Citing high inflation and a strong labor market, the Federal Reserve signaled on Wednesday that interest rate increases are coming “soon.” Predictably, that was enough to send stocks lower, though the Nasdaq Composite eked out a modest gain.
One day doesn’t make a trend, but that could be a sign that some market participants are awakening to the fact that higher interest rates don’t necessarily spell doom for technology stocks and exchange traded funds, such as the Goldman Sachs Innovate Equity ETF (GINN).
GINN isn’t a dedicated tech ETF, but it does allocate 33.8% of its weight to that sector. That’s more than 600 basis points in excess of the S&P 500’s tech allocation, indicating that the fund could have some vulnerability to rising rates, but some experts say that point of view is worth reconsidering.
“In our view, higher rates may be more positive for Financials than they are negative for Information Technology stocks,” writes David Kastner of Charles Schwab. “However, sector winners and losers likely will depend on the pace at which the Fed raises short-term rates, and the impact those higher rates have on the overall stock market, longer-term interest rates and the yield curve.”
GINN is underweight to financial services stocks with an allocation to that sector of just 6.8%. That doesn’t mean that the ETF’s biggest hurdle today is interest rates. If rate hikes are baked into tech stocks, or getting there, and with valuations in the sector starting to come in, GINN could prove more durable than expected later this year.
“One rationale for the lofty valuations has been extremely low interest rates. As their name implies, growth stocks’ earnings (future cash flows) are expected to grow relatively faster than other companies’ over the long term,” notes Kastner. “These increasingly higher future cash flows need to be ‘discounted’ by prevailing interest rates—in a sense comparing what future cash flows are worth today based on the alternative of investing in Treasuries. The higher interest rates go, the lower the value of those future cash flows, all else being equal.”
While many market participants continue focusing on tech stocks through the lens of Fed policy, it’s worth remembering that the truly important factor is business investment in tech. With cloud computing and cybersecurity demand still strong, tech might have some buffers against Fed tightening.
“The sector continues to play a pivotal role in advances in robotics and automation; the transformation toward big data and cloud computing; the software and artificial intelligence that make it work; and smartphones, tablets, and network interfaces to enable us to use it,” concludes Kastner.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.