Last Updated on March 7, 2021 by Henry John
Plot Twist: Technology stocks are no longer the darling of the market, they now seem distasteful. Over the past 30 days, the NASDAQ – 100 and the NASDAQ Composite are down over 7%. Individual tech darlings like Tesla, Apple, and Amazon are down by 30%, 11%, and 9% respectively over the past 30 days. Big data analytics darlings like Alteryx and Splunk are down 25% and 17% YTD respectively, Fastly, the edge computing darling, is down by 24% YTD, First Solar and Canadian Solar are down by 27% and 22% respectively, even renewable energy stocks are not spared.
Technology stocks have rewarded investors heavily for decades now, so much that growth stocks were becoming synonymous with technology stocks. And it’s hard to swallow the fact that some of these tech names are going down even after posting really positive quarterly reports.
For investors that are heavily invested in these names and in the technology/renewable space in general, it feels like the entire market is crashing down. You only need to look at the S&P 500 performance by sector and then you get a picture of what’s going on.
The S&P 500 Energy Sector is up by 40% YTD, Financial up by 14% YTD, Communication Services up by 7% YTD, Materials up by 3% YTD, and Industrials are up by 5% YTD. On the flip side, the S&P 500 Information Technology Sector is down by 1% YTD, IT Services down by 0.74% YTD, and Consumer Discretionary is down by 3% YTD.
This clearly shows that while some sectors of the market are down, others are doing really well. The rise of sectors that are doing really well outweighs the decline of sectors that are underperforming, which is why the overall S&P 500 Index is up by 2% YTD.
From the data, it’s clear that the market is not crashing yet, however, some sectors, especially consumer discretionary and IT, are melting down. And other traditional value sectors like Energy, Industrials and Financials are flying.
And you may wonder why your renewable energy stocks are tanking when the overall energy sector is going up? Well, the S&P Global Clean Energy Index is down by 18.5% YTD and that paints a picture of itself.
Why are Technology and Renewable Energy Stocks Melting Down?
The 2021 meltdown of growth stocks such as technology and renewable energy stocks could be rooted in the massive growth the sectors experienced in 2020, hitting new record highs over and over again. From its March 2020 lows to its January 2021 highs, the S&P Global Clean Energy Index grew by almost 300%.
The 2020 rate of returns in these sectors got many investors into believing that some sort of correction is imminent in 2021. Some even feared a market crash was coming in 2021.
These pessimism towards the market and high flying sectors like Technology and Renewable energy, set the tune for what was to come in 2021: Investors became extremely cautious and were one major negative press from exiting or significantly reducing the weight of their growth positions in their portfolio.
On January 18, 2021, I published an article titled “Cash is King for Stock Investors in 2021”, in it, I pointed out that the growing uncertainties and pessimistic sentiment around the market are causing investors to reassess their strategies and invest in large-cap stocks while holding lots of cash.
“Investing in large-cap stocks gives investors a great deal of protection in an uncertain market environment, however, having enough reserved cash will give an investor the opportunity to easily go from defense to offense in the advent of a market crash.”
In mid-January, “I started selling stocks in my portfolio that are relatively overpriced … increasing the percentage of cash in my portfolio to over 30%”. And I’m guessing that I wasn’t the only one making such moves at that time, a lot of investors were making similar moves.
Then the GLOBAL CHIP SHORTAGE hit companies selling or requiring anything ‘electronics’ from cars to microinverter systems to smartphones and consoles. And if these companies can’t get enough chips to keep manufacturing rates at expected levels, then their expected revenue and earnings are expectedly going to take a hit.
And what all these meant is that investors have to revalue the companies that are heavily affected by the chip shortage, and that was one of the reasons why technology and solar energy stocks started tanking.
And then came the RISING 10 YEARS TREASURY BOND YIELD.
If you are new to the stock market, you may not understand what the Treasury yield has to do with growth stocks tanking. And in normal times, rising treasury yield rates typically drive growth stocks high, however, because of the pandemic-induced economic meltdown, these times are not normal.
The Treasury yield is the interest rate that the U.S. government pays on its debt obligations (Treasury Bonds, Treasury Notes, Treasury Bills, or Treasury Inflation-Protected Securities). Typically when Treasury yield rises, it indicates that investors are optimistic about the future economic growth and when Treasury yield declines, it indicates that investors are pessimistic about future economic growth.
However, rising Treasury yields don’t always indicate investors’ optimistic sentiment around future economic growth, it sometimes indicates that investors are afraid that inflation is around the corner.
Let’s assume an investor holds a 10 Years Treasury bond of $100 at a 1% yield, the yield value is going to be $1 per annum over ten years, and upon maturity, the total value of the investor’s investment would be $110.
But what if during the same time frame (10 years), the dollar was inflated by 20% (meaning it lost 20% of its value)?
Then the value of the investor’s investment would be $110 – 20% inflation = $110 – $22 = $88
And you will agree that it doesn’t make investment sense to risk $100 today so you can get $88 in 10 years’ time. The investor is bound to lose today’s $22 purchasing power. Typically, the best move would be to cut your losses: SELL THE BOND.
The investor can decide to sell the bond for $90 and by so doing, he has saved himself $2. And the buyer of the bond, now valued at $90, will still receive the $1 interest per annum. For the new holder of the bond, the $1 interest on his $90 bond gives a yield of 1.11%.
In this scenario, because of the fear of inflation, the yield has now risen from 1% to 1.11%. And that’s how the fear of inflation can cause the Treasury yield to rise.
There has been an ongoing bond sell-off in the bond market which is triggering the rising Treasury yield. On the 27th of January 2021, the US 10 years Treasury yield stood at 1.04% and in less than 40 days, it has risen to 1.56% representing a 50% rise in rates. And IF the Treasury yield continues rising at this rate, surely disaster is on the way.
Moreover, investors’ fear of inflation is justified by the fact that over 35% of the US dollars in existence was printed in the 12 months (check out the FRED M1 Money Stock). And the Biden-led administration is still proposing to inject (print) more dollars into the economy, the proposal: AN ADDITIONAL $1.9 TRILLION DOLLARS.
So it’s no surprise that investors are selling-off stock positions that will be DRASTICALLY affected by the coming inflation and they are buying stocks of companies that will potentially benefit from the inflation.
STOCKS THAT WILL BE AFFECTED BY INFLATION
The US government are not the only ones who issue bonds, corporations can also borrow money from the bond market by issuing corporate bonds. And the higher the treasury yields climbs, the higher the interest rates corporation will have to pay in order to borrow money from the bond market.
Typical growth stocks have a negative net income, they are cash burning machines that needs to continuously raise cash in order to sustain growth. They raise cash by either diluting existing shareholders through additional share offerings or by issuing corporate bonds. Whichever the case may be, the company’s valuation is going to take a hit.
But that’s not all.
Apple (NASDAQ: APPL) has returned a positive net income over the past several quarters, and it has over $36 billion cash on hand. The company doesn’t look like a company in a bad financial situation, yet, its stock is melting down and is down by over 11% over the past 30 days.
So what else is going on?
Inflation will affect the equity valuation of growth stocks and typically companies in the consumer discretionary sector. For starters, that $36 billion cash on hand that Apple has will be worth less when massive inflation kicks in.
The present value of future cash flows for consumer discretionary stocks will become unattractively less valuable in the future if the dollar inflates heavily.
Revenue projections of growth stocks like Tesla’s will become less valuable and their stock less attractive to investors today, the regulatory credits that keeps Tesla profitable will become less valuable in the face of inflation. Moreover, cost of revenue will also spike further eating up the already inflated profit margin.
In essence, inflation causes investors to reassess the current valuation they place on companies, which is based on future performance and outlook. The rising risk of inflation paints a doomsday scenario for a lot of these companies and fearful investors are cutting their losses by selling off their position in risky growth stocks today. And the sell-off is causing these names to tank.
Basically, companies whose current valuation is majorly based on the ‘promise’ of a really good future cash flow will be affected in the present inflation-phobia market.
There are companies that will do really well in the face of inflation, like companies in the energy and financial sectors. And these are the names that investors are piling cash into.
Take Banks for instance, if the US Treasury yield continues to rise, the interest rates banks will charge for its loans will rise consequentially. And the more inflation there’s, the more money borrowers will borrow.
A car that is worth $100,000 in today’s dollar value, will cost $120,000 if the dollar inflates by 20%. Therefore, the principal for receiving a loan for the car in the future will rise with inflation.
THE BOTTOM LINE: Investors are afraid that heavy inflation is around the corner, and their fear is founded in the rising US Treasury yield. The melt down of technology and renewable energy stocks is caused by the massive sell-off from investors who are looking to protect their portfolio against inflation.