Why tech stocks are sliding and what the NFP report means for investors

The US Labour market surprised to the upside in August. While localised lockdowns paralysed some parts of the US, this didn’t stop the US economy from creating 1.371mn jobs last month and the unemployment rate falling to 8.4% from 10.2% in July, the lowest rate since April, at the peak of the coronavirus pandemic. This good economic news has not stopped US stocks from sliding for the second day on Friday. At the time of writing the Nasdaq is down more than 4.5% and the S&P 500 is down more than 2.6%. So, why aren’t US stocks cheering the better than expected labour market report? 

Digging deeper into the jobs report

There are three reasons why stocks are falling, in our view. To understand the first reason, it is worth delving a bit deeper into last month’s labour market report. However you look at today’s data, it’s pretty strong. Average hourly earnings are up 4.7%, and average weekly hours worked were also up a touch at 34.6, one of the highest levels for ten years. Added to this, the labour force participation rate also improved, rising to 61.7%, up from 61.4% in July. Although this figure is below the average prior to Covid, it is moving in the right direction. This figure includes those looking for work and people in work. Due to the expiration of the government’s jobs support scheme last month, it is positive that this figure didn’t increase at a faster pace, and coupled with the fall in the unemployment rate, it suggests that the US labour market is doing okay, even without government support.

Why a good jobs report = bad news for stocks 

There is also good news from the actual NFP figure for August. If you strip out the 344,000 jobs created by the government last month, many of them temporary due to the census, the US still created more than 1mn jobs at the same time as the coronavirus continues to ravage many parts of the US. A positive jobs market has two implications for financial markets. Firstly, it makes an extension of the government support package less likely. The Democrats and Republicans have been fighting over the size of this package since May, which is one reason why the jobs support package expired last month. However, today’s report has undoubtedly strengthened the hand of the Republicans, since it suggests that the US labour market is doing well without government support. Fiscal stimulus hopes had been one of the many pillars propping up the stock market in recent months, this jobs report dashes hopes of more fiscal support from Washington, which is one reason why stocks are falling. The second reason is bond yields, which we will talk about in more detail below. 

Why bond yields matter 

Bond yields are important for the stock market, even small moves in yields can have big impacts on the price of stocks, particularly when some stocks have seen their market capitalisation double since the start of the year (Apple), and valuations are extremely high (Amazon). We have spoken before about how low interest rates was one of the major factors underpinning the stock market, and last week’s announcement from the Federal Reserve that it would ignore stronger rates of inflation to foster economic growth only increased our view that bond yields are crucial to the US stock market’s performance . Today’s labour market report caused US Treasury yields to rise across the curve. 2-year yields rose 0.02%, while 10-year yields are up 0.036%. These may seem like tiny increases, however 2-year treasury yields are a mere 0.15%, while 10-year yields are 0.675%, thus even small moves matter. Today’s labour market report has reversed the gains made by Treasuries since the Jackson Hole symposium last week, and markets are getting jittery. Rising bond yields are bad for tech in particular. The big 5 US technology companies (Apple, Amazon, Microsoft, Alphabet and Facebook) are doing well because so much of their lifetime profits lie far in the future, and due to this they tend to do well in a low yield environment. Hence, tech stocks tend to have very high P/E ratios, meaning that investors believe that the best days for Apple et al are in the future. 

An unbalanced market could come back to haunt US stocks 

So, why is this bad news for the US stock market when bond yields rise, even a little bit? This is because the US stock market’s recent positive performance is largely due to these 5 tech stocks (and a few other innovative disruptors). The US market is heavily reliant on the fortunes of not just a few companies, but a few companies that all do the same thing. So, when one thing hurts this group it could drag the entire market down, as these companies make up 25% of the market value of the S&P 500. We have seen tech stocks outperform when economic data has been weak, for example the pandemic didn’t knock their performance, even when the rest of the market has been struggling. However, now that the economy is showing signs of life and producing decent monthly labour market reports, the tech sector is wobbling, which is dragging down US markets and global stocks. For example, on Friday Apple is down some 8% so far this week, yet JP Morgan is up 0.5% and Bank of America is up more than 1%. The outperformance of financials is not enough to prop up the broader market. Thus, going forward the US tech giants have the power to drag down the broader market, so watch out if you are trading US and global stock indices. 

Are tech stocks to blame for this sell off? 

Lastly, if you want to blame anyone for the selloff in tech, blame Apple, and maybe Tesla. Apple had a stock split earlier this week, where it divided its existing shares to boost liquidity and to make the stock cheaper for retail investors to buy. Interestingly, stock splits, while they don’t increase the value of the company, they usually have a positive impact on the stock price because of the extra liquidity that they generate. However, stock splits usually occur when the price of the stock is high, hence why some investors may see this as a good reason to book profit. Tesla’s announcement that it was going to sell an extra $5bn of stock was more than likely down to the strong share price rally in recent months, and could be another reason why investors, both institutional and retail, are all rushing to the exits at once: to book profits. We believe that tech stocks will be back as long as bond yields don’t continue to rise, but a decent pullback is to be expected at this stage.