Elon Musk and Cathie Wood Are Almost Right About the Fed

The underperformance of Ms. Wood’s exchange-traded funds and Mr. Musk’s largest asset can’t be entirely blamed on the Fed. The

ARK Innovation ETF

ARKK 4.01%

has fallen 69% this year, while

Tesla

‘s stock is down 68%. The Nasdaq-100, a tech-heavy index that includes only nonfinancial companies, meanwhile, is down just 35%. 

But the phenomenon these tech celebrities describe has broadly been true of late. A report published last year by Nasdaq Investment Intelligence on the interest-rate sensitivity of major indexes shows a negative correlation between the Nasdaq-100 and the average yield change of 10-year Treasury notes in 2021—a dynamic that continues to exist. This fits with what is taught in business schools and accepted across Wall Street: The valuation of growth stocks is tied to their future earnings potential, and as yields rise, the present value of those future earnings should diminish in value. 

Of course, reality hasn’t always been quite so simple. Nasdaq Investment Intelligence actually found that the Nasdaq-100’s performance has been positively correlated with the yield on 10-year Treasurys over the past 30 years, except when rates get to a high range and keep rising. That could be because early on in rate-hiking cycles, the economy is performing strongly. What this suggests is that investors need to keep an eye on many macroeconomic factors, not just rates.  

Even as we look forward to another year of potentially rising rates, some tech stocks are set to end the year looking almost irresistibly cheap. Take Facebook owner

Meta Platforms,

whose shares are currently fetching just over 14 times forward earnings, versus an average of nearly 29 times across the past 9½ years. Over the past few months, Meta has taken steps to right its business in a declining ad environment, laying off 13% of its workforce and cutting noncore projects. Indeed, JPMorgan upgraded shares of Meta to Overweight earlier this month, citing more-favorable risk/reward and valuation. 

Ditto that for such stocks as

Amazon.com,

Airbnb

and

DoorDash,

all of which have materially underperformed broader indexes this year, despite being businesses that, in aggregate, are still growing even on top of their respective pandemic surges.

To tech enthusiasts, these kinds of sales might look something like a New York City penthouse selling for under $5 million or an Hermès Birkin bag for a “mere” thousand bucks.

Just because something is cheap doesn’t necessarily make it a great investment. If the Fed suspends rate increases next year as many market watchers expect, tech stocks would be due for a bounce. But contra Mr. Musk and Ms. Wood, that isn’t the only thing weighing on the sector. Other macroeconomic factors need to be taken into account. 

Meta said in October that it expects its largest-ever year-over-year revenue decline in the fourth quarter, down around 7% at the midpoint of its outlook. The company was clear that some of its performance is “just going to depend on the broader economy.” In particular, the company stressed that worsening foreign-exchange rates would weigh on its top line.

Amazon similarly was clear on its third-quarter conference call that the broader economic environment would play a big role in its fourth-quarter earnings. The company highlighted “broad-scale inflation” and rising fuel and energy costs leading consumers to reassess their purchasing power, and corporations to reconsider their technology and ad spending.

Over the past two years, investors have been punished for forgetting that company fundamentals matter. Next year, they could be punished for forgetting the bigger story, too.

Write to Laura Forman at [email protected]