(Bloomberg) -- Betting on whether the good times roll on for the Nasdaq 100 index hinges on two points: that the Federal Reserve is done raising rates this cycle and that the economy avoids a recession.
There’s some sense that the first requirement is already in the bag. Inflation is down to about 3% and swaps markets show investors expect the Fed’s next move to be a cut, not an increase.
“The tech sector has absolutely 100% certainty that rates will not go any higher than where they are right now,” said Brian Mulberry, client portfolio manager at Zacks Investment Management. “Now, it’s simply a race to the first cut.”
The second one is less certain. Yes, economic data in recent weeks has shown an economy that’s growing more slowly but still resilient. There are various reasons for the central bank to dial back its target, but chief among them is that the economy needs juicing. That would bode poorly for large swaths of the tech sector, particularly smaller, unprofitable companies that depend on financing that has become a lot more expensive to fund operations.
“It’s a two-edged sword because if they’re cutting it’s also an indication that maybe we’re moving into a recession,” said Greg Marcus, managing director of UBS Private Wealth Management.
Big Tech investors have cheered as US Treasury yields dropped this month. Apple Inc.’s market value is back near $3 trillion and Microsoft Corp. isn’t far behind. The Nasdaq 100 is up more than 46% so far this year and within a few percentage points of a record high, with megacaps soaring on rising profits and bets that the largest tech firms will reap the biggest gains from demand for generative artificial intelligence applications.
Microsoft Record Leads $1.5 Trillion Nasdaq Surge: Tech Watch
The rally has proven that a 4% yield on the 10-year Treasury isn’t the kryptonite investors thought, after the level prompted much hand-wringing last year as the Fed embarked on an aggressive campaign of interest rate hikes. Even as rates topped 5% last month, the stocks took a breather but didn’t cave.
“The idea was that higher rates would hurt Big Tech because of the way people value long-term cash flows,” Jay Pelosky, chief investment officer at TPW Investment Management LLC, said in an interview on Bloomberg Television. “The reality of today is that big-cap tech are money making machines and they are printing money on top of the money they’ve already printed.”
The view for smaller companies is a lot less sanguine. While lower rates would mean cheaper loans, rate cuts also signal an economy in trouble, a backdrop that’s more difficult for less-mature companies more dependent on debt.
Still, if the Fed is able to pull off a soft landing and decides to lower rates without the threat of a recession, that could help smaller companies.
“When rates do actually start to come down, then we start to see that as more of a tailwind for growth and an uplift for the broadening of the sector,” said Mulberry.
Until that happens, however, he sees gains in technology staying narrow and focused in companies with large balance sheets and cash flows.
Tech Chart of the Day
ASML Holding NV’s shares have booked a tenfold gain over the decade-long tenure of outgoing Chief Executive Officer Peter Wennink, easily outperforming the Philadelphia Semiconductor Index over the period, and about in line with more direct peers, like Applied Materials Inc. and KLA Corp. The chip-equipment maker’s shares have soared about 930% since Wennink took the reins back in July 2013, helped by booming demand for semiconductors for use in smartphones and computers.
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Earnings Due Thursday
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--With assistance from Subrat Patnaik, Kit Rees and Rheaa Rao.
(Updates stock moves at market open)
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