The Pandemic Trade Part Deux

Given that the U.S. and large parts of Europe are reopening, the reflation trade that had marked most of 2021 would widely have been expected to continue, with more economically-sensitive stocks taking center stage.

Instead, the U.S. Federal Reserve’s shift towards a more hawkish stance longer term has seen tech companies and longer-dated bonds rallying hard.

But wait, isn’t that the pandemic trade?

During the height of pandemic panic, cash-creating tech giants and long-dated U.S. Treasuries soared, with yields on long-dated U.S. government debt falling and tech firms garnering eye-watering valuations.

Tech however had been on the decline this year, as many investors took the view that a reopening economy would favor cyclical stocks.

Instead, because the Fed appears to be taking a more proactive stance on inflation, cash-spewing tech giants like Apple (+1.26%), Nvidia (+4.76%) and Microsoft (+1.37%) helped to push the Nasdaq 100 (+1.29%) to a record high.

Commodity prices have also slipped after the Fed revealed that it was prepared to slow stimulus.

When inflation increases, purchasing power declines so each dollar can buy fewer goods and services.

Using a discounted cashflow method to value growth stocks, which have little to no cash flow today but are expected to generate future cashflows, typically don’t fare well when inflation expectations are high.

Which is why when interest rates are expected to rise to combat inflation, growth stocks can be expected to be negatively impacted.

So why are tech stocks, which some investors classify as growth stocks doing so well?

Because a close examination of these clutch of tech companies that are doing really well aren’t really “growth stocks” in the traditional sense.

Just because tech is a “growth” sector doesn’t meant that all tech stocks are growth stocks.

Many of the storied names that rallied in the wake of the Fed’s apparently more hawkish stance, albeit in the future, are tech institutions which generate a lot of cash NOW.

As the U.S. reopens, businesses will advertise more, and where will those advertising dollars go?

To platform companies like Google (+0.80%) and Facebook (+1.64%) which capture our attention more than anywhere else.

Money is being put back into growth, but at a reasonable price and for cash-generating names.

U.S. Federal Reserve Chairman Jerome Powell downplayed the risk of any immediate rate hikes, but his comments can be seen as prepping the market for an inevitable and eventual hawkish tilt and tapering.

The rotating back into tech stocks then should be seen not so much as a pandemic-led trade, but part of a durable trend where the winners in the next epoch are digital platforms like the railroads and energy companies of the 20^th century.