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Red


TECH STOCKS’ BIG PLUNGE: HOW LATTE PRICES AND FED RATES HELP EXPLAIN THE
“CORRECTION”

Monday, January 24, 2022 by Robinhood Snacks | Disclosures


[Mario Tama / Staff via Getty Images]

Color of the week: red... We're not talking lipstick. Last week the Nasdaq index
entered correction territory — a drop of 10% or more from the most recent high —
for the first time since March. The Nasdaq is the techiest of the Big Three US
indexes.

 * Big Tech: More than half of the Nasdaq’s 3K+ stocks are tech. After gaining
   22% last year, it's down 13% from its November record (#corrected).
 * Big Red: 40% of Nasdaq stocks have fallen by half since November.

Some ingredients… of the tech sell-off: Most are related to inflation, which is
nearly at a 40-year high as demand > supply. To tame rising prices, the Fed is
expected to hike rates at least three times this year. The problem for tech
stocks: They’re “competing” with other investments.

 * Rising interest rates can make US gov’t bonds and savings accounts more
   attractive compared to riskier assets like tech stocks.
 * Wall Street tends to value stocks based on their potential future returns
   (key word: future). But $1 today is worth more than $1 tomorrow because…
   inflation.
 * As interest rates rise, the value of a dollar today also rises because it
   could be invested ASAP in bonds or savings with higher returns. But the
   prices of many high-flying tech stocks are based on potential growth. That’s
   one reason Tesla’s worth 12X as much as GM, despite having only a quarter of
   its sales.
 * Opportunity cost: As the potential returns from lower-risk investments (like
   US gov’t bonds) rises, investors want to see higher returns from tech to
   justify prices.

The TLDR… Tech shares soared as the Fed gave us near-zero rates during the
pandemic, since any potential growth seemed better than zero interest. Now that
rates are rising, tech is rebalancing. The Dow — which is heavier on non-tech
stocks with lower expectations of fast growth — is barely down.


THE TAKEAWAY

Corrections are normal… While they might be painful short term, corrections can
help rebalance overvalued stocks. They can hit assets, indexes, or entire
markets. Tech stocks felt frothy at their November peak (a correction is like a
barista skimming off foam). And we’ve been here before: The Nasdaq has had 66
corrections since 1971, but is still up nearly 7,400% over the past 40 years.

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