Good for ↑
The 10-year yield breaking above 5% set off selling across tech. Yet profitable giants with cash piles, like Apple, Alphabet and Microsoft, earn more on their cash and face no refinancing risk. The blunt rule that higher rates hurt tech ignores balance sheets. Unprofitable, indebted growth companies take the hit.
Source: Bloomberg ↗
Higher yields lower what investors will pay for future profits, so tech stocks fell across the board. But tech giants with $50-150B in net cash are lenders, not borrowers, when rates are high. Their cash sits in Treasury bills and other short-term holdings that now pay solid interest with no risk. A company with $100B in cash earns billions a year in interest. Forecasts made in the zero-rate years leave that out. Their debt is mostly long-term at fixed rates, so they face no refinancing pressure soon. Unprofitable growth companies really are hurt by 5% rates. But index rebalancing and momentum trading are dumping both groups together. Fear is building, with the VIX volatility gauge at 17.1, but it has not reached panic. Forced selling like this can leave the best balance sheets priced too low for a while.
Investors believe rising yields hurt all tech stocks, because higher rates shrink what they will pay for future growth. They are selling tech broadly and treating every tech company as the same kind of rate-sensitive growth stock.
Why that may be wrong
Index selling and momentum trading programs dump the whole tech sector. They do not separate cash-rich, profitable giants, which lend more than they owe, from unprofitable growth companies with floating-rate debt. A balance sheet like that of Apple (AAPL) gets the same rate math as that of an indebted, cash-burning software company. Yet at 5%, the first earns billions more in interest, while the second faces refinancing pressure that could threaten its survival.
If 5% yields cause a broad slowdown that crushes business IT spending, even cash-rich tech giants could see sales fall by more than their interest income gains. Watch the US services PMI, a monthly survey of business activity. A reading below 48, or falling software renewal rates in Q3 earnings guidance, would mean the sales risk outweighs the cash benefit.
Yields of 5% may signal falling demand ahead, beyond their effect on valuations. If the jump reflects inflation speeding up again, with US crude at $101.96 after rising 11.5% in a week, business customers face their own cost squeeze and cut IT budgets. That would hit sales even at cash-rich tech giants. The weakest assumption is that interest income offsets lower valuations. At 30 times earnings, a 100 basis point rise in yields can cut the multiple by about 3-4 points. For a $3T company, $5B of extra interest cannot make up for that. Broad cuts to Q3 earnings guidance would show demand is already falling.
The 2022 rate shock is the closest match, and it shows where the blunt rule fails. The Nasdaq fell about 33% in 2022. By 2023, the most profitable tech giants with net cash recovered fastest and did best, because their earnings held up. In the 1994 bond shock, 10-year yields rose about 250 basis points in 12 months. Stocks first fell across the board. Companies with strong balance sheets and pricing power recovered within 6-9 months, while indebted, rate-sensitive companies took years. In a panic, investors sell the index, not single companies. Warren Buffett compared rising rates to gravity on all assets. That holds for valuations, but a company with $100B in cash also gains from higher rates. Investors have usually taken 2-4 months to see the difference.
The 10-year yield breaks above 5%, and stocks fall broadly as investors pay less for future profits. Tech, the most richly valued sector, falls hardest. Index rebalancing and momentum selling widen the drop.
Index outflows push all tech stocks down alike, whatever their balance sheets. Profitable Nasdaq 100 giants with $50B or more in net cash fall alongside smaller, unprofitable software companies loaded with debt. At 5%, the giants earn much more interest, while the indebted companies risk being unable to refinance.
If high rates last into Q3 earnings season, investors start telling tech balance sheets apart. Profitable giants with net cash report higher interest income and confirm their forecasts. Unprofitable growth companies miss and cut theirs. Big profitable tech companies with $50B or more in cash, strong free cash flow and little floating-rate debt then pull ahead of smaller software companies that burn cash and must refinance soon.
No comments yet.
Sign in to comment