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Why are tech stocks falling?


23 February 2021

The Nasdaq 100 has just recorded its longest losing streak since October, having declined for 5 consecutive days. The tech-heavy index fell 2.63 percent to commence the trading week on a weaker note, in contrast to the Dow Jones index, which inched up 0.09% on Monday.

The Nasdaq 100’s year-to-date climb has also slid below the gains seen in the Dow and the S&P 500 so far in 2021:

To be clear, the upward trend for the Nasdaq 100 remains intact, even as it looks destined to test its 50-day simple moving average (SMA) as a support level. Tech stock fans can take heart that previous forays below the 50-SMA have proved fleeting; such has been the resilience of tech stocks.

The Nasdaq 100 minis still have to break below the 12,750 region in order to post a lower-low to potentially bring its upward trend to a shuddering halt. But what could make things different this time?

The reflation trade


Investors are expecting the US economy to outperform as it continues its post-pandemic recovery. This recovery has been aided by trillions of dollars in support measures, both from the US government (fiscal policy) and from the central bank (monetary policy), as well as the rollout of the Covid-19 vaccine. The rosier economic outlook has prompted a rise in Treasury yields (10-year Treasury yields have risen to a one-year high), which could eventually prompt investors to prefer treasuries over stocks.

As economic activity is restored, this is expected to lead to faster inflation. More importantly, some investors think that the inflation will actually stick this time around, as opposed to the languid price pressures that have kept the Federal Reserve from consistently achieving its 2% inflation target since adopting that goal in 2012.

Should inflationary pressures continue building, that may bring forward the Fed’s timeline for easing up on its support measures for financial markets. Note that the US central bank has been purchasing about $120 billion in bonds per month since the pandemic. An overheating US economy may warrant a pullback in these asset purchases, which could then pave the way for an interest rate hike. Once this flow of easy money is constrained, that removes a major tailwind for many corporations that have thrived under such easier financial conditions.

What does the reflation trade mean for specific sectors?


The reflation trade suggests that stocks that are more exposed to the economic cycle stand to benefit at the expense of tech counters, which had been darlings amid the pandemic. Here’s a snapshot of the reflation trade as per Monday’s price action within the S&P 500:

Also note that the concerns surrounding overstretched tech valuations are now coming to the fore. Even after Monday’s declines, the Nasdaq Composite Index now has a PE ratio of 70.43, which is still more than double its average of 33.22 from the past decade. That’s in contrast to the S&P 500’s current PE ratio of 31.7, while the Dow Jones index’s PE ratio stands at 28.26.

In other words, non-tech stocks have plenty of room to catch up, while tech counters could have more downside to explore, as funds are rotated away from tech amid the reflation trade.

To be clear, this does not herald the capitulation of tech stocks. Rather, it may be the case that tech stocks are set to lag behind other sectors that are exposed to the traditional “Main Street” economy that are more likely to benefit from more fiscal stimulus.

And as if to prove the point further, at the time of writing, the futures contracts for the Nasdaq 100 are edging lower while their counterparts for the Dow and the S&P 500 are little changed. This suggests that the reflation trade is set to persist for a while longer, with tech stocks likely to languish out of investors’ favour for the time being.

#source

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