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Why tech stocks hate higher interest rates

Yahoo Finance Live’s Julie Hyman breaks down today's Morning Brief topic on why the Fed raising interest rates has been a problem for tech stocks.

Video Transcript

- The NASDAQ is off to a strong start this year as investors look ahead to the central bank's pivot towards a pause. But what does it mean for big tech companies? Julie Hyman dives into the feud between tech stocks and higher interest rates in today's Morning Brief. Julie.

JULIE HYMAN: Obviously, this is something that we have been talking about pretty consistently, right? That higher rates last year is one of the things that really damaged what happened with tech stocks. Of course, it helps to take a step back and look at what happened before when rates were very, very low and the NASDAQ kept rallying and rallying and rallying.

This was a very long period. Basically, the NASDAQ 100 bottomed back in 2008 and then had about a 1500% rally, outperforming the S&P 500, outperforming the Dow in the ensuing years as we had rates that were very, very low. And why, exactly, was that? Why were we seeing rates that were low that were benefiting growth stocks and tech stocks?

Specifically a lot of different reasons why. But the folks over-- let's take a look at some of the reasons why and, now that we are seeing rates go up, what effect that's having. Now, there's a higher cost of capital, right?

So a lot of these growth stocks borrow, or it's perceived that they can borrow if they want to, to fuel different growth initiatives. And those growth initiatives can take all kinds of different shapes, including hiring more people or actually building physical facilities as well, like a Tesla, for example, building factories. So now, the higher cost of capital has gone up.

So it's perceived that it's going to be pricier for these companies to grow. Now fixed income is more attractive. With yields going up, I mean, every investor that we have talked to practically has said that they like fixed income this year. Some of that money is coming out of growth stocks and going into fixed income.

And another important reason why, and we're going to talk more with our next guest about this in just a few moments, is that the valuations are higher because what growth and tech stock investors do is try to value these stocks against future cash flows. They are discounting future cash flows. When rates are going higher, even if maybe the fundamentals are getting better, these stocks can still look quite expensive.

So that's another factor. All of this putting pressure on a lot of these tech stocks. And specifically, I talked to the folks over at Jefferies and our friend Brent Thill over there.

And he looking at the relationship between software stocks specifically and what we have seen with rates. And it's a pretty clear correlation here. So, what you have here is the 10 year yield here in this bright orange color. And then you have software stocks in purple-- the correlation between software stocks, I should say-- and the 10 year, and then on the bottom here energy stocks versus the 10 year.

So basically, what you have seen is as rates have gone higher, you've got this negative correlation between software stocks and the 10 year. Yields up, software down. Yields up, energy up. So you have these different correlations between different groups.