Last night witnessed a resumption in technology stock selling on Wall Street. The drivers of this are obvious. During periods of rising interest rates, growth stocks underperform as investors look to more immediate yields over long-term returns:
So, how inflated is the Nasdaq and how far has it got to fall? First question first. A few charts from Goldman. The bubble is not as widespread as it was in 2000:
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Also, unlike many bubble periods, the fundamental EPS for the leading Technology companies and for the more widely-owned favoured retail stocks have significantly outstripped those of the rest of the market, so that the rise in the performance has been supported by superior growth and fundamentals. It has been based on achieved reality, not purely on hope and possibility. Exhibit 10 shows, in the post financial crisis era, the Technology group – and the group of most heavily owned stocks by retail investors (Bloomberg tickerGSXURFAV) – has significantly outpaced the rest of the world in terms of EPS growth.
The quality end of the Nasdaq is expensive but it’s not in a bubble. Stocks like Apple, Microsoft, Alphabet and Facebook have been huge earnings winners to rationalise highish prices. Some deflation can be expected there as yields rise but nothing like what we would describe as a “bust”.
Where there is a bubble is in the technology segments without earnings. These have gone truly stupid over the past year as retail speculators flushed with stimulus cash combined with an uber-supportive Fed:
This is where the bust is underway and it is not over by a long shot.
This brings us to question two. The key to the bust will be the speed and size of the rise in yields, followed by the speed of withdrawal of Fed stimulus. Goldman has a decent framework:
With strong economic gains in the coming quarters, we assess the potential scale of upside risk to 10y UST yields beyond our current forecasts. While there are plausible pathways to get 10y yields above our 1.9% target without requiring markets pricing further front-end tightening, the extent of ‘overshoot’ possible is limited without some rather extreme assumptions on either yield curve steepness, levels of intermediate real yields, or sustainable levels of bond risk premia.
From a variety of perspectives, we find these plausible yield upside levels cluster around 2.25-2.4%. If 10y yields were to achieve (or exceed) these levels over the summer, we believe the risk/reward to adding duration would be fairly compelling, as we do not see such levels as sustainable under our current economic projections. The fact that the Fed will likely be on hold for the next two years is a strong limiting factor to higher 10y yields, even after making somewhat extreme assumptions on yields curves, real rates, and bond risk premia.
My view is we could pop above 2.5% on the ten year for a bit but I’d certainly be a buyer there. More importantly for this discussion, that still leaves us with a back-up of 100bps ahead, driven by supply-side inflation, the US catch-up boom, huge fiscal spending and a super-dovish Fed driving yield curve steepening.
Without putting too fine a point on it, that is more than enough to comprehensively pop those Nasdaq bubble stocks. Indeed, I can see them fully retracing which means we are only one-third of the way into Tech Wreck 2.0. At the headline level, the Nasdaq might fall 25-30% peak to trough.
That might raise the prospect of Fed intervention but my base case is still not. It will be pleased to see the thing deflate amid strong economic conditions. Especially if, as I expect, the value rotation in broader stocks means the overall market is stable.
After that, I’d expect yields to pull back once again into a new version of lowflation and global secular stagnation which will once again make growth stocks a buy.