How rising interest rates could hurt big tech stocks

Low interest rates have helped the biggest companies to entrench their positions. But what if rates rise?

The five biggest stocks in the S&P 500 – Facebook, Apple, Amazon, Microsoft and Alphabet/Google – now account for just under a quarter of the market capitalisation of the US index. That’s well above the long-term average of 14%. The top ten, meanwhile, account for nearly 30% – again, well above the long-term average of about 20%. These figures help explain why the big tech firms have become such a lightning rod for competition concerns, but they don’t explain how this dominance has come about. 

Now a new working paper from the National Bureau of Economic Research, an American think tank, suggests that record low interest rates have been critical. In “Falling rates and rising superstars”, Thomas Kroen, Ernest Liu, Atif Mian and Amir Sufi analysed market data going back to 1962. They compared the market performance of companies in the top 5% of their industry with the returns on a portfolio consisting solely of their smaller rivals. They found that when interest rates were falling, the dominant companies outperformed. “Falling...rates disproportionately benefit industry leaders, especially when the initial... rate is already low.” 

Why is this the case? Industry leaders are able to borrow more cheaply and in greater quantities than their smaller competitors, so they get more benefit from falling rates. In turn, this means they can buy back more shares and also leverage up their balance sheets (both of which tend to boost valuations while rates are falling). Privileged access to cheap money also means they can invest in expansion, or in buying rivals, more easily. In effect, lower rates give leading companies the ammunition to entrench their dominance.

What does this mean in practice for investors? If falling rates have boosted valuations of the biggest stocks on the way up, it implies they may struggle if rates rise, particularly as this would mean investors place less of a premium on future earnings. So if inflation isn’t transitory (even central bankers are finding this argument hard to sustain), betting on big tech – and by extension, the US market in general – may no longer be such a sure thing.  

Of course, rates may remain low. However, as recent events in both the US and China amply demonstrate, governments don’t like it when one group of companies appears overmighty. So if rates don’t rise, heavy-handed regulation may step in to knock big tech off its perch instead. One way or another, superstars eventually tend to fall to earth. This is all worth bearing in mind when considering your asset allocation. Don’t dump your tech holdings that have done so well. But ensure you have some exposure to assets that may benefit from a changing backdrop – having some exposure to commodity producers probably makes sense. 

Recommended

Imperial Brands has an 8.3% yield – but what’s the catch?
Share tips

Imperial Brands has an 8.3% yield – but what’s the catch?

Tobacco company Imperial Brands boasts an impressive dividend yield, and the shares look cheap. But investors should beware, says Rupert Hargreaves. H…
20 May 2022
What's behind Sri Lanka’s crippling debt crisis?
Emerging markets

What's behind Sri Lanka’s crippling debt crisis?

Sri Lanka has been hit by a triple whammy of economic shocks and has gone to the IMF for a bailout. It may just be the first domino to fall in a globa…
20 May 2022
Investing in drugmakers: uncommon profits from curing rare diseases
Share tips

Investing in drugmakers: uncommon profits from curing rare diseases

Treatments for medical conditions with only a small number of sufferers can still be very attractive for pharmaceutical companies and investors becaus…
20 May 2022
Share tips of the week – 20 May
Share tips

Share tips of the week – 20 May

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
20 May 2022

Most Popular

Barry Norris: we’re already in the 1970s. Here’s how to invest
Investment strategy

Barry Norris: we’re already in the 1970s. Here’s how to invest

Merryn talks to Barry Norris of Argonaut capital about the parallels between now and the 1970s; the transition to “green” energy; and the one sector w…
19 May 2022
The ten highest dividend yields in the FTSE 100
Income investing

The ten highest dividend yields in the FTSE 100

Rupert Hargreaves looks at the FTSE 100’s top yielding stocks for income investors to consider.
18 May 2022
Share tips of the week – 20 May
Share tips

Share tips of the week – 20 May

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
20 May 2022