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Why you should be wary of the tech stock bandwagon
After a strong year of tech stock gains, tech shares have been on a decline in recent weeks as increasing bond yields rattle equity markets.
Why you should be wary of the tech stock bandwagon
After a strong year of tech stock gains, tech shares have been on a decline in recent weeks as increasing bond yields rattle equity markets.
The rise in bond yields has had a strong impact on tech stocks, with the S&P/ASX All Tech Index losing 6.5 per cent so far this year as investors fled from stocks that could potentially appear overvalued if interest rates increase.
According to an expert, while this decline can be associated with a stock price correction, increasing bond yields have reduced the prospective value of profits made by growth stocks like tech companies, thus impacting their stock prices.
“What goes up must come down,” Dr Angel Zhong, RMIT’s senior lecturer in finance, told nestegg.
“This is also related to the increase in long-term bond yield, in particular the increase in the 10-year US Treasury yield reaching 14-month high,” Dr Zhong explained.
According to the market expert, the decrease in tech stock prices can be attributed to an increase in bond yields for several reasons.
Firstly, rising bond yields imply higher borrowing costs.
“Tech stocks and growth firms rely on borrowing to growth their business. Higher borrowing costs increase their expenses and funding constraints, thus affecting future growth,” Dr Zhong said.
Secondly, she noted, it’s important to remember that share prices reflect the present value of future cash flows.
“To estimate share prices, investors discount future cash flows using a discount rate. When the discount rate increases, share prices become lower,” Dr Zhong clarified.
And finally, relative attractiveness plays a key part in stock price movements.
“When bond yields increase, stock markets become less attractive as investors can also get decent returns from bond market,” Dr Zhong said.
At the time of writing, Wall Street tech rebounded slightly, with the tech-heavy Nasdaq rising 1.2 per cent to 13,378 points.
Commenting on this stock movement, Dr Zhong reiterated that “when bond yields increase, tech stocks price drop, when bond yields slip, tech stock prices increase”.
So, is now the perfect time to jump on the tech stock bandwagon?
Dr Zhong’s opinion is that it may not be the right time to buy.
“I believe that tech stocks are overly expensive and this is likely to be a bubble that echoes the dot.com bubble in early 2000s,” Dr Zhong opined.
“There are several large tech firms in the market with an expensive valuation without making any profits,” she concluded.
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