Interest rates at the longer end of the yield curve have been going up sharply as of late. At the same time, the tech sector has been lagging value stocks by quite a lot. This dynamic is to be expected, since growth tends to perform best in a low interest environment.
But TheStreet’s Jim Cramer seems to think that the “funk” in Big Tech and FAAMG, including Apple shares, is overdone. Here is his take:
I am inclined to agree with Jim. Below, I explain why. As usual, I will explore the subject from the perspective of an Apple investor.
Why high rates could be bad
There are a few reasons why an increase in intermediate-to-long term interest rates could put pressure on the stock of a tech company. Let’s look at the main ones.
- Higher interest expenses: when yields rise, borrowing costs do as well. While most corporations hold fixed-rate debt, they inevitably need to pay the higher market price once the bonds reach maturity and need to be rolled over.
- Less incentive to invest: in a high interest environment, there is a higher opportunity cost to putting money to work (i.e. invest) in projects, like new product launches or increased production infrastructure. The appeal of high-growth companies is precisely this ability to invest in the business.
- Deteriorating market sentiment: something like the above happens with investors in the market. The higher the yields, the lower the incentive to move money to (i.e. invest in) risk assets, including growth stocks.
- Unfavorable market cycle: rising rates tends to coincide with an increase in economic activity (the stagflation scenario of the 1970s would be an exception). This environment is better for cyclical stocks, like banks and airlines, and less favorable to growth and tech stocks.
The Apple Maven’s take
If I go down the list above, I see very few (if any) reasons to be concerned about Apple specifically, or even the broader FAAMG group. First, the Cupertino company’s business fundamentals remain solid, and the future looks bright: 5G upgrade cycle, increased adoption of wearables, growth in services, etc.
The first bullet point is almost irrelevant for Apple, since the company holds more cash and equivalents than debt. If anything, rising rates could be good for the iPhone maker, because it can earn more on its parked reserves.
The second bullet would only make sense if Apple did not have several investable, secular growth opportunities to choose from beyond smartphones or laptops: mixed reality technology and devices, driverless and electric vehicles, etc. I do not believe that a few percentage-point increase in yields will convince Tim Cook & Co. to abandon their growth ambitions.
Finally, the third and fourth bullet points are a real risk to Apple stock, but one that I believe impacts only the short term. At some point, investors will probably rotate back to high-quality growth. This is one of the reasons why I believe that Apple is a good buy-and-hold on the dip, particularly below the $120 price tag.
One last word on Jim Cramer
There is one piece of Jim’s tweet above that caught my attention: “[the Big Tech selloff is caused by] algorithms set to the ten year and nothing else”.
What he probably means is that valuation models that discount cash flow at the ten-year rate or market timing models that use the ten-year yield as a buy or sell signal have been pushing tech lower. The selloff, therefore, seems to him more mechanical than driven by fundamentals.
I think that this is a great point, and Jim is probably right about it.
I wonder what people think of Jim Cramer’s views on Big Tech and my assessment of them. Is growth poised for a rebound? Here are the responses:
Read more from the Apple Maven:
(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Apple Maven)