Volatility has returned on Wall Street after a brief interval for the last three trading days of last week. The September-specific meltdown has struck U.S. stock markets and the three major stocks indexes — the Dow, the S&P 500 and the Nasdaq Composite — plummeted 3%, 3.8% and 4.7%, respectively, month to date.
On Sep 28, Wall Street tumbled as the Dow, the S&P 500 and the Nasdaq Composite plunged 1.6%, 2% and 2.8%, respectively. Yesterday’s market mayhem was technology sector-specific and was driven by soaring yields on U.S. government bonds across the time curve. In addition to the tech-heavy Nasdaq Composite, the Technology Select Sector SPDR (XLK), one of the 11 broad sectors of the market’s benchmark the S&P 500 Index, slid 3%.
Surging Yields Pull Down the Technology Sector
On Sep 28, the yield on the benchmark 10-Year U.S. Treasury Note ended at 1.534% after touching 1.567%, its highest level since Jun 25. The yield on the long-term 30-Year U.S. Treasury Note closed at 2.07% after hitting 2.085%, its highest since Jun 21. Likewise, the yield on the short-term 2-Year U.S. Treasury Note closed at 0.305%, the highest level since Mar 25, 2020.
The reason for the recent spike in government bond yields is Fed Chairman Jerome Powell’s signal given after the FOMC meeting on Sep 22 for a possible tapering of its $120 billion per month bond-buy program starting this year. Lack of demand will reduce bond prices and consequently, yield to maturity will increase.
Higher market risk-free returns mean a higher discount rate for future cash flows from stock investing. This will affect the growth-oriented stocks — especially the technology stocks — as these stocks generally provides higher returns over a long term.
Moreover, these companies depend on easy access to cheap credit to expand their businesses. In fact, the Fed Chairman also indicated that the first hike of the lending rate from the current level of 0-0.25% may come in the second half of 2022 instead of 2023 expected in June.
Tech Meltdown Temporary
The recent meltdown of the technology sector is a temporary phenomenon. The Fed has taken a $120 billion per month bond-buy program to ensure adequate liquidity in the system and tackle the pandemic-led economic devastations. It was clear from the very beginning that the central bank will remove this stimulus gradually as the U.S economic recovery moves forward to a reasonably strong footing.
On Sep 28, Powell, in prepared remarks delivered to the Senate, indicated that higher inflation may last longer than anticipated. He said that the reasons behind higher inflation are partly supply-side bottlenecks and partly strong aggregate demand.
Strong aggregate demand indicates solid fundamentals of the U.S. economy. The logic that the technology sector will underperform other cyclical sectors may be true for a short period of time but in the long term, technology stocks will remain the best bet.
In fact, the fundamentals of the technology sector are rock solid. The growing demand for hi-tech superior products has been a catalyst for the sector in an otherwise tough environment. A series of breakthroughs in 5G wireless network, cloud computing, predictive analysis, AI, self-driving vehicles, digital personal assistants and IoT, has given a boost to the overall space.
Tech Has Vast Potential – Buy on the Dip
The leading emerging markets of Asia, Latin America, Africa and some European countries are still way behind in using digital technology compared to the developed world. While mobile phone penetration is nearly 90% in these countries, a large number of people are still using phones with old features, since voice communication and not data served most of their needs. Even those using smartphones, rarely utilize online digital features.
However, the outbreak of coronavirus quickly changed the lifestyle and lookout of these people. People were not entirely used to the digital platforms for their office work (work from home), ordering foods and other daily needs or transferring money and making payments. Moreover, online schooling, video conferencing and virtual networking have now become essential.
The countries that are more digitized have been able to minimize their losses during the pandemic. These are major lessons to the other countries. Even those who are less inclined toward digital technology and online platforms, either because they have to learn using smartphones or tablets or due to fear of data theft, are now feeling the massive advantage of the online platforms.
The impact of a higher market interest rate is already factored in the technology sector’s valuation to a large extent. Share prices of several technology behemoths have suffered a blow in September.
These companies have highly established business models worldwide, strong product pipelines, globally acclaimed brand recognition and robust financial positions, which help them cope with a higher interest rate. Investment in these stocks should be fruitful going forward.
Stock Selection Criteria
The technology sector is indispensable and the reopening of the U.S. and global economies will only act as a positive catalyst for this sector. At this stage, several stocks are available that looks attractive for future growth. However, picking them on the following four criteria will make the task easy.
First, select U.S. technology giants (market cap > $100 billion) that are currently trading at more than 5% discount to their 52-week high prices. Second, these stocks have seen positive earnings estimate revisions within the last 60 days for the next one year.
Third, these stocks have strong upside left reflected by a long-term (3-5 years) growth rate of more than the S&P 500’s estimated long-term growth rate of 11.3%. Fourth, each of these stocks carries either a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see
the complete list of today’s Zacks #1 Rank stocks here
.
Six stocks have fulfilled our selection criteria. These are:
Microsoft Corp
.
MSFT
,
NVIDIA Corp.
NVDA
,
Qualcomm Inc.
QCOM
,
Applied Materials Inc.
AMAT
,
ServiceNow Inc.
NOW
and
salesforce.com.inc.
CRM
.
The chart below shows the price performance of six stocks mentioned above in the past month.
Image Source: Zacks Investment Research
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