Interest rates have been rising for the last 12 months. In that period, both the Federal Reserve and the Bank of Canada raised their policy rates several times. During the 2020 COVID recession, rates went to near 0%. Today, both Canadian and U.S. treasuries in the two-year to 10-year terms to maturity yield 5% or higher. Current treasury yields are higher than the inflation rate. This means that you can enjoy positive real returns by investing in treasuries today.
In light of this, it’s somewhat surprising how growth stocks traded this year. The NASDAQ-100 — the index that includes most of the high-growth U.S. tech stocks — rallied 40% in the first half of the year. It was a sight to behold. However, it theoretically shouldn’t have happened. Rises in interest rates make future growth less valuable, as they increase the amount of return available risk-free today. In theory, tech stocks should have crashed this year. They did just the opposite. In this article, I will explore the topic of whether tech stocks can continue to withstand the pressure of rising rates.
What caused growth stocks to rally this year
One reason why growth stocks defied the macro forces affecting them this year is because they fell so much in the prior year. 2022 was a brutal year for tech stocks, with the NASDAQ-100 declining 30% for the year. It was a pretty major selloff — perhaps bigger than what the increase in interest rates would have predicted. So, it’s no surprise that tech stocks rose in the first half of 2023. The initial selloff from which they recovered was quite extreme.
Consider Shopify (TSX:SHOP), for example. This technology stock fell 70% during the tech bear market of 2022. That year, interest rates rose, and Shopify lost its previously high growth rates. During the 2020/2021 COVID-19 period, SHOP grew its revenue at nearly 90% per year. It was quite a showing. However, the company lost its growth in 2022, as a sector-wide tech slowdown weighed on results. At one point, SHOP’s top-line growth was all the way down to 13% year over year. It’s not surprising that the stock crashed that year, nor is it surprising that the stock rallied this year. To a large extent, SHOP’s 2023 rally has just been a recovery from an extreme selloff. The stock is still down from its 2021 highs.
Why the momentum might slow down
Precisely because Shopify stock has risen so much this year, it may slow down in the months ahead. Shopify at its all-time high was trading at 60 times sales. That kind of bubble-era valuations rarely last long. I would not expect Shopify to retake its all-time high ($213) any time soon. With interest rates as high as they are now, such valuations are hard to justify. True, Shopify has regained its revenue growth. In its most recent quarter, Shopify did $1.7 billion in revenue, up 26%. Its net income and free cash flow figures also swung from negative to positive. The company certainly isn’t down for the count. Still, it may never again be valued as richly as it once was by the markets. The macro-environment has changed.
