Stock Market Momentum Comeuppance Gets No Sympathy From the Fed
(Bloomberg) -- Last summer as the Faang block was tightening its strangle-hold on equities, a theory was hatched that the only thing that could ever halt the rally in megacap tech would be evidence the economy is healing.
Three weeks into the worst selloff of the year, it’s a view looking more and more prescient. The Nasdaq 100, which surged 48% in 2020 on bets people would be stuck indoors forever, is now tumbling toward a correction. Thursday’s leg came as Federal Reserve Chair Jerome Powell did nothing more than recommit himself to an economic recovery whose pace is picking up.
The impetus for the selloff is twofold. One, economic optimism is pushing up yields, creating competition for investor dollars that puts stress on share valuations that have soared to bubble-era levels. Ten-year yields got above 1.55% Thursday, though Powell said little to suggest he’s panicking over the runup, much less concerned with what it means for equities.
“Why would the Fed worry about these companies?” said Matt Maley, chief market strategist at Miller Tabak + Co. “Just because a company is a great company does not mean it’s a great stock 100% of the time. Sometimes they get ahead of themselves.”
The other is uncertainty of how to price automated and online assets should the economy roar back. For months companies like Amazon.com Inc. and Apple Inc. were the only game in town when it came to earnings growth. Now it’s possible a much wider swath of companies will be capable of expanding profits, taking the shine off what had become a giant algorithmic safety trade.
“Whether it’s in the supermarket or the stock market, when something is abundant, we don’t pay a premium for it,” Wells Fargo & Co. strategist Chris Harvey said by phone. “Growth is improving, growth will be abundant, and the scarcity value that we’ll be willing to pay for growth is compressing.”
A related problem for investors is the size of tech stocks relative to the rest of the market. At 27% of the S&P 500, they’re double the next biggest industry. According to an estimate from Goldman Sachs Group Inc., if the Faang stocks declined by 10%, the bottom 100 S&P 500 stocks would need to rise by a collective 90% in order for the S&P 500 to be unchanged.
In other words, however well banks and energy hold on to their gains, there is a tipping point where tech selling overwhelms everything.
Here’s what market-watchers had to say about today’s moves:
Chad Morganlander, senior money manager at Washington Crossing Advisors:
“How low can this go? You can certainly see an additional 10% adjustment in growth stocks, not because they’re not good companies, but their valuations are just lofty,” he said. “That’s the issue for market participants, in particular growth investors that have very high valuations they need to justify. And one of the ways to justify that is by looking at the risk-free rate being virtually nil. As the risk-free rate starts to normalize, that’s putting pressure on their P/E.”
Quincy Krosby, chief market strategist at Prudential Financial:
“In an uncertain world, they represented growth, and they delivered. But they delivered at a higher multiple. And if the 10-year Treasury yield continues to climb higher and the Fed doesn’t perform an operation twist or yield-curve control, it becomes less attractive at those multiples. At lower multiples, they become exceedingly attractive -- the question is at what multiple is that? And because we don’t know, at this point we don’t know where inflation is going to land,” she said. “Long-term investors are going to be buying them at some level, but the level is clearly not at this point.”
Max Gokhman, head of asset allocation at Pacific Life Fund Advisors:
“Growth stocks’ valuations go from lofty to gargantuan when you start discounting their future cash flows at higher rates. Pair this with the fact that yields are rising due to prospects of higher economic growth and it creates the perfect scenario for further rotation out of growth and into value,” he said. “We think this is the beginning of a cycle. The last one saw over a decade of growth outperformance. While this period of value domination may not be as long, it can nonetheless last for several years.”
Arthur Hogan, chief market strategist at National Securities Corp.:
“We’ve got a market that has an irrational fear of higher yields on the 10-year and I think that for some reason all of a sudden, we’ve pinned all our hopes up on the 1.5% level on the yield on the U.S. 10-year for no good reason necessarily. It seems like when that line in the sand is crossed, it rings the death knell for equities -- and to a large extent, none of that makes sense,” he said. “When does that dissipate? I think that calms down when we get through this bout of volatility in yields.”
Gene Goldman, chief investment officer at Cetera Financial Group:
“A lot of the growth and tech names did get a little ahead of themselves. This selloff is warranted right now because you have investors questioning with higher interest rates and higher yields. Tech is really valued on long-term growth prospects, so this puts valuations under question. This is why we have been overweight value and cyclicals in our portfolio for some time now,” he said. “The market wants the Fed to come in and save things and soothe the market but what really can Powell say? What Powell has said is consistent with what he and the other Fed governors have said -- inflation is going to rise.”
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