Temporary underperformance in Tech

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The Tech sector came under pressure in the new year as expectations of Fed tightening increased – the Fed could raise interest rates as early as March and might finish its string of rate hikes higher than is currently expected. The timing of the reduction of the Fed’s balance sheet remains uncertain, but could be before the Fed stops raising interest rates. As far as Tech companies go the two keys questions are 1. When will Fed fund expectations stabilize 2. What will happen to Tech companies in the following weeks and months.

1. When will the US Treasury curve stabilize?

The Federal Reserve is faced with an economy bolstered by a fiscal and monetary impulse above what can be sustained without creating elevated inflation. Some of this is due to supply chain constraints as global demand is too elevated. Some is due to a high quit rate and the fear of a price wage spiral spreading across the labor market. As a consequence, the Federal Reserve has been steadily turning more hawkish with the likelihood of rates rising both sooner and higher than expected with potential terminal rate of 2.5%, and a reduction in the Fed balance sheet that could start next year.

The question is when will the market price in the fact that the Fed is still somewhat running behind the curve. This is a function of four factors 1. The importance of inflation for the midterm elections 2. The terminal rate – which reflects the belief in long-term growth 3. The demand for safe havens and fixed income when parts of the equity market are very expensive 4. How much investors have allocated to risky positions compared to what they feel comfortable with. All of this suggests that the Fed stays on the hawkish side ahead of the midterm elections and then reverses, helping Tech and Growth stocks.

2. What happens to Big Tech?

The technology sector benefited enormously from Quantitative Easing both by easy financing conditions and investors pushed into such long-term investments far above what they would normally feel comfortable with. The consequence is that this sector is highly sensitive to hawkish Fed talk, especially to balance sheet reductions. Yet – and this is the essence of the conundrum — the Tech sector is likely to be the one that rebounds the most and the fastest from an eventual significant correction. The question therefore is what to own in anticipation of going through the eye of the needle, namely 1. Innovation 2. Climate. In a world where the average speed of growth is expected to decline, the onus will be on innovation particularly regarding Climate change in a secular trend.

What does it mean?
The conclusion seems to be that some of the pressure on Tech should ebb soon as the Fed fund expectations stabilize, leading to a continued rally, but that positioning for the long-term is becoming ever more important. Simply put, too much liquidity has gone into the Tech sector. Hence, the secular trends of Innovation and Climate are the likely the ones to latch onto. One key opportunity is in China Tech which is now very cheaply valued and has already gone through regulatory reviews by the Chinese government. Such companies will continue to innovate and adapt in a new ecosystem.

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