Tech stocks are getting a makeover.
Though the stocks were historically a way to chase cyclical
growth, investors have started to trade them as a safe,
risk-averse alternative to bonds.
At the heart of the shift is the dearth of price swings in tech
shares, which has been a byproduct of the sector’s recent
success. As the group known as FAAMG — Facebook,
— has produced world-beating returns, their rising cash balances
and a lack of market shocks have sapped the entire tech sector of
volatility, Goldman Sachs says.
That low volatility has shifted the industry’s entire profile.
Tech is now more highly correlated with consumer staple and
utility stocks — both defensive groups offering reliable yields —
than at any point in the past 15 years, according to Goldman’s
data. On the flip side, tech is less correlated with “risk-on”
areas like financials, industrials, and materials than it has
been in, you guessed it, 15 years.
By extension, tech is also now negatively correlated with
interest rates, a reversal of the usual relationship. So as the
Federal Reserve takes its time with monetary tightening, it plays
right into the hands of the surging tech sector.
Sounds good, right? Well, it may not be.
While Goldman concedes that the ongoing situation in tech is
working for the time being, it’s less optimistic about what could
happen if the broader market faces a shock. If price swings come
back in force, the party could be over.
“We believe low realized volatility can potentially lead people
to underestimate the risks inherent in these businesses,” Robert
Boroujerdi, the head of global securities research at Goldman
Sachs, wrote in a note from June. “Mechanically, we expect that
as the realized volatility of a stock drops, more passive ‘low
vol’ strategies buy the stock, pushing up the return and
dampening downside volatility. The fear is that if fundamental
events cause volatility to rise, these same passive vehicles will
sell and exacerbate downside volatility.”
In tech’s wake lie healthcare stocks, which were previously a
popular bond proxy but are now seeing their lowest correlation in
15 years with consumer staples stocks.
It’s entirely possible these sectors will revert back to their
historical roles. But with the US market fresh off several rounds
of unprecedented economic stimulus, and with the Fed about to
embark upon an unprecedented balance-sheet unwind, it’s safe to
say the investment playbook is being rewritten on the fly.