Tech stocks fall amid fears of rates increase. Recently, the momentum stocks have lost some value. What is the reason for this? Do tech companies sink when interest rates rise? And if so, why do tech and growth stocks in particular decline when interest rates rise and not other companies as well?
Tech or growth companies lose value, but the drawdown differs
Growth and tech stocks, in particular, have lost value in recent weeks. However, the loss in value varied widely. Plug Power, for example, lost almost half of its market value, while Microsoft’s loss was limited.
We must view losses in relation to past performance
However, investors must view plug Power’s losses in relation to past performance. The shares are still up more than 1000 percent since January 2020. Therefore, an investment of 100 USD/EUR would have increased more than tenfold despite the loss of 50 percent. Tesla is still up 600 percent compared to January 2020, and the Salesforce share has gained 30 percent in value during this time.
Why do growth and tech stocks fall when rates increase?
But why are tech and growth stocks losing some steam on their peak path right now? Of course, it’s because of the fear of rising interest rates. Rising interest rates, first of all, have thoroughly historical relevance in connection with recessions, which could weigh on the entire stock market and thus also cause selling pressure on growth stocks. Below you can see how phases of interest rate hikes have almost always led to recessions (the recession phases are shown below in gray bars).
As rates rise, other forms of investment become more attractive. Interest is nothing more than the cost that a debtor must incur to borrow money. In this respect, all forms of investment in which one party lends money to another are interesting, especially bonds. Investors could then withdraw their money from the stock markets, which could also trigger selling pressure.
Making debt is especially bad when rates are rising
However, rising interest rates are particularly problematic for companies that are not profitable. Such companies need capital. When interest rates rise, the costs that companies have to pay for borrowed capital increase. Even an increase from 1 percent to 2 percent would double the interest burden. Imagine what would happen to these companies if they had to pay four or even 5 percent interest on borrowed capital.
Many unprofitable companies could then no longer survive. At the very least, the risk of their failure increases. Growth companies from the tech sector are most affected by this. Especially after a company has been established, expenses are very high, and the income relatively low, which squeezes the profit margin. The business model of companies should therefore depend on debt capital in the long term.
Other companies could benefit
Profitable companies are less affected by this risk. If they operate in the same sector, they even have an advantage over the unprofitable companies because they save the cost of borrowed capital.
So you can see why my readers and I put a lot of emphasis on the profitability of companies. After all, growth isn’t everything. It has to be built on a stable, profitable foundation. Below you will find some exceptional companies with very little interest-bearing debt that even pay a decent dividend. Accordingly, interest rate increases would not affect these companies at all.
|Dividend Paying Company||Debt ratio – interest bearing||Dividend Yield|
|Procter & Gamble||13.5%||2.5%|
|Johnson & Johnson||17.04%||2.70%|
We are responsible for our investment decisions
We are responsible for our investment decisions. That doesn’t mean we control what happens in the stock markets, but we can choose the risks we want to expose ourselves and our assets to. I’m a big fan of profitable companies that pay a dividend and are on an excellent financial footing.
I leave these companies dormant in my portfolio and buy more shares now and then. These anchor companies or core investments give me a monthly cash flow. They make me independent and let me sleep soundly. Besides, I also invest in other growing but not yet profitable companies. However, these are not core investments for me, but (as I call them) satellites that orbit my anchor companies.
You see, each investor must choose the strategy with which he or she feels comfortable. From my perspective, however, it is essential to be aware of the risks you cannot control. Rising interest rates are a risk. Once for the performance of the stock markets and once for individual companies.
Regarding the overall risk, I accept that the performance of the stock markets could suffer when rates rise because it is only of secondary importance which asset class currently brings the highest return or whether bonds become more attractive again alongside equities. I want to be the owner of great companies. That’s why I invest.
Concerning the specific risk for individual companies, I am more selective and critical. If companies whose business model is only on shaky financial ground, I invest only small positions and thus keep the risk limited.
This is how we do it. And no matter which path you choose, I wish you nothing but the best!
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