Do Rising Yields Trouble Tech?

Over the past month or two, weak Tech stocks coincided with rising 10-year US Treasury yields. It all fuels a long-running narrative that Tech is allergic to high and rising rates, spurring worries a further rise from here—or rates just remaining higher than the last decade’s—threatens the leading sector in this bull market since October. But in our view, coincidence doesn’t mean causation, and a review of the data shows (short-term sentiment wiggles aside) higher rates don’t threaten Tech.

The notion Tech hates rising rates hinges on the theory future profits for the growth-oriented sector are worth less relative to Treasurys when interest rates are high or rising. Recently, that may seem right: Global Tech stocks have fallen -8.1% month to date and -11.0% since July 18’s year-to-date high, trailing global stocks.^[i] And since mid-July, 10-year Treasury yields have jumped from 3.79% to 4.55%.^[ii] Some experts argue supply and demand dynamics in the Treasury market (namely, increased Treasury issuance and shrinking investor appetite) as well as sticky inflation will keep yields elevated—and this “higher for longer” interest rate environment will weigh on Tech stocks in particular.

But to understand the actual relationship between Tech and rates, look longer than just a couple months. Focusing on what just happened seems like cherry-picked recency bias to us. Go back a few months, to the 10-year Treasury yield’s year-to-date low of 3.29% on April 6.^[iii] From there it rose fairly consistently, crossing the 4.0% threshold on July 6.^[iv] Over those three months, Tech stocks rose 14.8%, nearly tripling global stocks’ 5.3%.^[v] Did Tech suddenly realize in mid-July Treasury yields were rising and needed to fall in response? Considering stocks are efficient discounters of widely known information, we don’t think so.

Recent history shows extended stretches where rising 10-year yields weren’t an automatic negative for Tech stocks. During the 2009 – 2020 bull market, when Treasury yields climbed from 1.39% to 3.00% from July 2012 – January 2014, Tech stocks rose 34.1%—trailing global markets’ 40.9% but still nicely positive.^[vi] From July 2016 – November 2018, Tech returned 69.7%—more than doubling global stocks’ 30.8% despite Treasury yields’ also more than doubling (1.37% to 3.23%).^[vii]

Even during the 2002 – 2007 bull market—when Tech lagged global stocks overall—the sector still delivered positive returns and occasionally outperformed when Treasury yields rose. In 2003, 10-year yields jumped from 3.13% to 4.60% between June and September—yet Tech was up 16.1% to global stocks’ 4.4%.^[viii] From October 2004 – March 2005, Tech was up 3.0% (to global stocks’ 10.3%) as long-term interest rates rose more than 60 basis points, from 3.99% to 4.63%.^[ix] The lesson here: Sometimes Tech lags the broader market when Treasury yields rise and sometimes it outperforms. Conclusion: Rising interest rates don’t automatically poison Tech returns in either an absolute or relative sense. 

To see this another way, over the past 20 years, the weekly correlation coefficient between Tech returns and Treasury yield moves is 0.23.^[x] A correlation coefficient of 1.00 means identical movement while -1.00 is exactly opposite. So the 0.23 reading shows they tend to rise and fall together more often than not, but the figure is far too low to be statistically significant. In lay terms, it is a nothingburger. So while it may or may not be true that rising rates have hurt sentiment towards Tech over the past month, extrapolating that movement from here looks like a dodgy forecast.

Beyond data, we don’t think the theory underpinning why rising rates are supposedly anathema for Tech holds water, either. The logic sounds sensible: Investors value growthy Tech firms based on the expectation of big, far-future profits. When interest rates are low, those prospective future earnings look like a good value. But when interest rates are rising, the present value of those future profits is worth less since investors can purportedly find better use for their money in the near term.

The issue with this, in our view, is the extrapolation of present conditions indefinitely. It presumes yields will stay high perpetually and that Tech returns are only far-future. Yet neither of those are correct. Yields, obviously, aren’t static. And Tech companies can and do deliver earnings in the here and now. Rather than taking the conventional wisdom to the bank, we think investors should look at upcoming economic conditions and assess the likelihood Tech will generate attractive earnings and sales over the next 3 – 30 months. That appears to be the case right now, given the robust demand for certain semiconductors and cloud services. For example, on the chips front, though demand for some memory chips has cooled, it remains hot for artificial intelligence-related chips (particularly graphics processing units, or GPUs). Growth at cloud services companies appears to be solid, too, as a wave of spending cuts seems to be subsiding.^[xi]

Moreover, Tech has a history of eking out earnings growth in a slow-growing global economy, as the growth-oriented sector tends to invest profits back into the business to expand over time—so their profits are relatively less sensitive to economic growth rates. We think this explains much of the above-referenced Tech outperformance in the 2010s. And, moreover, Tech companies’ costs also aren’t that interest rate sensitive today—a critical point to grasp. In addition to locking in low borrowing costs in recent years, the biggest Tech and Tech-like companies boast balance sheets flush with cash along with fat gross profit margins, allowing them to fund growth internally. So it isn’t like today’s high rates are going to cut hugely into future margins. On the contrary—rising short rates may actually boost the return on their large cash coffers while they wait to deploy it otherwise.

Stock and bond markets are similarly liquid and are aware of the same information. Those opinions that 10-year yields will remain elevated? Stocks are familiar with those viewpoints and the underlying information. The argument bond market developments impact Tech stocks implies the former is more knowledgeable than the other, which isn’t true, in our view—the two just have different drivers. That said, the many takes Tech stocks are due to pull back (i.e., the hot streak couldn’t last) and can’t do well amid higher yields indicates skepticism remains prevalent. Doubts persist about this near-one-year-old bull market, suggesting a high wall of worry remains.