Stock of the week: How to trade tech in an era of rapidly rising US interest rates
Last week gave us a clear idea of what themes investors are trading at the start of the new year. It was a rough first week for risky assets, with the tech sector experiencing the brunt of the sell off. The Nasdaq was down some 4.5%, while the Dow Jones fell a mere 0.3%. The contrasting fortunes between growth and value are clear to see: the Technology Select Sector SPDR Fund, which tracks a range of tech stocks, was down some 4.6% for the week, while the Financial Select Sector SPDR Fund, which tracks banks and other financial firms in the US, was up 5.4% for the week. The theme of the first trading week of the new year was clear: banks are in, while tech is out. But will this theme prevail?
Some may think that this week’s stock of the week is a contrarian pick, however, there are four compelling reasons to like Microsoft right now:
- Relative value tech: We mentioned in our 2022 outlook that tech could have a rough ride this year, but the market would start to differentiate between those tech firms that were trading on ridiculous multiples without posting actual profits, and those firms that have strong balance sheets, are profitable and have multiple earnings streams. For example, we prefer Microsoft over Zoom, and if you are a fan of the relative value trade, this one could work for you.
- Earnings outlook: This is incredibly important. In an environment where yields are rising rapidly and the market is rushing to catch up with a Fed that is showing signs of being more hawkish than the market had expected, you need to own resilient companies that can withstand both higher inflation and higher interest rates. Microsoft had an excellent 2021, and while we do not expect the company to repeat this feat, analysts still think that Microsoft can deliver double-digit returns in 2022. Added to this, Microsoft is also buying back shares regularly and it has successfully changed itself into a cloud and mobile-centric company, which is paying off handsomely. So, while there may be some headwinds due to the prospect of a Fed interest rate increase later this quarter, we still think that Microsoft is a solid company that traders, both retail and institutional, will want to hold in the short term.
- Yields could stabilise: The 23-basis point surge higher in 10-year US Treasury yields last week was an impressive re-pricing of US bond yields (prices fall as yields rise). Even after a weaker than expected payrolls report for December, the 10-year US Treasury yield touched 1.8% on Friday, although it fell back to 1.76% by the time the market had closed for the week. We doubt that we will see yields rise at such a clip this week, and Treasury yields could fall back slightly at the start of the week as we wait for testimony from Fed Chair Jerome Powell, who will appear at a Senate hearing on Tuesday. This hearing is hotly anticipated after last week’s Fed minutes revealed that the US central bank is also considering shrinking its $9 trillion balance sheet at the same time as it considers when to hike interest rates. We think that a more pragmatic Powell this week, who sounds ready to hike interest rates but not smother the economic recovery, could see US 10-year Treasury yields settle below the 1.75% rate. If Powell performs as we expect, then this could be good news for Microsoft. Rising US interest rates are not such an issue for Microsoft; however, it needs strong economic growth to grow in 2022. Thus, a moderate Powell may spook the less profitable end of the Nasdaq, however, it is unlikely to dent demand for Microsoft, in our view.
- The technical picture: As you can see in the chart below, Microsoft is at an important short-term technical junction. It’s recent drop to $314 is a key support zone that corresponds to the 61.8% Fibonacci retracement level from the 12th October low to the 22nd November peak close to $350. The fact that Microsoft’s share price stabilised on Friday around this key Fibonacci level and that its share price rose a touch even though the broader tech sector sold off, is also a sign that this stock could be ripe for a short-term recovery. Back in November, when Microsoft approached $350, some analysts were calling Microsoft over-valued, thus this recent sell-off will allow investors to enter into a long position at a much more reasonable valuation, which is another positive in Microsoft’s favour in our view.
As you can see, we are wary of tech in the current economic environment, however, we still like quality names. Thus, it could be time for Microsoft to recover this week.