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Global Weekly Commentary: Why we still like technology stocks
Key points
Bond yield spike
The recent government bond yield spike has pressured tech stocks, yet we are still constructive on technology both on tactical and strategic horizons.
Market backdrop
The Federal Reserve made clear its intent to stay behind the curve on inflation, keeping short-term rates low for longer than they would have in the past.
Data watch
Investors will focus on U.S. nonfarm payrolls data this week to gauge the restart in the labor market.
The recent bond yield spike has been blamed for pressuring tech stocks as they are seen as vulnerable to rising rates. We believe this view is too simplistic: tech is a diverse sector and the driver of higher yields matters more than the rise itself. Our new nominal theme implies central banks will be slower to raise rates to curb inflation than in the past, supporting our pro-risk stance and preference for tech.
Chart of the week
Annualized five-year trailing earnings growth in selected sectors
Sources: BlackRock Investment Institute, with data from Refinitiv, March 2021. Notes: The chart shows the three sectors on the MSCI World Index with the highest annualized earnings growth over the past five years, and the three sectors with the biggest annualized earnings decline for the same period.
Many tech stocks have fallen out of favor recently despite strong earnings. Over the past month information technology has been the worst-performing sector on the MSCI World Index, down 2% versus a flat broader market – after a year of strong performance. Tech’s underperformance since mid-February has coincided with a rise in the U.S. 10-year Treasury yield to a 14-month high, yet we believe the sector’s vulnerability to higher yields is overstated (more on that later). The sector has delivered the best earnings over the last five years on the MSCI World Index, as the chart shows. Looking ahead, we still see long-term trends including digitalization and a “green” transition to a low-carbon economy as supportive of the sector, even as more cyclical sectors may deliver much stronger earnings growth in the near term amid the economic restart. It’s important to recognize the IT sector as defined by the GICS – a widely used industry classification system – covers software and services, tech hardware and equipment, and semiconductors and equipment – but not online search and ecommerce giants.
Rising yields are in theory bad for tech stocks with high growth expectations: it reduces the present value of their long-dated cash flows. Yet simply concluding that higher 10-year yields are bad for tech misses a crucial part of the story – the key is what is driving those yields higher, in our view. A sharp rise in yields across the curve – reflecting an upward shift in the Fed’s expected policy path – would hit equity valuations. But instead, the recent yield spike has been driven by an increase in the term premium– the excess yield investors demand over and above the expected policy path of cash rates for bearing interest rate risk. The “term premium tantrum” mostly reflects investors requiring higher compensation for the now greater risks to portfolios presented by government bonds and inflation, in our view. This makes equities even more appealing than bonds in a multi-asset context – and suggests any further sell-offs in tech may present opportunities. We believe tech companies beating earnings expectations once again will be rewarded if bond yields settle back into a range.
Yet it is important to recognize what a diverse sector tech is: The rate sensitivity for equity valuations is greatest for the highest-growth, least-profitable companies. A rotation into cyclicality amid an accelerated restart may pose a near-term challenge for some tech companies that have benefited from “work from home” and other pandemic-related trends, and benefit more cyclical tech industries, such as semiconductors. Strong pricing power due to global semiconductor supply chain disruptions and demand for consumer electronics could give it a further boost. Strategic U.S.-China competition – especially on technology – is likely to persist and could cause bouts of volatility. Yet we believe investors need exposure to both poles of growth. Tactically we are overweight U.S. and Asia ex-Japan equities partly because of the tech exposures in both. We are also overweight U.S. small caps and emerging market equities as part of our broadened pro-cyclical stance.
Regulation is a growing risk in the tech sector – and not just in Europe. This includes an anti-monopoly drive in China that threatens large-cap behemoths, and potentially a tough stance on big tech regulation and higher corporate taxes in the U.S.
The bottom line: We maintain a positive tactical and strategic view on the tech sector. Any further “term premium tantrum” may present tactical opportunities. On a strategic basis, we see tech supported by structural growth trends – and as one of the sectors set to benefit most from the “green” transition. See our climate-aware return assumptions for more.
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