more about sentiment—a relief rally when widening spreads between long and short rates encourage lending to firms that were otherwise loan starved until central banks cut, not raised, rates.

Now, the actual rise in long rates since August’s lows is truly tiny—insufficient to turbocharge lending and propel credit-sensitive value stocks to lasting leadership. It is also largely about sentiment.

For example, the Fed’s months-long telegraphing about tapering its “quantitative easing” (QE) bond-buying programs surely stoked some selling, pushing yields up somewhat. As Fed officials’ statements made November 3’s taper announcement ever more clear, rates eventually turned lower. Markets were over and done pre-pricing “taper terror”—a phrase pundits once loved they now have seemingly forgotten.?Funny and fortunately!?

Now yields are up again on chatter that newly reappointed Fed head Jerome Powell might evolve from a hippity hoppity kangaroo into a hyperventilating hyena and hike rates in mid-2022. Yet if tapering’s impact was so short-lived, why would improvable rate hike jitters be any different? And, will Powell actually do that??Give him and it a break!?No one knows that.?And, while it isn’t 100%, FED heads have typically shied a mile away from big moves heading into big elections to avoid the appearance of intentional political interference.?Who knows what happens there??I don’t. You don’t. Powell doesn’t.?And no one else does?

Regardless, in my view, little remains to boost rates materially here and now. Foreign demand for Treasurys remains super strong and should rise with any U.S. rate uptick. Headlines bemoaning a miniscule slip in the 10-year’s bid-to-cover ratio in November’s auction?make monstrous mountains out of molehills. Elevated inflation and supply chain snarls? Far too widely watched and media blathered not to be near-fully pre-priced. Higher long rates require further and lasting inflation pressures exceeding what markets already priced. Unlikely, at least that’s my view

Headlines shriek of sky-high inflation doom, sapping surprise power. Less noticed: In Q3, S&P 500 earnings reports showed firms’ gross profit margins, the mother’s milk of all business—remained just as fat as in Q2 despite all the blather (Yes, I said blather two paragraphs in a row for emphasis).?And that was especially true for Tech and Tech-like stocks in the Communication Services sector. They are coping exceedingly well, perhaps even startlingly well, with higher costs.

In my view, and you’re not supposed to say this right now: but price pressures will wane. Commodity after commodity from March to now has hit peak prices and started down the other side. ?Energy? That’s here and now. Global oil and gas producers are upping output, while Asian coal prices have plummeted. Europe, overly wind dependent for energy yet having suffered record windless months, find that now abating, easing their burden, cooling energy prices there and stifling rates’ climb and the sentiment around it there.

Moreover, economic growth is slowing--which, again, helps firms that can grow despite tepid economic activity. That is doubly true if supply and labor constraints persist. These complications favor firms requiring smaller workforces relative to profits—but with the capital and clout to dictate supplier and shipper terms—as well as digital service providers that ship few physical goods. That points to fat-margin businesses riding longer-term trends—like Tech and other big growth companies.

The notion long-term (or short-term) interest rate wiggles alone mean a darned thing for Tech—or any sector—presumes one liquid capital market knows better than another, an always hugely ridiculous notion. Interest rates move on the same information, fundamentals, rumors, opinions and sentiment as stocks, both in real time. Nor do today’s fluctuations determine tomorrow’s. So don’t overrate short-term swings. See the rates-kill-Tech phobias for what they are: a sign Tech’s fundamental strength for the period now and ahead is underappreciated, building a sentiment base for its next run.

?Ken Fisher is founder and executive chairman of Fisher Investments. Follow him on Twitter @KennethLFisher.