Why investors should not give up on tech stocks entirely as interest rates rise

Published Thu, Jan 6 20226:50 AM EST

Patti Domm @in/patti-domm-9224884/@pattidomm

Stung by rising interest rates, technology stocks have stumbled out of the gate in 2022, but strategists say don't give up on the group even if they face a rocky period ahead. The past week has been a tough one for tech. On Monday, the tone was set when the benchmark 10-year Treasury yield zipped higher in the biggest move to start a new year in 20 years . The yield touched 1.64% Monday, from 1.51.% at year-end Friday, and then it kept going to 1.7% by Wednesday. Tech stocks succumbed to pressures of rising rates by Tuesday and were ripped again Wednesday, along with the broader market. The Federal Reserve issued minutes from its last meeting Wednesday afternoon, showing the central bank could become even more aggressive about raising interest rates and tightening policy than expected. By the end of the day, the major technology sector was down 3.3% so far in the first week of 2022 trading. The Technology Select Sector SPDR Fund was down 3.2% for the week by Wednesday, and off 4.3% over the past five trading days. Patrick Palfrey, senior equity strategist at Credit Suisse, said investors are under the misconception tech did very well last year because it outperformed into the year end. He said the main issue with tech is valuations, and he expects the market to reward cyclical names, like financials, this year, as well as small caps and international stocks. "I think you're going to see tremendous outperformance from these groups, but I think tech is a laggard relative to the market but not an outright loser," said Palfrey, also co-head of quantitative research. "The businesses that underlie technology remain strong." Even so, he does not expect investors to give up on the group, which should see valuations come down. "I don't think investors are willing to entirely walk away from their technology portfolios. I think on the margin, they may shift to more cyclical stories for a period of time," Palfrey said. Tech and growth benefit in an easy money environment, as investors are willing to pay up for future earnings. But as interest rates rise and the cost of money gets more expensive, that calculus changes and valuations are pressured. Many bond strategists expect the 10-year-yield to end the year at about 2% , but Palfrey said some investors are fearing an even bigger move in interest rates. The 10-year was last above 2% in July, 2019. "I don't think rates are going up as much as most investors think. I don't think it represents as much of a threat for valuations of technology shares. If we're going back to 3%, we need to have a very serious conversation but moving from here towards 2% in a stable manner, with non-recessionary conditions, tech is going to underperform but it's not going to be an outright loser." Adam Parker, founder of Trivariate Research, said he is advising his institutional clients that tech is broken into two camps. There are stocks like Microsoft , which have embedded products and strong cash flow, versus the "stay-at-home" tech companies that became overvalued, like Zoom and DocuSign. "If you have a longer-term investment horizon, you can buy Microsoft for sure," he said. He said the risk reward is skewed to the positive, and investors continue to look to buy FAANGM on dips. That would be Facebook parent, Meta Platforms ; Apple , Amazon , Netflix , Google parent Alphabet , plus Microsoft. Even Apple, which became the first stock with a $3 trillion market cap just this week, has been whacked in the sell-off. Apple was down 1.5% for the week of the year so far and off 2.7% ion Wednesday. Microsoft is down nearly 6% for the week. "If you want to beat the market, it's very risky to be underweight FAANGM," Parker said, noting it amounts to more than 22% of the market cap of the S & P 500. "I think people are focused on where is there positive free cash flow, where is there margin expansion and where is there pricing power," he said. Parker said semiconductors are in favor because they have benefited from the chip shortage, but investors need to keep track of backlogs. The VanEck Semiconductor ETF was down 3.4% on the day Wednesday. "I think the more old school tech, Cisco, Dell, Intel , that looks cheap," he said. He said investors are wondering if those types of names have attractive risk reward. "The crazy stay-at-homes, they're still shorting," he said of names like Peloton . "Dell is super cheap…It may be a work at home beneficiary but it's very attractive…I think people are looking for justifiable pricing power and margin expansion stories," he said.

A trader in a face mask works on the trading floor at the New York Stock Exchange (NYSE) as the Omicron coronavirus variant continues to spread in Manhattan, New York City, U.S., December 20, 2021.

Andrew Kelly | Reuters

Stung by rising interest rates, technology stocks have stumbled out of the gate in 2022, but strategists say don't give up on the group even if they face a rocky period ahead.