October 17, 2021

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Tech stocks’ correction threatens Wall Street rally; here’s why

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Wall Street investors dropped expensive tech stocks on Tuesday, and indices stumbled in what was the sharpest pullback in the market since May this year as Treasury yields traded near three-month highs.

Experts and market watchers believe tech shares are currently overvalued and this once again gave Nasdaq a shock as the index slumped as much as 3 percent after statements by Federal Reserve officials.

The officials concurred US economy was close to exhibiting “substantial further progress” but also indicated a moderation in asset purchases might be around the corner. The stalemate in US Senate over raising the debt ceiling did not help investor optimism either.

Why are investors worried?

Analysts say investors have a lot to be worried about as treasury yields rise. Yields have been surging for the past four days as investors prepare themselves for the hawkish turn of the Federal Bank’s monetary policy.

Yields on government securities — that move inversely to bond prices — have risen almost dramatically since the central bankers in the Federal Reserve and the Bank of England indicated interest rate hike is very close as inflation continues to rise.

While investors were trying to match their portfolios with Fed’s commentary, yields of the five-year treasury rose to the highest level in a year. This means investors are indeed worried about sluggish growth and higher inflation.

The yields on 10-year treasuries also rose to levels not seen since June. This yield acts as a benchmark for borrowing costs for companies and households worldwide.

As yields move higher, the losses were majorly centred in the tech sector.

Also Read | As S&P 500 suffers worst slump in 4 months, a look at Wall St’s wildest days in past 10 years

For much of the decade gone by, investors stocked the stocks of fast-growing technology companies, betting they would deliver robust returns. Even when the economic environment wasn’t much robust. But supported by near-zero interest rates, investors piled them.

Now that bond yields are rising, these overvalued tech stocks are the first that investors drop as the returns in the treasuries become more attractive. Plus, when interest rates will eventually rise, which going by the Federal Reserve will happen ‘very soon’, investors will dump the richly-valued tech stocks as their valuations are not fundamentally sound.

The valuations of tech stocks are tied to the company’s prospects for growth years into the future. If interest rates and inflation both are rising, investors won’t be very optimistic about their future growth.

Also weighing on investor sentiment is the showdown in the US Senate. Investors were looking forward to a resolution to avoid the possible shutdown and default. Senate Republicans, on the other hand, blocked the bill that would have avoided that.

Also Read | Explained: Why the US government could shut down this week and what would happen

The bill would have funded the government into December, suspended the US debt ceiling until next year, and helped Democrats avoid economic calamity. They still have until Friday to avoid the calamity though.

“The Washington goings-on certainly don’t help, as we have a lot of uncertainty around tax policy and of course, the debt ceiling,” Jeff Buchbinder, an equity strategist with LPL Financial told CNBC.

Some analysts noted concerns about global power shortage, supply chain issues, and rising consumer prices might have contributed to the sharp sell-off.

The Fed Chair Jerome Powell also told Senate Tuesday that inflation could persist longer than expected due to reopening pressures and disrupted supply chains. He did say the inflation abate, it would just take a little more while.

Having plunged nearly 5 percent this month, Nasdaq has shown some strength Wednesday, trading in the positive territory. European stocks too are surging almost half a percent, but choppy trading in Asian markets continued. Shares in Japan slumped over 2 percent.

Also Read | We may be worrying about rising Treasury yields, here’s why

What about Indian markets?

Investors on the rest of the continents looked worried Tuesday, with Asian markets extending losses in the Wednesday session as well, reflecting the interconnectedness of the global markets.

Over here in India, while the share market didn’t seem too bothered, the currency and bond market reacted.

Indian bonds rose and the rupee weakened to its lowest level in a month on Wednesday. As the narrative of the Fed unwinding its bond purchases gains popularity, the momentum is lifting the dollar and sinking rupee.

The 10-year bond yield was down 2 basis points in India, tracking the US yields and fall in global crude oil prices.

Also Read | Explained: How rising bond yields impact stock markets

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