The recent tech sell-off: Opportunity or a Wake up call?

I have been reading about the tech stocks sell-off and its relation to the rising yield on the 10-year US Treasury note (which acts as a benchmark for global borrowing rates).

Many people are asking what they should do, and should they be concerned.

My personal view and quick answer to the above question, is one should not be too concerned. However, as with everything that is related to stock investing, the longer answer needs a bit more elaboration.

The yield of the 10 year US Treasury note as of writing is now 1.591%, and has been steadily increasing since Aug 2020. Since the start of 2021, the rate of increase has accelerated.

Why this rate-driven sell-off is hitting tech stocks hardest (read here)

The above article helps to explain why the increasing yield has a pronounced effect on tech stocks, namely:

1) The market is a discounting mechanism, and using the Discounted Cash Flow model, the higher rates go, the lower the present value of the future stream of earnings of companies. This is more pronounced for high-growth equities like many technology stocks.

2) Bonds are competing with stocks as an investment, and with rising rates, bonds are starting to become more attractive.

It appears logical. Oh dear.

Past History

If we look at the recent yield chart of the 10-year US Treasury note, we can see that over a 1 month period. it has been increasing upwards. See below.

On the other hand, if we look at the tech heavy Nasdaq, over a 1 month period, it has been trending down. See below.

So given all the news that we have been reading it does appear that 10-year US Treasury note yield has an effect on tech stock prices.

However, let’s extrapolate these two charts further back: Using the 5 year charts for both (10-year US Treasury note yield & Nasdaq). See below.

As you can see there is an ‘almost’ smooth upward trend for Nasdaq, with some ‘hiccups’/ low points in Dec 2018 and March 2020. However, in the case of the 10-year US Treasury note yield there is really no consistent trend.

Next if we superimpose both charts, it is really hard to find any defining pattern.

True, there are periods whereby a rising yield trend led to a drop in the Nasdaq (see period 1 – before 2018, and period 2 – Sept 2018, and a dropping yield is in step with the rise in Nasdaq (see period 3 – after early 2019). See below.

However, we could also argue that in the periods A (2017 to 2018) and B (mid 2018), yield was range bound but Nasdaq kept rising. In period C (late 2018), a dropping yield did not result in a rising Nasdaq. In period D (which we are more familiar with), a rising yield did not result in a dropping Nasdaq.

In fact, throughout history there are many market corrections and crashes, and these are caused by a myriad of factors. The 10-year US Treasury note yield does not factor much in those, more of an after effect, IMHO.

In addition, many of us are unable correctly predict what will cause the next crash or correction.

Way forward

My opinion is that we are all different (in character and with regards to our portfolio). There is really no one strategy that fits all.

Nevertheless, there are a few points which I think we as investors should ask overselves.

1) Do you view this tech sell off as an opportunity or as something that keeps you awake at night. For me as I have only a small percentage of my portfolio in tech stocks, I view it as a blessing.

If you feel that it is something that keeps you awake at night, and fear further drops, perhaps you have too much of your portfolio in risky speculative tech stocks. Hence, it might be advisable to adjust your stock portfolio proportions. To have a more diversified portfolio (between more speculative and less risky assets). Eg. include a mix of bonds, REITs, slow growth dividend stocks, etc.

2) Do you have high conviction in your holdings. Typically I believe in a bottom up approach. For example, I need to know the financials and business of the companies behind the stocks before I invest. So that I have more conviction in holding it long term and not be swayed by macro market movements and negative outlooks, provided the fundamentals of the companies are still sound.

The issue with tech stocks, especially small, newly listed, high growth but loss making tech stocks is that it is hard to value these stocks.

Why you shouldn’t use the P/E ratio to value every stock (read here)

In the article above, it mentions that we should look beyond P/E ratios and look at price-to-cash-flow (P/CF) ratio. For a company that generates a consistent cash flow but low earnings, it’s more appropriate to use the price-to-cash-flow (P/CF) ratio to determine the intrinsic value of the company.

Now, even with this, at these times, with many popular high growth tech stocks, even using the P/CF ratios, they still appear expensive. For instance, looking at The Trade Desk, the P/CF ratio is 97.4 (at the time of writing) as shown in this site. Compared to the April 2020 ratio, it is low. However that is only till April 2020. In addition, 97.4 does not appear cheap to me. See below.

If we compared its P/CF (and for that matter its other valuation metrics) to the industry and sector, it appears high. See below. Click here.

So yes, hard to value, and what do you rely on for conviction?

Moreover many of these tech companies’ headquarters are in the US, and their operations / business are not as transparents to us retail investors in Singapore. For instance, I would say I am more familiar with Sheng Siong as a company than The Trade Desk. The former business is more transparent, tangible and easy to understand.

Of course, different people have different circumstances. For example, you may be working in the tech industry, so it is within your circle of competence.

3) Your past experience could have an impact. Another way of saying, is anchoring bias. Let’s use an extreme example. There is this group of investors, some call them the 2020 Spring investors. Typically young newbies who just started investing from March 2020 onwards. Their timing is impeccable, and they chose the right sector (tech) to invest. So it has been a rather smooth journey until the tech sell off recently.

There is a saying – they say the worst that can happen to a newbie gambler is to win big on his first time in Vegas. He get lulled into this belief that high rewards is easy. Everything he touches will turn to gold.

Well, on another note, there is a difference between investing and trading.

So back to these group of investors, perhaps they are not used to such volatility given their past experience (probably less than a year). In addition, many really did not know how to value tech stocks nor understand what they are investing in (or shall I say trading in).

4) We can’t predict yield. There are many factors that affect the treasury yield rates, and really it is beyond us. To put it simply, we can only fret about stuffs we can control. Yield rates are like the weather. Well, on the other hand, you can choose to go down the rabbit hole and ponder about what will move rates next (see below article).

On another level, as mentioned earlier, many factors influence the stock market movement not just yield rate.

Understanding Treasury Yield and Interest Rates (read here)

In gist

I am just sharing my thoughts. Your situation might be different from me eg. age, portfolio proportion, past experience, etc.

Personally for me, my approach will be to take this as an opportunity, and slowly DCA into tech stocks which I have a high conviction in. Nevertheless, my warchest is low and hence, I would prefer to wait and see.

Even recently, there are news to include more tech stocks (eg. Sea Ltd and Razer Inc) into the MSCI Singapore, which will make it more current and up to date (thought more volatile).

Potential listing of Sea on MSCI Singapore will bring tech exposure and visibility to Republic (read here)

Tech Stocks Slowly Gaining Prominence in Singapore’s Market (read here)