Stock markets roared higher in 2020 and 2021 as the Federal Reserve pumped trillions of dollars into the economy and slashed interest rates to record lows.
Technology stocks were the big winners, with the tech-heavy Nasdaq 100 index shooting more than 130% higher between the bottom of the coronavirus-driven sell-off in March 2020 and November 2021.
Yet the Fed has abruptly pivoted to inflation-fighting mode, as it tries to cool the hottest price rises for 39 years. It’s bringing its bond purchases to an end and is likely to hike interest rates numerous times this year.
The prospect of higher rates has caused bond yields to shoot up, as investors demand higher returns.
Higher bond yields have a huge effect on the rest of the market. Not only do they make the bond market look somewhat more attractive, they dramatically alter calculations about stocks, because they erode the present value of future earnings. Higher yields also increase companies’ borrowing costs and, by and large, benefit banks.
Tech stocks, particularly at the more speculative end of the spectrum, have tumbled.
Nowhere is the impact of rising interest rates and bond yields more evident than banks – which have jumped – and speculative technology companies – which have slumped.
The Dow Jones banks index was up more than 10% for 2022 as of Wednesday’s close, with higher rates and yields set to boost the amount of money banks can make from lending.
But the Ark Innovation ETF, run by star stockpicker Cathie Wood, has cratered. That’s because it’s chock full of technology companies that don’t yet make any money. Their far-off future earnings look a lot less attractive when there’s more money to be made in bonds and other assets in the here and now.
Investors have “rotated” heavily away from so-called growth stocks, companies that are expected to grow more rapidly than the broader market, which are often in the tech sector.
They’ve moved instead towards so-called value stocks, those whose price looks cheap when their financial performance is taken into account. That’s because these companies’ health is more closely tied to the economy, which is set to stay strong, and interest rates, which are going up.
The Russell 1000 value index has fared particularly well in 2022 so far. Among its biggest components are Warren Buffett’s Berkshire Hathaway, which invests largely in consumer companies such as Coca-Cola, JPMorgan and Walt Disney.
By contrast the Russell 1000 growth index has dropped. Among its biggest components are Apple, Tesla and chip-maker Nvidia – the latter of which is down more than 8% for the year.