Shopify (TSX:SHOP)(NYSE:SHOP) stock surged 33% in a week after falling 69% in four months. Is this the end of the tech stock crash or a pause before another dip? To answer this, you need to know why Shopify stock went into a downturn. Two reasons:
- Hedge funds started selling growth stocks over fears of a U.S. Fed interest rate hike
- Shopify reported a weak revenue guidance
In its latest earnings, Shopify guided 2022 revenue growth to be lower than the last two years’ revenue growth of 57% and 85.6%, respectively. This reflects the end of the pandemic-induced growth.
Why did Shopify stock surge 33%?
The first uncertainty was over when the U.S. Federal Reserve hiked interest rate by 25 basis points. Fed Chair Jeremy Powell stated that the Fed might hike interest rates six times this year to bring it to 1.75%-2.25% by the end of 2022. As the uncertainty around interest rates is over, investors have returned to buying Shopify stock.
You might wonder what Shopify’s stock price has to do with U.S. interest rates. In fact, the U.S. central bank’s interest rate is watched closely markets. It has a dual impact on a stock like Shopify that hinges on consumer spending for growth.
The correlation between Shopify stock and the Fed interest rate
During the pandemic, the Fed released trillions of dollars into the U.S. economy by reducing its interest rate to a record low and buying Treasury bonds. This created too much liquidity in the market. People used this liquidity to buy tech stocks. Hence, Shopify became the highest valued stock on the Toronto Stock Exchange in 2020. That time, billionaire investor George Soros warned of a tech bubble as the buying spree inflated the price of tech stocks and made them overvalued even for a growth stock.
But excess liquidity has its side-effect. Inflation increased when the economy started recovering in 2021. On top of that, the Russia-Ukraine war accelerated the inflation in the U.S. to a 40-year high of 7.9%. The 7.9% inflation will impact the purchasing power of individuals and reduce consumer spending in the short term. This will impact Shopify’s gross transaction volumes.
The Fed is raising interest rates to control inflation. If a higher interest rate succeeds in controlling inflation and boosting spending, it will be a positive sign for Shopify. But a higher interest rate also makes high-risk equity, like Shopify, less attractive as investors can earn high interest from bonds. The pandemic created a growth atmosphere for tech stocks where inflation and interest rates were low.
Is the tech stock downturn over?
The stock has surged on the Fed interest rate hike. But if higher interest rates fail to curb inflation and boost consumer spending, there could be more downside for the stock. Although the Fed chair believes that the economy has the strength to absorb the rate hikes, I would remain cautious as war is unpredictable. The risk of recession in the U.S. is not yet over.
How to trade on Shopify stock?
In such a scenario, I would recommend buying Shopify stock in phases. If you plan to buy 10 stocks of Shopify, buy three stocks now. Wait for a month, as equity generally reacts to Fed rate hikes after a month.
Shopify stock could fall below $800 amid rising energy prices and the upcoming tax season. April would see reduced liquidity in the hands of investors as they pay their taxes. That is a good time to buy another three to five stocks. You can buy the remaining two to four stocks after the company releases its first-quarter earnings at the end of April end or start of May. The first quarter is seasonally weak for Shopify and could pull out the bearish sentiment.
This will reduce your overall purchasing price and set you up for future growth where inflation comes down and people have enough liquidity to spend on non-essential items.
