Even if one buys into the view that the current inflation spike is transitory and that the Fed is becoming too hawkish, a lot of the big rotational moves seen in the tech sector between Thursday and Friday were still arguably questionable.
To recap: After rising on Wednesday, longer-dated bond yields tumbled on Thursday and Friday, as investors took the Fed's Wednesday inflation commentary and growing expectations of 2023 rate hikes as a signal that the economy will be cooled off by tightening monetary policy sooner than hoped, thus leading to lower rates rather than higher ones over the long-term. Along the way, various stocks seen as commodity, cyclical and/or value plays also sold off, as did many tech companies whose fortunes are seen as being strongly tied to improving macro conditions.
Meanwhile, high-multiple tech companies seen as likely to be secular growers in the face of a tightening Fed (think cloud software firms, high-growth consumer Internet companies, etc.), and which benefit more from having a lower long-term discount rate for their future cash flows, were bid higher. And some (though not all) of the EV/clean energy names that had previously been bid to the moon by retail investors rallied as well.
Of course, if one thinks inflation is something more than a transitory problem caused by post-pandemic supply/demand imbalances that will soon be fixed, a lot of the moves that happened in equity and bond markets on Thursday and Friday will seem utterly irrational. And the Fed's Wednesday remarks won't be taken as a sign that policymakers will be prematurely ending an economic boom out of over-caution, but rather as a sign that a central bank that has been incredibly dovish and printed unprecedented amounts of money over the last 15 months is finally facing the music a little bit about the macro consequences of its actions -- and perhaps still not fully facing it.
As I discussed a week ago, dismissing inflation fears because one believes prices for things like used cars and ride-sharing services will cool off might amount to missing the forest for the trees. Between current personal savings levels, interest rates, bank deposits, labor demand, housing inventory and wealth effects, as well as how the rebounds taking place in consumer services spending and spending by pandemic-impacted businesses still appear to have a ways to go, there are a lot of reasons to think that inflation could further accelerate in the back half of the year even if prices for used Hondas and Uber rides are lower in December. And perhaps now, at least some Fed bankers are cognizant of this risk.
But suppose, for the sake of argument, that the transitory-inflation argument proves correct and the Fed is poised to cool off an economy that would otherwise see healthy growth with low inflation in 2022/2023. If that proves the case, many of the tech-stock moves seen on Thursday and Friday would still look pretty suspect.
Regardless of whether the 10-year Treasury yield happens to be at 1.4% or 1.8%, a lot of the software and Internet companies that rallied sharply on Thursday and Friday -- companies that often have forward EV/sales multiples above 15 and forward EV/gross profit multiples above 25 -- would still look pretty expensive. And even if these companies would be relatively less affected by cooling macro conditions, they'd generally see some impact.
Meanwhile, many of the tech names that sold off over the last two trading days sported far lower valuations. By my count, at least 25 tech firms with forward P/Es below 20 -- mostly chip and hardware companies -- were down more than 3% on Friday.
What's more, declaring that all of the cheap stocks that sold off would see their growth crippled by a tightening Fed would be as mistaken as declaring that all the expensive ones that rallied would see their sales unaffected by a tightening Fed.
For example, some of the chip equipment names that fell hard on Friday, such as Applied Materials (AMAT) and Lam Research (LRCX) , are poised to benefit long-term from secular trends such as rising semiconductor capital-intensity, investments in localized chip manufacturing supply chains, massive cloud capex and growth chip content within cars. Likewise, some of the chip developers that sold off, such as II-VI (IIVI) and Analog Devices (ADI) , could still see meaningful growth due to secular demand drivers even if macro pressures weigh on some of their hardware end-markets a little.
In this context, what happened on Thursday and Friday was really a case of factor investing run amok. To a large extent, markets weren't thoughtfully gauging what individual companies should be valued at in the wake of the Fed's announcements, but mindlessly shifting money away from companies associated with industries and/or valuation profiles that are seen as relatively less attractive in a tightening monetary environment, and towards companies associated with industries and/or valuation profiles that are seen as being relatively more attractive in such an environment.
And quite possibly, much of this behavior was amplified by options expirations, given that Friday was a historically huge expiration day and many high-multiple/high-beta tech names had already seen large gains over the prior few weeks.
Either way, I think there's a strong case for avoiding the temptation to chase after the expensive names that got bid to even higher multiples on Thursday and Friday, and instead comb for bargains among the stocks that were sold off and/or selectively look for shorts among high-multiple stocks. And that's even if one believes equity and bond markets are correct in being fairly unconcerned about inflation.
