How Rising Rates Could Influence Tech Earnings

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Summary

  • Rising interest rates tend to hurt growth stocks, and more specifically tech stocks due to their high price-to-earnings ratios and low dividend payments.
  • The S&P 500 is trading at its cheapest since before the pandemic, with a current P/E ratio of about 25.6.
  • Inflation and supply chain constraints will continue to be a theme in the coming quarters, and forecasts may be a bit muted in lieu of those themes.

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By Scott Bauer

At A Glance

  • Rising rates tend to hurt growth stocks, but across the last five rate hike cycles, the Nasdaq median gain was nearly 27%
  • Inflation and supply chain constraints will continue to be a theme, and earnings forecasts may be muted as a result

When I last covered the NASDAQ on March 23, it was in the midst of a rally that pulled it out of the bear market territory for the year. I noted we may have found a temporary bottom at the 12,500 level back on March 14. Now, weeks later, the index is lower but has not come close to re-testing the 2022 bottom we saw on March 14.

The Federal Reserve predictably raised rates by 25 bps at their March meeting, and with Fed Chairman Powell indicating that we could see additional rate hikes in each of the remaining six meetings this year, how will the rapidly rising interest rate environment affect earnings for high growth stocks?

Rising Rates and Tech Stocks

Rising interest rates tend to hurt growth stocks, and more specifically tech stocks due to their high price-to-earnings ratios and low dividend payments. Higher rates can slow down businesses' cash flows and stunt their reinvestment into innovation and growth prospects. During times of uncertainty, investors turn towards more steady companies, just as they generally look to the fixed income markets to invest in safer assets. Investors may run for greener pastures in the short term. However, there is no real data to show that that decision is warranted given equities' performance during past rate hike cycles.

According to Dow Jones Market Data, across the last five rate hike cycles, the Nasdaq median gain was 26.9%. During the rate hikes from June 2004 through September 2007, rates ballooned all the way to 5.25% from 1%, yet the Nasdaq gained 26.9% during that period. The most recent rate hike cycle came between December 2015 and December 2018, and although the S&P 500 lost 9.3% the month after the first hike, the average monthly decline following the nine rate hikes was just 0.9%. The data is rather ambiguous when it comes to stock market performance during and following rate hikes, but Q1 earnings could paint a clearer picture for the near future of large-cap tech stocks.

rate hike cycle

Dow Jones Market Data

Prospects for 2022 Tech Earnings

In my last piece, I noted that although the stock market was in the midst of a correction, the market's movements were more emotional and fundamentals still looked strong in big tech. The S&P 500 is trading at its cheapest since before the pandemic, with a current P/E ratio of about 25.6. Earnings and revenues are projected to grow year-over-year for Q1 2022 by close to 4% and 10% respectively. The "great re-opening" took longer than expected in the United States, and with almost all states having no remaining COVID restrictions in place, companies should be reporting growth in Q1 as we inch back to normalcy.

E-mini nasdaq

Author

Inflation and supply chain constraints will continue to be a theme in the coming quarters, and forecasts may be a bit muted in lieu of those themes. However, fundamentals in big tech remain strong and will look to provide support for a resurgence in their respective stock prices. The coming weeks' earnings reports will be telling not only for the Q1 revenue numbers but perhaps more importantly how they forecast the coming year and beyond.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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