Tech Wreck – Week in Review

Tech Wreck

If one was to describe the US stock market in 2022, the words tech wreck comes to mind. Tech stocks are being hammered with a continuous downward trend. This poor performance comes after about an 18-month bull market from the nadir of the COVID-19 downturn.

The Nasdaq is down (-11.8%), the worst-performing major exchange or indices. According to StockRover*, the Dow Jones Industrial Average (DJIA) is down only (-4.4%), the S&P 500 Index has declined (-7.3%), and the Russell 2000 has decreased (-9.5%) year-to-date (YTD). In addition, the Technology sector is the worst-performing one YTD.

Reality Is Worse

However, the reality is worse than the headline number about the NASDAQ. The top stocks by market capitalization in the Nasdaq are performing well. It is the more speculative names that are performing poorly creating the tech wreck.

The chart below shows that the five largest stocks by market capitalization in the Nasdaq exchange have performed somewhat better than the overall Nasdaq. The total market capitalization of these five stocks is around $8,904 billion, which is more than 25% of the entire Nasdaq market capitalization of roughly $24.56 trillion.

Name	Ticker	Market Capitalization ($B)	Returns (YTD)
Apple	APPL	$2,752	-5.2%
Microsoft	MSFT	$2,212	-12.3%
Alphabet	GOOG	$1,774	-7.3%
Amazon	AMZN	$1,555	-8.1%
Tesla	TESLA	$611	-18.6%

The fact indicates reality is worse for many stocks in the Nasdaq exchange and thus the tech wreck. For instance, some the best performing stocks through the end of 2021 were often speculative and had no profits or were significantly overvalued with too high growth forecasts.

For instance, Affirm Holdings (AFRM) had a solid 2021 but is trading at its 52-week low and down from its all-time high of $176.65. The unprofitable company’s stock price is down (-53.71%) YTD. In another example, Netflix (NFLX) performed well in 2021 but us down (-35.1%) YTD due to more competition and slowing subscriber growth. Similarly, Meta Platforms (FB) had a decent 2021 but is down around (-34.7%) YTD, because of cuts to the top line from iOS privacy changes. In addition, Palantir Technologies (PLTR) is down (-27.9%) YTD on lower expectations.

Interest Rates and Tech Stocks

How do rising interest rates affect tech stocks? The 10-year US Treasury and other rates are trending up. Simultaneously, the Invesco QQQ Trust (QQQ) is trending down. The chart below from StockRover* shows both QQQ and the 10-year US Treasury rate. Although not perfect, a generally inverse relationship between tech stocks and the interest rate is observed. The price of tech stocks falls as interest rates rise and vice versa.

The main reason is that the present value of future cash flows is discounted at the prevailing interest rate. If interest rates are rising, the future cash flows are worth less in the present. Hence, investors are unwilling to pay as much for tech stocks, especially if they are unprofitable or have slow growth. This point usually means tech stocks and 10-year US Treasury interest rates are generally inversely correlated, but not always.

On the other hand, value stocks are more correlated to Gross Domestic Product (GDP) and interest rates. This point is because value stocks tend to be larger, more established companies paying dividends. Hence, they are positively correlated to interest rates. Value stocks tend to be found in the Energy, Financial Services, and Consumer Defensive sectors. The table above from StockRover* shows these three sectors outperforming the other eight. In addition, the Energy and Financial Services sectors are the only ones with positive YTD returns.

Final Thoughts about the Tech Wreck

Interest rates are likely to rise further. The US Federal Reserve is tapering its bond-buying program. This action should be complete by March 2022. Subsequently, The Fed may raise interest rates, especially after considering the accelerating inflation rate. It rose to 7.5% in January 2022, a 40-year high. 

In all likelihood, the Fed will raise rates by at least 0.25% in March 2022. However, a more significant increase is possible. The CME Group’s FedWatch tool has a 100% chance of at least a 25-basis point target rate. However, the probability of a 50 to 75 basis point increase is 93.8%. The US Federal Reserve last conducted a 0.50% increase during the dot-com boom in 2000.

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The Stock of the Week

Today I highlight 3M Company (MMM). The company is faced with challenges with lawsuits from earplugs and PFAS. In addition, inflation will probably cause margins and thus earnings per share to drop in 2022. However, 3M has been through periods of inflation and rising interest rates before. In addition, 3M is appealing the earplug lawsuit verdicts. The stock has paid a consistent dividend for more than 100 years and is a Dividend King. The current dividend yield is 3.7%+ and covered with a ~59% payout ratio. 3M has solid dividend safety and an improving balance sheet. Furthermore, the valuation has dropped to about 15.4X, the lowest in years. The stock is trading below its 50-day and 200-day EMA. Despite the challenges, 3M is still one of the best dividend growth stocks.

 The screenshot below is from Stock Rover*.

Dividend Increases and Reinstatements

I have created a searchable list of dividend increases and reinstatements. I update this list weekly. In addition, you can search for your stocks by company name, ticker, and date.

Dividend Cuts and Suspensions List

I updated my dividend cuts and suspensions list at the end of December 2021. As a result, the number of companies on the list has risen to 543. Thus, well over 10% of companies that pay dividends have cut or suspended them since the start of the COVID-19 pandemic.

One new addition indicated that companies are experiencing solid profits and cash flow in January.

The new addition was Compass Diversified (CODI).

Market Indices

02/12/22

Dow Jones Industrial Averages (DJIA): 34,738 (-1.00%)

NASDAQ: 13,791 (-2.18%)

S&P 500: 4,419 (-1.82%)

Market Valuation

The S&P 500 is trading at a price-to-earnings ratio of 25.2X, and the Schiller P/E Ratio is about 36.5X. These two metrics were up in the past week. Note that the long-term means of these two ratios are 16.0X and 16.9X, respectively. 

The market is still overvalued despite the recent market correction. Earnings multiples more than 30X are overvalued based on historical data.

S&P 500 PE Ratio History

Shiller PE Ratio History

Stock Market Volatility – CBOE VIX

This past week, the CBOE VIX measuring volatility was up ~4.1 points to 27.36. The long-term average is approximately 19 to 20. The CBOE VIX measures the stock market’s expectation of volatility based on S&P 500 index options. It is commonly referred to as the fear index.

Yield Curve

The two yield curves shown here are the 10-year US Treasury Bond minus the 3-month US Treasury Bill from the NY York Fed and the 10-year US Treasury Bond minus the 2-year US Treasury Bond from the St. Louis Fed.

Inversion of the yield curve has been increasingly viewed as a leading indicator of recessions about two to six quarters ahead, according to the NYNY Fed. The higher the spread between the two interest rates, the higher the probability of a recession.

Economic News

US Energy Information Administration (EIA) reported in its Short-Term Energy Outlook (STEO) that it expects power demand to climb to 3,992 billion kilowatt-hours in 2022 and 4,034 kWh in 2023. Power demand was more than 4,003 kWh in 2018 and was as low as 3,856 BkWh in 2020. The EIA predicted that natural gas’ share of power generation will decrease from 37% in 2021 to 35% in 2022 and 2023. Coal’s share will drop from 23% in 2021 to 22% in 2022 and 2023 as renewables take hold. Renewable power is expected to increase from 20% in 2021 to 22% in 2022 and 24% in 2023. Nuclear power is expected to hold steady at 20% for the foreseeable future.

The US Bureau of Labor Statistics reported the consumer price index rose 0.6% in January, mirroring December’s reading. However, the index’s year-over-year rate is up a seasonally adjusted 7.5%, the fastest annual pace since February 1982, and follows a 7.0% reading in December. Much of the seasonally adjusted all-items increase is attributable to increases in the indexes for food (+0.9%), energy (+0.9%), and shelter (+0.3%). Energy reported up 27% on a year-over-year basis as fuel oil prices surged 9.5% and electricity jumped 4.2% in January. Shelter, which makes up about one-third of the total CPI number, reported 4.4% year over year. Along with the index for shelter, the indexes for household furnishings and operations (+1.3%) used cars and trucks (+1.5%), medical care (+0.7%), and apparel (+1.1%) were among multiple indexes reporting increases in January.

The Labor Department reported a decrease in initial jobless claims for the week ending February 5th. The seasonally adjusted initial claims came in at 223,000, a decrease of 16,000 from the previous week’s upwardly revised level. In addition, the four-week moving average was essentially flat at 253,250, a decrease of 2,000 from the last week’s revised average.

Thanks for reading Tech Wreck – Week in Review!

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