You've gotta feel for
and his chums on the
Federal Open Market Committee
. Fueled by a big run-up in tech, the stock market goes higher. Those gains keep the consumer buoyant and thus send the economy skipping along at a too-quick pace -- despite the
But the funny thing is that those interest-rate hikes may be a big reason money keeps heading into tech.
It's no secret that, outside of technology, things haven't been so hot in for the stock market. Though the
Nasdaq Composite Index
has tacked on about 63% since the Fed began this rate-hike cycle on June 30, the
New York Stock Exchange Composite Index
has actually fallen about 7% over the same period. Chart the stocks in the
on an equal-weighted, rather than a capitalization-weighted, basis from the June Fed meeting, and the index has fallen 5%. Strip out technology and it gets worse -- it's dropped 17%. Not that any of this matters when it comes to talking about wealth. Tech stocks carry such large capitalizations relative to most of the market that gains in them have overwhelmed the losses in other areas.
That tech has run higher against a Fed that is tightening does not necessarily mean, as the chairman might be wont to say, that investors are being irrational. Compared with the rest of the market, technology companies are very well insulated from rate increases in the current environment. Because they have tended to raise money in the stock market rather than at the bank window, they carry very little debt. And unless the rate environment becomes truly onerous, corporations probably will not let up on their technology spending.
"For the most part in this cycle, it's really paid to increase your technology spending," says Mitchell Held, economist at
Salomon Smith Barney
. Moreover, he points out, much of the world is playing catch-up with the U.S. when it comes to technology. "When you look at tech penetration ratios, it's higher here than elsewhere. If elsewhere is going to emulate us, elsewhere is going to have to boost their tech spending."
Interestingly, Salomon's economics group, which does the firm's S&P and sector profits forecast, does not look at interest rates for predicting tech earnings.
Paying Up for Growth
Investing is a relative game. When the outlook is rosy for corporate profits across the board, growth is cheap -- everybody has it. So putting money in companies that aren't so richly valued makes sense. But things change when the Fed starts hiking and you start worrying about future growth.
"If growth is getting scarcer, those that can deliver it get more valuable," says Jeffrey Applegate, chief equity strategist for
. And many of what were once considered growth stocks no longer fit the description. "Consumer staple stocks haven't been growth stocks for years," he says. "Drugs aren't growth, either. All the drugs can offer these days is the earnings growth rate of the market."
So to Applegate, it makes sense that the market has narrowed, and that tech companies, particularly the big tech companies that garner a lot of their profits overseas, continue to prosper.
Not everyone agrees with this.
Chief Quantitative Analyst Rich Bernstein points out that the long-term earnings growth outlook for the stocks in the
Merrill Lynch 100 Technology Index
has been decelerating -- company analysts still think profits will grow a lot, but not as much as in the past. So he thinks being overweight tech isn't a good idea right now.
"Whenever you have a rising-rate environment, you need incremental earnings growth to offset the effect of rising rates," he says. "What sectors have accelerating earnings growth? Basic industry and energy."
Bernstein may be quantitatively correct, although Applegate (his old boss at
) might argue that Merrill's tech index doesn't include a lot of new tech -- and that, in any case, analysts have never been able to predict long-term growth very well, particularly in tech. Still, it seems that in practice investors are more interested in buying absolute growth.
'This Potential Problem'
So long as that persists, tech may continue to do well while the rest of the market flounders. Tough times for the FOMC.
"The Fed has this potential problem," says Salomon Smith Barney Equity Strategist John Manley. "The very thing that has created this
wealth effect is the stuff that goes down most slowly when the Fed goes after it." Or, for that matter, keeps on going up, boosting America's stock portfolio, keeping consumer sentiment high and raising the prospect that inflation -- the thing that could force the Fed to really tighten the screws so hard that the economy would risk recession -- returns from its long hiatus.
How does the Fed get out of this? Raise margin requirements? (So far, it's rejected that as an option.) Hike rates aggressively now in hopes that the economy can take the blow? (Not likely unless we see some real inflation.) Somehow engineer a capital flight out of markets? (There can be a
wealth effect, too -- a sharp drop in the stock market could be deleterious to the economy.)
If you've got any answers, Alan Greenspan would like to talk to you. His office is in the Federal Reserve's
Marriner S. Eccles
building, which sits between 20th and 21st on C Street in Washington. He's got a busy schedule these days, but he could probably pencil you in.