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Business News/ Companies / News/  Elon Musk and Cathie Wood are almost right about the Fed
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Elon Musk and Cathie Wood are almost right about the Fed

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The two are correct in that higher rates are dragging down tech, but that is hardly the whole story.

Replying to an investor’s gripe in a tweet earlier this month over Tesla‘s recent stock drop, Elon Musk called the Fed the real problem.Premium
Replying to an investor’s gripe in a tweet earlier this month over Tesla‘s recent stock drop, Elon Musk called the Fed the real problem.

Some of tech’s biggest losers this year, including Elon Musk and Cathie Wood, haven’t exactly been poster children of successful investing lately. But, especially as tech stocks are starting to look pretty cheap, investors might want to heed at least some of their advice.

Both Mr. Musk and Ms. Wood have publicly blamed rising interest rates for their assets’ poor performance. Ms. Wood published an open letter to the Federal Reserve back in October warning that the central bank’s hawkish stance raised the risks of a “deflationary bust." Replying to an investor’s gripe in a tweet earlier this month over Tesla‘s recent stock drop, Mr. Musk similarly called the Fed “the real problem." As the return on risk-free Treasurys rises, he explained in another tweet, the value of owning more-risky equity assets drops.

The underperformance of Ms. Wood’s exchange-traded funds and Mr. Musk’s largest asset can’t be entirely blamed on the Fed. The ARK Innovation ETF has fallen 69% this year, while Tesla‘s stock is down 68%. The Nasdaq-100, a tech-heavy index that includes only nonfinancial companies, meanwhile, is down just 35%.

But the phenomenon these tech celebrities describe has broadly been true of late. A report published last year by Nasdaq Investment Intelligence on the interest-rate sensitivity of major indexes shows a negative correlation between the Nasdaq-100 and the average yield change of 10-year Treasury notes in 2021—a dynamic that continues to exist. This fits with what is taught in business schools and accepted across Wall Street: The valuation of growth stocks is tied to their future earnings potential, and as yields rise, the present value of those future earnings should diminish in value.

Of course, reality hasn’t always been quite so simple. Nasdaq Investment Intelligence actually found that the Nasdaq-100’s performance has been positively correlated with the yield on 10-year Treasurys over the past 30 years, except when rates get to a high range and keep rising. That could be because early on in rate-hiking cycles, the economy is performing strongly. What this suggests is that investors need to keep an eye on many macroeconomic factors, not just rates.

Even as we look forward to another year of potentially rising rates, some tech stocks are set to end the year looking almost irresistibly cheap. Take Facebook owner Meta Platforms, whose shares are currently fetching just over 14 times forward earnings, versus an average of nearly 29 times across the past 9½ years. Over the past few months, Meta has taken steps to right its business in a declining ad environment, laying off 13% of its workforce and cutting noncore projects. Indeed, JPMorgan upgraded shares of Meta to Overweight earlier this month, citing more-favorable risk/reward and valuation.

Ditto that for such stocks as Amazon.com, Airbnb and DoorDash, all of which have materially underperformed broader indexes this year, despite being businesses that, in aggregate, are still growing even on top of their respective pandemic surges.

To tech enthusiasts, these kinds of sales might look something like a New York City penthouse selling for under $5 million or an Hermès Birkin bag for a “mere" thousand bucks.

Just because something is cheap doesn’t necessarily make it a great investment. If the Fed suspends rate increases next year as many market watchers expect, tech stocks would be due for a bounce. But contra Mr. Musk and Ms. Wood, that isn’t the only thing weighing on the sector. Other macroeconomic factors need to be taken into account.

Meta said in October that it expects its largest-ever year-over-year revenue decline in the fourth quarter, down around 7% at the midpoint of its outlook. The company was clear that some of its performance is “just going to depend on the broader economy." In particular, the company stressed that worsening foreign-exchange rates would weigh on its top line.

Amazon similarly was clear on its third-quarter conference call that the broader economic environment would play a big role in its fourth-quarter earnings. The company highlighted “broad-scale inflation" and rising fuel and energy costs leading consumers to reassess their purchasing power, and corporations to reconsider their technology and ad spending.

Over the past two years, investors have been punished for forgetting that company fundamentals matter. Next year, they could be punished for forgetting the bigger story, too.

This story has been published from a wire agency feed without modifications to the text

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