Tech and home-building stocks are both highly sensitive to bond yields, which is the reason for their recent decline and the possibility of further losses.
Impact on Home Builders
The 10-year Treasury yield has risen over 4.3% in less than a month, driven by market concerns that the Federal Reserve will maintain higher interest rates to control inflation. This increase in interest rates has resulted in higher mortgage rates from lenders, making it difficult for potential buyers to enter the housing market. Last week, the average 30-year fixed-rate mortgage reached 7.09%, the highest seen in over 20 years.
Effect on Tech Companies
In the tech sector, many companies are valued based on the expectation of future profits, which are now diminished due to higher long-dated bond yields. These increased yields reduce the value of future profits for tech companies.
Consequently, both tech and home-building stocks have experienced declines. The SPDR S&P Homebuilders Exchange-Traded Fund (ticker: XHB) has fallen 6% from its peak earlier this year in August. Likewise, the Nasdaq 100, a tech-heavy index comprising 101 of the largest nonfinancial companies listed on the Nasdaq Composite, has declined 7% from its peak in mid-July.
Buying Opportunity?
While it may be tempting to view this as a buying opportunity, now may not be the most advantageous time to enter the market.
The 10-year yield may continue to rise, potentially leading to further losses. Although it reached around 4.2% in October before pulling back, there is a possibility of it surpassing this level.
Investors have been selling bonds, causing prices to fall and yields to rise. With selling continuing at the current yield level of 4% and above, it is uncertain when this trend will end.
The Federal Reserve’s actions may also play a role in the short term. If the central bank indicates at its annual Jackson Hole summit this week that it intends to maintain higher interest rates for an extended period, the selling pressure could persist, causing yields to continue rising.
Home Builder Stocks Vulnerable to 10-Year Yield
If that happens, expect home builder stocks to really feel the pain. Bank of America strategists describe the sector as one of the most vulnerable to the 10-year yield.
Home Depot: Weakening Housing Demand Affects Sales and Earnings
Home Depot (HD) is an example. While the home-improvement reported better-than-expected sales and earnings just a week ago, both measures dropped year over year because of weakening housing demand. And management didn’t increase EPS guidance for this year, a decision that reflects the outlook for demand, especially given the level of mortgage rates.
Risky Bet Due to Expensive Valuation
To go along with the poor outlook, the stock is a risky bet because it’s expensive. Shares trade at 20.8 times analysts’ forward EPS estimates, almost 12% above the S&P 500’s aggregate price/earnings multiple, according to FactSet. The stock, for reference, often trades in line with the market when home builders are out of favor. More declines are in store until the economic outlook improves.
Clearer Signs Needed for Stock to Flourish
For the stock to flourish from here, “investors will likely need clearer signs the housing market is improving and consumers are taking on more and larger projects,” wrote Joe Feldan, analyst at Kelsey Advisory Group.
Tech Faces Downside Risk
Tech, too, has more downside risk. The Nasdaq 100, at around 14800, has dipped below its 50-day moving average of just over 15000. That means there haven’t been many buyers at a recent average of prices, which signifies the market may have lost enough confidence to send the index further south from here.
Potential Fall for Nasdaq 100
The index could fall to about 13600, according to Evercore strategists—a support level where buyers propped it up in May, which was part of a double-digit rally for the year. That rally may just need to keep taking a breather right now.
At some point soon enough, all these stocks should become buys. But let bond yields settle out first.