A US interest rate hike to fight inflation will likely give new impetus to the heaviest sell-off of tech shares in a decade
https://asiatimes.com-by David P. Goldman
US technology stocks like Amazon, Facebook and Netflix are being dumped wholesale on concerns of an imminent interest rate rise. Photo: iStock
NEW YORK – The so-called FANG index of top tech companies – Facebook, Amazon, Netflix, Google and others – has fallen by nearly 10% from its early November peak, after so-called real interest rates rose to their highest level in two years.
Wednesday’s release of Federal Reserve minutes showed that the US central bank was slightly more inclined to raise interest rates than investors had thought, prompting the heaviest selling of tech stocks in volume terms in a decade.
As I warned on December 28 (“Can Tech Stocks Survive Fed Tapering?”), tech stocks trade in tandem with the so-called “real” interest rate, the yield of inflation-indexed Treasury notes. They are the new utilities: long-term monopoly cash flows that investors buy in lieu of the negative real rates offered by all Western governments.
Is the worst over? That depends on what you think about inflation. The Fed said there wasn’t any inflation, and then it said that it was transitory anyway, and said at least that even if it wasn’t transitory it would go away late next year.
But if prices keep rising at north of 5% a year, the Fed will have no choice but to tighten.
Why, for example, should Apple trade at a price-earnings ratio of 35, compared to only 15 in 2018? Apple had a great 2021, to be sure, as consumers loaded up on electronics, with an estimated 72% growth in earnings per share, but analysts expect that to fall to just 2.4% growth in 2022.
As the chart below indicates, the surge in Apple’s valuation followed the plunge of the 10-year real Treasury yield from more than 1% to a low of -1.2%.
Inflation hawk St Louis Reserve president James Bullard warned on January 6 that the Federal Open Market Committee “could begin increasing the policy rate as early as the March meeting in order to be in a better position to control inflation.”
That can’t be good for tech stocks.
Will inflation recede? There’s no sign of that happening any time soon. The American services sector, which accounts for nearly four-fifths of GDP, continues to pay higher costs, especially for labor.
The closely-followed Philadelphia Federal Reserve survey of non-manufacturing companies and the Institute for Supply Management’s survey of service companies show that costs continued to rise through the end of November.
The two biggest items in the consumer budget, houses and cars, continue to inflate. The Case-Shiller 20-Cities Index for American homes was up 18.4% year-on-year as of October. The Zillow Rent Index rose 12.5% year-on-year as of the end of November. And the price of used cars has doubled since March 2020, according to the Manheim Used Car Index.
There’s no relief in sight from strained supply chains. The Federal Reserve just issued its own index of global supply chain pressures, which shows that bottlenecks are getting worse.
And inside the United States, transportation costs continue to rise at an accelerating rate, now almost 40% a year. I calculate the inflation rate for shipping by dividing expenditure for freight by the volume of freight, according to the CASS Index.
Finally, commodity prices are close to their recent peaks, and a 10-year high point.
Why are supplies so constrained?
American manufacturers aren’t adding to capacity, and a lot of Americans haven’t gone back to work. According to the consensus of analysts reported by Bloomberg, America’s manufacturers (the Industrials component of the S&P 500 Index) cut capital spending drastically during the pandemic, and will continue to cut this year.
After taking inflation into account, their investment in plants and equipment has fallen by a third since 2019. The data in the chart reflect global capital spending by US corporations rather than CapEx in the United States as such, so the picture could be somewhat better or worse than shown, but the broad direction of the chart is correct.
The United States reported January 6 a record trade deficit in goods of $99 billion in November, or a $1.2 trillion annual rate. Manufacturing can’t meet demand at home, and America’s aging and inefficient ports can’t handle enough goods to keep up with the demand.
In sum, there’s no improvement in the inflation picture on the horizon. The likelihood is that the inflation hawks will have their way, US interest rates will rise, and overpriced, rate-sensitive assets will suffer.
Follow David Goldman on Twitter at @davidpgoldman