The Federal Reserve is tightening monetary policy. That has spooked tech investors.
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Tech investors have been taken on a wild ride, and strategists at UBS suggest they should keep their seat belts fastened despite a moment of relative calm late last week.
Investors wanting an explanation need to look no further than monetary policy. Faced with high inflation, the Federal Reserve has signaled that it will soon raise interest rates and, later, reduce its balance sheet, removing liquidity from markets. Traders expect four or five rate increases this year, with the first in March.
This makes it a resoundingly bad environment to be an investor in high-growth companies like those in the tech sector. The prospect of higher interest rates has ushered in a surge in bond yields, which is expected to continue.
Higher long-duration yields reduce the discounted current value of cash that will roll in years from now, and the prices of many tech companies are based on those future profits. The yield on the benchmark 10-year U.S. Treasury note closed out 2021 at 1.51% and got close to 1.9% over the course of January. It was sitting above 1.8% on Monday.
Wall Street’s so-called “fear gauge”—the Cboe Volatility Index, or VIX—was at its highest level since late 2020 last week.
“Volatile trading looks set to continue,” said a group led by Mark Haefele, the chief investment officer at UBS Global Wealth Management, in a report Monday. “Investors will continue to grapple with higher rate expectations and geopolitical risks on one side, set against robust macroeconomic and corporate fundamentals on the other.”
But Haefele and the rest of his team at the Swiss bank continue to be bullish on the whole. “A bull case might seem hard to envisage at such a turbulent time for equity markets, but if inflation starts to retreat, markets could go back to viewing the Fed as flexible and responsive to financial conditions,” the group at UBS said.
However, before things gets better, they could get much worse, especially if bond yields keep rising, the team said.
“Further declines remain possible as government bond yields rise. Our analysis of the global tech sector suggests that a further derating of 6–8% is possible based on rate considerations alone,” said Haefele and his team.
“The sharp fall in many high-quality tech firms is already creating opportunities for longer-term investors to add exposure,” the strategists said. “Rather than giving up on tech in the face of near-term headwinds, we recommend a more selective approach.”
The bank’s preferred stance on tech, as Barron’s reported earlier this month, is away from megacaps like Apple (ticker: AAPL) and Tesla (TSLA), and toward players in artificial intelligence, big data, and cybersecurity. They added 5G stocks to that list in their Monday note.
“Buy the winners from global growth,” they added. Despite the volatility, UBS sees underlying economic growth remaining robust in the first half of the year, helping cyclical stocks. Haefele’s favorites are Eurozone equities, energy, and commodities.
In addition, the Swiss bank suggested investors balance their portfolios with the global healthcare sector, which they said is relatively cheap, as well as dividend stocks.
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