PremiumWhen American stock indices sneeze, world bourses catch a cold. Quantitative easing, jargon for printing money, became a mainstream policy response to economic stress in the aftermath of the 2008 global financial crisis. After the pandemic struck, something like $14 trillion has been generated in extraordinary liquidity, bringing the world’s total cross border financial assets to $130 trillion, 153% of world GDP in 2020, reports the Economist.
Policy interest rates were held ultra-low by the central banks of developed countries. They also purchased government and private sector bonds, further depressing yields. As a result, even with inflation on the ascendant, the yield on German bunds has barely crossed into positive territory. Low yields have two kinds of effects on the supply of capital from developed countries to emerging markets. One, the likes of pension funds have to look outside their borders for decent returns; two, it is easy to raise funds to invest in emerging market ventures, whether by emerging market agents or by developed country funds.
Low yields boost stock valuations: the present value of the stream of future incomes expected from stock is inversely related to the discount rate used. If the interest rate is 10%, ₹100 today would become ₹110 next year. In other words, ₹110 a year from now is worth ₹100 today. If the discount rate is 8%, a net present value of ₹100 is derived from a valuation of ₹108 a year hence. When yields are ultra-low, stock values are ultra-high, and vice versa.
Now, the Fed is expected to raise policy rates at least three times in 2022. That means stock prices come under double downward pressures: from the pullback of some portfolio funds from emerging markets back to the home country, where the risk-free rate of return is now higher, and from the effect of a higher discount rate. Stock markets have been receding from their liquidity-driven highs, in anticipation of rate hikes by the Fed and the Bank of England, with the European Central Bank and the Bank of Japan expected to follow with a lag.
Tech stocks behaved as if they swore by the Olympic motto: faster, higher, stronger. When the pandemic forced everyone to work from home, businesses had to, perforce, go digital. All kinds of tech companies gained, from videoconferencing utilities to service providers who helped companies that had dragged their feet on tech adoption migrate their businesses to the cloud. The clutch of five companies dubbed Big Tech — Apple, Alphabet, Microsoft, Amazon and Meta (called Facebook till recently) — gained the most, with companies like Zoom and Netflix tagging along. Tech now accounts for 27.5% of the S&P 500, double the share of the next largest group.
Just as tech gained faster than other classes of stocks, it is inevitable that when markets correct, tech should fall faster than the rest: companies that had had their business repressed by the pandemic are now raring to go, while over-reliance on Big Tech is coming down. In addition, there are fears that Big Tech would face a regulatory crackdown, sooner or later, depressing their valuations further. Because of their bloated weight in the index, a tech correction translates into an overall correction as well.
Since markets across the world move in sync, tech correction in the US has been accompanied by tech correction in India, although without any rational basis. Indian software service providers do not have to worry about anti-trust government crackdowns, nor of a talent crunch, nor would emergence from the pandemic truncate their growth opportunities. If Meta plans to invest $10 billion in the near future in developing the metaverse and could lose that money if the synthetic cyber universe does not take off, Indian tech companies do not face such threats. If Big Tech is the eager-beaver gold prospector, Indian tech companies are the suppliers of the picks and shovels, guaranteed an income regardless of whether the prospectors strike it rich or not.
The prospects of Big Tech making significant advances in technology remain bright, given their heavy investment in artificial intelligence, health, quantum computing and communications.
Global markets also register geopolitical tensions. The faceoff of the West with Russia over Ukraine has contributed some downward pressure on stock prices.
Rate hikes stemming from rebounding growth and inflation set the stage for a correction in bloated stock valuations around the world. Global recovery would improve corporate bottom lines, buoying stock prices. These two counteracting forces will determine where stock markets end up. So, even if there is some near-term correction, the medium-term prospects remain bright. Especially for technology companies that have been investing massive amounts in what they consider to be technologies and business opportunities of the future.
India remains a growth story, notwithstanding temporary setbacks. That would provide a backstop as stock prices slide in response to Fed rate hikes.
