Tech Stocks Feel The Pain As Fed Plans Raise Hikes In 2022

The last Fed meeting signaled hikes were on the cards for 2022, and the minutes released today from the December Fed meeting made that picture a little clearer. It’s not good news for growth stocks such as the tech sector.

Fed Minutes

The minutes show that the Fed views the labor market as “very tight”. In addition, policy makers have revised up their inflation forecasts. The Fed’s goal of having inflation exceed 2% has been “more than met” according to the minutes from the December meeting. This is perhaps not surprising with inflation running at over 6% currently, though most expect that to moderate as supply chain pressures ease.

Price Stability

The Fed’s goals are maximum employment, stable prices and moderate long-term interest rates. Employment isn’t a concern currently so the Fed should pat itself on the back for that. However, prices are rising far more than the Fed would like, hence the logic for a rate increase is clear. The Fed needs to get inflation under control.

Policy Options

The main nuance is the Fed’s large balance sheet today after all its asset purchases. There is a trade-off between raising rates and reducing the size of the Fed’s balance sheet, which the Fed is considering. Either way higher rates are likely to form some part of the Fed’s approach.

Likely Rate Moves

The CME’s FedWatch tool breaks down what the bond market thinks the Fed will do in 2022. There are a range of outcomes. The most likely path today, which is still far from certain, appears to be 3 hikes in 2022 with one in March, June and November 2022. That said, there are still a broad range of outcomes and the market currently sees a fair chance of anything between one and five rate increases in 2022, very likely subject to economic data over the remainder of the year.

Impact On Tech

Now unfortunately, rising rates are generally not good for stocks. However, tech stocks to appear to suffer disproportionately as the Fed becomes more hawkish.

The reason for that is tech stocks are generally trading at higher valuations compared to their current earnings. That means that the market expects most of the return from the likes of Apple

AAPL
, Amazon and Microsoft

MSFT
to be earned many years from now given relatively lofty valuations in today’s market.

Discounting

Those expected profits must be discounted back to today, and often the level of interest rates is part of that discount rate. So when rates rise, those future earnings become worth less in today’s money.

That matters particularly to tech stocks as opposed to, say, coal mining companies, because tech stocks tend to have more long-term earnings in the market’s view. For example, today many tech stocks trade at 30x there current earnings or more. It requires many years of growing earnings for that to be a good investment. Yet, should the Fed raise rates, then the value of those future earnings declines. So the Fed’s potential moves may be disappointing for the stock market, but particularly for growth stocks.