Stocks continue sell-off as inflation fears intensify

Market Update

Tech stock selling intensified overnight as market-based inflation measures hit the highest levels in ten years ahead of tomorrow's key April CPI reading.

  • Global stocks have extended their sell-off after concerns about rising inflation have resurfaced, with technology stocks on track to be among the worst performers.
  • Inflation concerns intensify as market-based gauges hit the highest levels in a decade ahead of tomorrow's April CPI reading that is likely to indicate a headline rate of 3.6%.
  • US 10-year note yields rise to 1.618% in overnight trading ahead of $126 billion in auctions of 3-year, 10-year and 30-year paper starting later today.
  • Investors are betting that inflation is likely to climb steeply in coming months, driven by pent-up spending as well as supply bottlenecks and a leap in commodity prices.

A sharp and sustained jump in inflation could erode returns on fixed-income assets and stocks whose valuations rely on future earnings, primarily technology stocks. Some money managers are concerned that inflation may also prompt the Federal Reserve to pare back its easy money policies sooner than anticipated as perhaps monetary and fiscal stimulus has taken a step too far.

“Inflation is an issue that is on everyone’s minds right now, and it is injecting a lot of uncertainty,” said Peter Langas, chief portfolio strategist at Bessemer Trust. “The question is, how does the Fed react to that?”

Tech bearing the brunt

Growth stocks led the market’s steep rally since last spring. Investors are increasingly worried that their high valuations may not be justified if inflation negatively impacts the value of future earnings. This week, those concerns have spilled over to other sectors as well, leading to a broader selloff.

It is important to note however, this sell-off is coming after an extraordinary year of returns for technology stocks. Many of the high price to sales companies with little to negative earnings that were up massively last year, are being hit the hardest. Many are still up double digit percentage points on a one year basis.

We believe that the tech sell-off continues and after a lesser correction in the S&P 500 and Dow Jones, a strong rotation will be seen into sectors that inflation typically has less of an impact on (ie. financials, industrials, infrastructure, materials). It is important to note that we still remain bullish on technology, however overweight tech portfolios should be looked at as 2-5 year holdings.

Key levels to watch

The Nasdaq recently made a new all time high (ATH) of 14,211.57 on April 29, 2021. As the selling intensifies in the Nasdaq, some key levels we are monitoring are:

  • 13,290 (-6.48% off ATH)
  • 12,960 (-8.81% off ATH)
  • 12,575 (-11.52% off ATH)
  • 12,400 (-12.75% off ATH)
  • 12,060 (-15.14% off ATH)

We believe that the Nasdaq could sell-off to a range of 12,575 to 12,960, representing approximately a 10% correction from the recent all time high. It is important to note that if April’s CPI number comes in lower than expected, the sell-off could run out of steam. 

Why would a rise in interest rates or inflation hurt growth/tech stocks?

The market is a discounting mechanism. It is a way of trying to value what a future stream of cash flow, or earnings, is worth today. Investors think about growth stocks in terms of the profits they are expected to bring in, rather than their current profits or cash flow. Typically, their valuations take a bigger hit than those of mature companies as rising rates erode the worth of future cash flows/earnings.

Market Outlook

As a continuation to our research/investing thesis of “Seeking opportunities in business cycles”, we believe that we are now in the mid-cycle of the business cycle.

We continue to remain bullish on technology for the medium to long-term, however investors should expect lower returns compared to 2020 and increased volatility in this sector as the economy continues to open up.

Sectors that typically outperform growth during rising inflation and interest rates are:

  • Mining and materials
  • Financials
  • Industrials and infrastructure
  • Transports

Investors should consider pairing back heavily overweight technology portfolios to add exposure to sectors that inflation typically has less of an impact on. Our current sector outlook for medium to long-term portfolios can be found below.

Thank you for your interest.

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