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How To Cash In If Tech Stocks Crash 25%

How To Cash In If Tech Stocks Crash 25%

Posted On March 19, 2021 11:02 am
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In Part 1 of this series, I explained the research behind the scary idea that the tech-laden Nasdaq could fall as much as 30% off its highs due to rapidly rising interest rates.

(Source: MarketWatch)

I also explained why, according to a study from Lipper Financial, the reality of inflation expectations means that such a severe 30% tech bear market is highly unlikely.

That’s not to say that unlikely things can’t happen. The 2020 pandemic was unlikely in any given year, and look at how dramatic last year was for stocks.

However, the fact is that the relationship between interest rates and stocks, including fast-growing tech names, is far more complex than many in the financial media might have you believe.

Interest Rates Don’t Matter: Fundamentals Do

During the four rising-rate periods that saw the least yield curve steepening, as measured by the difference between 10-year and 3-month Treasury yields, S&P 500 Index returns were weaker than for a typical period, averaging an annualized 3.5%. In the four periods when the yield curve steepened the most, the S&P 500 averaged an annualized 14.5%.” – Lipper Financial (emphasis added) 

According to LPL’s research, from the 1960s through 2020 when the yield curve was steepening the most stocks did almost 5X better than when it steepened the least.

(Source: Ben Carlson)

Data from Ritholtz Wealth Management also found that from 1004 through 2014, rising rates proved good for all stocks, even large-cap growth.

Why is that?

  • a steepening yield curve = economic optimism
  • because long-term rates are rising faster than short-term rates

The Fed, via the Fed Funds Rate, has strong control over short-term rates. But long-term rates? Those are primarily a function of economic forecasts and inflation expectations.

Today the Fed has repeatedly said that it will never again raise rates simply because unemployment is low.

  • it will wait to see actual inflation rather than try to head off inflation just because its models say it should be coming
  • the Fed’s new approach is based on data, not merely risks of what MIGHT happen

The bond market has become somewhat skeptical of the Fed’s repeated claims that it isn’t worried about an overheating economy. But guess what? That skepticism is what’s creating incredible long-term investment opportunities right now.

That’s because rising rates are, without statistically GOOD for stocks, because it means a strong economy and strong earnings growth.

  • from 2020 through 2023 the FactSet bottom-up consensus is for about 60% earnings growth
  • the strongest growth in a decade

We also can’t forget, that rates are up big, but off the lowest levels in history.

An increase from 0.5% to 2% is a lot different on the economy than an increase from 3% to 4.5%.

“Rates have been rising but they are still historically low, with the 10-year Treasury yield at the end of February falling into the bottom 2% of all values dating back to 1962.

While it’s true that rates become a bigger burden for businesses, consumers, and governments as they rise, even at current and higher levels rates are still attractive and can continue to support a robust economic rebound.

Looking back again at the different rising rate periods, during the four periods with the highest initial 10-year Treasury yield, the S&P 500 averaged a 2.5% annualized return, while those with the four lowest initial yields averaged 15.4%.

A lower initial yield likely reflects manageable inflation and a Fed that isn’t tightening, but it also represents the added economic support of a still low cost of borrowing even as rates rise.” – Lipper Financial, emphasis added

Lipper finds that if rates are TOO high, then stock returns can indeed suffer. JPMorgan’s research also concludes that 10-year yields above 5%, if combined with rising interest rates, usually mean falling markets.

  • though the tech bubble occurred when rates were as high as 7%
  • because boom economic growth overcomes even high-interest rates as far as stocks are concerned

But note that Lipper’s study looked at rates as high as 16% back in 1981. If you honestly expect 10-year yields to soar from 1.6% to 5.6% in a matter of months, then yes you might want to worry about short-term corrections.

But ask yourself, why would interest rates rise that quickly when

  1. the bond market sets long-term rates based on inflation expectations
  2. the bond market’s medium-term inflation expectations are still within the Fed’s long-term target range
  3. they have been changing at a very slow rate, over nearly a year

In other words, the catalysts for triggering a 30% Nasdaq bear market, are not actually threatening us right now.

But what if tech stocks just roll over, because enough people believe they will. Or to put it another way, what if millions become convinced a tech bear market is inevitable, creating the exact plunge in growth stocks they feared?

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About author

Dividend Sensei
Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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