March
20
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What’s driving the surge in tech shares?
By David Nelson, CFA CMT
Investors are questioning the rush into mega cap tech at the height of a banking crisis that has rippled through markets in the last two weeks. I think CNBC’s Josh Brown said it accurately. Investors today view many of these large digital companies as consumer staples. It’s hard to deny that Apple (AAPL) and Microsoft (MSFT) are as much a consumer staple as Procter & Gamble (PG) or Coca Cola (KO) were during their reign. Josh makes a great point, but I think there is another dynamic adding to the rush into these very crowded trades.
Working capital
Working capital and how you fund it shouldn’t be overlooked. If you look at the sales cycle of companies that sell anything from diapers to trucks building inventory is a major part of the process. If you can’t fund your working capital needs through revenue you can sell debt or turn to banks for financing. Rising rates of course add to those costs.
Microsoft
Bloomberg Data
A software company doesn’t have the same inventory challenges making their financing needs less than the typical industrial or retail company. Microsoft (MSFT) at $2 trillion in market cap has less than $78 billion in debt with close to $100 billion in cash. They could pay off most of their debt tomorrow. Even though Apple looks more like a retailer the same holds for them as well. They are net cash positive and could pay off their current $111 billion debt load quickly.
Most other sectors of the economy aren’t as fortunate. From consumer staples to retail to industrial giants and even healthcare all have working capital needs with access to debt and bank financing critical to operations.
While technology and other long duration equities were exposed to rising rates because of excessive valuations, a credit crunch isn’t as big of a burden as most other growth engines of the economy.
2-year yields crash
Bloomberg Data
Of course the above doesn’t hold true for all tech. Certainly, semis and other tech hardware centric companies have major inventory concerns, so what gives? The other half and perhaps more important dynamic driving a surge in technology shares is rate expectations.
The failure of three US banks with more to follow has dramatically changed rate expectations at least in the short run.
Terminal Rate expectations
Bloomberg Data
At the end of February markets had priced in a fed funds terminal rate well above 5% peaking sometime in September. What a difference a banking crisis makes. It took just 7 trading days for 2-year yields to collapse from over 5% to 3.83% on Friday, fuel for a long duration equity rally. The question; with an FOMC decision Wednesday and press conference to follow, is Jay going to acknowledge that a regional banking crisis is a deflationary pulse that will do some of the Fed’s work?
As pointed out in my article on the Credit Suisse takeover by UBS, banks are likely to reduce lending which in turn will tighten financial conditions. It’s no wonder Goldman and other bulge bracket banks are raising odds of a recession.
A tale of two cities
Bloomberg Data
Wall Street has a habit of rushing from one side of the lifeboat to the other, often trampling other investors in the process. The herd mentality spreads like a brush fire sucking all the oxygen out of the room. Month to date technology is up close to 5.9% with large cap dividend stocks down close to 5%. A tale of two cities. Given the heavy exposure the index has to Financials and Energy it isn’t surprising.
Like most things Wall Street touches, recent moves are likely overdone with some reversion to the mean expected.
Rate expectations is the dominant theme for sector positioning so Wednesday’s FOMC decision and press conference that follows take on added importance. Will Jay echo what the market already sees or hold fast to his view that the Fed needs to keep hiking until something even bigger breaks.
*At the time of this article some funds managed by David were long MSFT and KO
DAVID NELSON, CFA 