Market strategist: The issue with tech stocks is ‘simply one of valuation’

Simeon Hyman, ProShares Global Investment Strategist, joins Yahoo Finance Live to discuss how the market and investors may be expected to react to Fed Chair Powell's confirmation hearing, inflation pressures, interest rates, the tech sector, and the market growth outlook.

Video Transcript

ALEXIS CHRISTOFOROUS: I want to move to the markets now and bring in Simeon Hyman, global investment strategist at ProShares. Simeon, I want to start with what Fed Chair Powell said today at that confirmation hearing. Among the things he talked about, he said the economy is strong enough not to have to have all that aggressive stimulus from the Federal Reserve, and also basically said we're going to throw whatever it takes at higher inflation. If that means more aggressive interest rate hikes in the future, we're ready to do that. At this point, what is more important to this market, those interest rates hikes or normalizing the balance sheet?

SIMEON HYMAN: Let's parse this out for a minute. First, the inflation pressures are already subsiding a little bit. That old school measure, the Baltic Dry Index, which is a great measure of supply chain issues, is actually down 68% from its highs earlier in 2021. And even the ISM Manufacturing Prices Paid Index was at the lowest reading in quite some time. So inflation pressures are already mitigating. Again, Omicron wild card, but if we just-- if that comes to at least a reasonable unwind, we're in a decent place with regards to inflation.

Now let's talk about the Fed and what's important to markets. You can see I would argue from the equity markets that the equity markets are assuming that-- investors in the equity markets are assuming that inflation comes down to at least a low enough level to not bother stocks that much. Maybe that number is 3%, a little higher than the Fed's long-term average. But the Fed's activity, you need to split into two pieces.

Number one, before you get to the rate hikes, you have to talk about tapering and the new news of the last 10 days, an accelerated unwind of the balance sheet. That's going to allow longer term rates to rise, regardless of whether inflation comes down and regardless of whether and to what speed the Fed increases rates.

Ultimately, those actions in and of themselves might mean there don't have to be too many rate hikes. But even if there are two, three, or four rate hikes, they're unlikely to flatten the yield curve in kind of the Paul Volcker style because we've got the removal of QE and the unwinding of the balance sheet that removes those suppressions of longer term yields.

KARINA MITCHELL: Simeon, I guess, buy the dip is alive and well. You see this remarkable turnaround in tech, now up 181 points. It was in correction territory at one point yesterday. What do you make of that, and where does tech go from here?

SIMEON HYMAN: I think the perhaps misguided notion is this idea of duration in technology. So there's almost an overreach of trying to pretend that stocks are bonds. Well, the problem with tech stocks is they have really long duration. Think about what the shortest duration in equities might be. A stock with a PE of 10-- and please, nobody dot I's and cross T's and telling me I'm off by one-- would have a duration of somewhere around 10. Now the aggregate bond index only has a duration of about 5. So even the shortest duration, stocks still have lots of duration risk in them.

The issue with tech, I would argue, is not so much one of a little extra duration exposure because growth is further away, but it's simply one of valuation. And indeed those top, top-- the top heavy largest cap tech stocks perhaps just were a little bit of expensive going into the end of this year in the beginning-- end of last year and the beginning of 2022. But don't completely rule out good growth stories because that is the biggest defense against inflation. It is the growth of earnings and dividends.

ALEXIS CHRISTOFOROUS: When you think about fundamentals, we need earnings to come in strong in order to sort of feed the rally on Wall Street. Which sectors, or if you can share specific companies, do you think are best positioned to provide that strong profit report, even in the face of high inflation and rising wages?

SIMEON HYMAN: Yeah, I'll split it into a couple of places. First, quality is a little bit on sale because of how far those megacap tech names ran. So things like consistent dividend growers-- you've heard us talk about the S&P 500 dividend aristocrats-- they delivered almost double the dividend growth last year to the S&P 500. That's an important place that can thrive and deliver that dividend growth and earnings growth that will be really important.

Now there's also the cyclical opportunity. With interest rates, again, extremely likely to rise, given tapering and the unwind of the balance sheet, you still have an opportunity to look at financials, energy, and materials in places where let's say inflation stays not 6% or 7%, but maybe 3%, maybe even 4%. That's a place where those stocks can persevere.

And then finally-- this doesn't mean to stay away from technology-- you can look for some of, shall we say, the older school dividend growing technology plays. Consider equally weight opportunities to invest in technology. There's a flavor of dividend aristocrats, detective and aristocrats, where companies like Microsoft and Accenture live, things where, again, you have growth not just of earnings of dividends to be a testament to the defense against inflation and rising rates.

KARINA MITCHELL: Yeah, Simeon, we saw the 10-year yield stuck below 1.5 for the longest time, now seeing it rise. It touched 1.8. As these rates continue to rise, how important is it to consider valuation? Because, you know, last year, it was sort of close your eyes blindly and throw your money into anything you want, and it would stick.

SIMEON HYMAN: Well, remember, valuation has come down substantially because earnings growth was so strong. So the S&P 500 went from somewhere around 30 times to somewhere around 25 times. And with about a 15% consensus growth for 2022, you're looking at an S&P 500 that's somewhere in the low 20s. And if you scatter plotted those PE multiples against 10-year yield, that's where you get with about a 2% 10-year yield.

So at the risk of taking the average valuation-- and I had an old mentor who said, be careful of averages because if you have one hand in boiling water and one hand in a tray of ice cubes, on average, you're OK. But it is true that on average, even assuming rates rise materially to 2%, 2 and 1/2%, even 2 and 3/4%, valuations overall are not that stretched. But quality is a little bit on sale, and the mega cap techs are a little expensive when you parse it out.

ALEXIS CHRISTOFOROUS: All right, Simeon Hyman of ProShares, thanks for being on the show today.