Can the new era of interest rate hikes keep tech stocks derailed?

The new era of tightening monetary policy and higher interest rates has crippled growth pockets of the market, most notably tech stocks. 

As interest rates rise, there’s an expectation that safer assets will become more attractive and re-rate richly valued and at times, loss making tech companies. 

This theory has so far held true, with heavyweight tech names like Xero (ASX: XRO), Altium (ASX: ALU) and NextDC (ASX: NXT) down -32%, -27% and -16% year-to-date.

It's not that bad

While several individual tech names have been battered, the S&P/ASX 200 Info Tech Index sits somewhere in the middle of the 10 other major sectors.

Since February 2020:

• Materials +30%

• Tech +11.1%

• Consumer Discretionary +8.4%

• Financials +3.9%

• Energy -9.2%

More pain ahead?

The US Federal Reserve raised interest rates for the first time in three years last Wednesday and what did the stock market do? 

It rallied.

The 25 bps rate hike was widely expected and the market has largely 'priced-in' seven 25 bp rate hikes this year.  

Between December 2015 and December 2018, the Fed raised interest rates 8 times from 0.25% to 2.5%.

Source: TradingView (Annotations by MarketIndex)

Between the first and the last rate hike, the S&P/ASX 200 Info Tech Index rose around 28%.

Over the same time period, the ASX 200 was up 7.1%, while other sectors varied in performance. Financials were down -7.2%, Consumer Discretionary up 6.8% and Materials rallied 64% (thanks to higher iron ore prices).

The Fed raised interest rates in 2015 on the basis that "economic activity will continue to expand at a moderate pace and labour market indicators will continue to strengthen".

While rate hikes are designed to take some heat out of the economy, strong economic conditions continued to prevail, which helped buoy company earnings.

A similar scenario played out between June 2004 and June 2006 where the Tech Index rallied 80% despite 16 rate hikes.

S&P/ASX 200 Info Tech Index 2003-2008 (Source: TradingView, annotations by Market Index)

The Fed's recent rate hike was on the same premise of solid economic growth and an "extremely tight" labour market.

However, ongoing supply chain issues and surging commodity prices poses a significant risk to the economy. High inflation curbs consumer purchasing power, elevates input costs for businesses, which could ultimately lead to "demand destruction".

So far, reports like China's Jan-Feb retail, industrial and fixed investment data as well as US jobless claims have exceeded economists expectations.

However, upcoming data will likely reflect the recent spikes in commodity prices, will be key in telling us whether or not the consumers, business and the economy remains intact.

Equity markets could be in for a double whammy in a world where economic conditions deteriorate alongside aggressive interest rate hikes.