Tech Stocks Lead Wall Street Higher as Investors Reassured
Last week, the Federal Reserve released the minutes from their policy meeting in December, which implied they may act sooner and more aggressively to tackle rising US inflation than the markets had previously anticipated.
This revelation led to widespread declines in US stocks, particularly in technology, which lasted several days and dragged down Wall Street’s main indices.
Yesterday, Federal Reserve Chair Jerome Powell spoke in front of the Senate Banking Committee during his confirmation hearing and his comments reassured investors. Despite confirming that the Fed would take steps to curb rising inflation before it got out of control, the sense of urgency which many had interpreted from the Fed’s December minutes was not so apparent. In other words, a dramatic rise in interest rates may not be necessary or forthcoming.
In response to this news, US equities rebounded, with the Dow Jones, S&P 500 and the tech-heavy Nasdaq 100 rising 0.51%, 0.92% and 1.47% respectively.
Leading this rebound were technology stocks which, as already mentioned, were particularly affected by last week’s sell-off. The world’s largest company, Apple, which made history as being the first company in the world to surpass a market capitalisation of $3 trillion on the first two trading days of the year, fell by 7.5% last week after the release of the Fed’s December minutes. Yesterday, however, the tech giant’s share price recovered by 1.68%.
Interest rates and equities tend to have an inverse relationship, hence last week’s declines, but tech stocks are especially sensitive to the prospect of interest rate hikes. This is because tech stock valuations tend to be based largely on the prospect of future profits, which are negatively impacted by higher interest rates.
Why is this?
Firstly, higher interest rates increase the cost of borrowing, meaning that businesses will have to pay more to service their debt, increasing their operating costs and impacting their profitability.
Secondly, higher interest rates increase the amount of money people receive for simply storing their money in the bank, incentivising them to save their money instead of spending it. In other words, higher interest rates lead to a decrease in consumption resulting in less sales for companies, which naturally will impact their profits.
Thirdly, and probably most importantly for tech stocks, the standard practice among professional investors is to “discount” future profits – as a dollar’s profit today is considered to have higher value than a dollar’s profit in future years. In that calculation the interest rate plays an important role – and the bigger the interest rate, the less valuable future profits are deemed to be. As tech stocks often have low or no profits today and huge potential profits in the future, rate rises tend to have a bigger impact on them.
Although Powell’s comments have reassured the markets for the time being, today at 13:30 GMT the latest inflation data from the US is set to be released. The Consumer Price Index (CPI) is anticipated to be reported at 7%, but if it comes in higher than this, we could see another drop in tech stocks such as Apple this afternoon.
Moreover, whilst uncertainty over the Fed’s plans to tackle inflation remain, we are likely to continue to see volatility on Wall Street.
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