It may come as a surprise, but tech and home-building stocks share a common vulnerability when it comes to bond yields. As bond yields continue to rise, both sectors have been facing significant declines, and the downward trend may continue.
Over the past month, the 10-year Treasury yield has increased by over 4.3%, surpassing the 4% mark. This surge is largely driven by concerns in the market that the Federal Reserve will maintain higher interest rates for a longer period to ensure inflation remains under control.
For home builders, higher interest rates have translated into elevated mortgage rates from lenders. Consequently, this has deterred many potential buyers from entering the market. As an illustration, last week saw the average 30-year fixed-rate mortgage reach 7.09%, marking the highest level in over 20 years.
In the tech sector, the value of many companies is based on the expectation of future profits. However, the surge in long-dated bond yields diminishes the value of these projected profits.
As a result, both tech and home-building stocks have experienced declines. The SPDR S&P Homebuilders exchange-traded fund (ticker: XHB) has dropped 6% since reaching its peak earlier this year in August. Similarly, the Nasdaq 100, an index comprised of 101 large nonfinancial companies listed on the Nasdaq Composite, has declined by 7% from its peak in mid-July.
Although it may be tempting to view this decline as a buying opportunity, it may not be the most auspicious time to enter the market.
Here’s why: There is a possibility that further losses lie ahead due to a potential increase in the 10-year yield. In October, it reached approximately 4.2% before continuing its upward trajectory.
Investors have been selling off bonds, which in turn pushes yields higher. The fact that yields have risen to the 4% level suggests that it is uncertain when this selling pressure and subsequent yield increase will cease.
The actions of the Federal Reserve may heavily influence short-term developments. If the central bank signals at its annual Jackson Hole summit this week that it intends to keep rates higher for a longer duration, the selling pressure could persist, thereby leading to further yield increases.
In such a scenario, it is expected that home builder stocks would bear the brunt of the impact. According to Bank of America strategists, this sector is particularly vulnerable to fluctuations in the 10-year yield.
Home Depot Faces Challenges in Weakening Housing Market
Home Depot (HD) recently reported better-than-expected sales and earnings, but the company is still experiencing a drop in both measures compared to the previous year. This decline can be attributed to weakening housing demand, which has impacted the overall outlook for Home Depot. Additionally, the management has decided not to increase EPS guidance for this year, indicating their cautious approach towards future demand, especially considering the current mortgage rates.
Although Home Depot is facing challenges due to the poor housing market outlook, investors should also be wary of the stock’s expensive valuation. Shares are trading at 20.8 times analysts’ forward EPS estimates, which is nearly 12% higher than the S&P 500’s aggregate price/earnings multiple. Typically, Home Depot’s stock performs in line with the market when home builders are out of favor. However, until the economic outlook improves, further declines in the stock’s value are anticipated.
If investors want to see the stock thrive, they will require clearer signs that the housing market is improving and consumers are undertaking more significant home improvement projects. According to Joe Feldman, an analyst at Telsey Advisory Group, these signals are necessary for investor confidence in Home Depot’s growth potential.
Tech Sector also Faces Downside Risk
Not only is Home Depot facing challenges, but the technology sector also carries downside risk. The Nasdaq 100, currently hovering around 14,800 points, has fallen below its 50-day moving average of just over 15,000 points. This suggests a lack of buyer interest at recent average prices, indicating a potential loss of confidence in the market. Consequently, experts at Evercore anticipate that the index could drop further to approximately 13,600 points—a support level observed in May when buyers helped stabilize it during a double-digit rally.
While a breather in the technology sector may be necessary at present, there will come a point in the future when these stocks become attractive buying opportunities. However, it is crucial to monitor the settling of bond yields before making any investment decisions.
