Technology Sector Gains Amid Fed's Rate Hike Signal: 6 Picks

·7-min read

On Jun 16, in his post FOMC statement, Fed Chairman Jerome Powell said that inflation will be much higher in 2021 than the central bank's earlier projection and a hike in the benchmark interest rate is likely to take place in late 2023, sooner than the previous expectation of 2024. This means, tapering of Fed's $120 billion per month bond-buying program likely to initiate either in late 2021 or early 2022.

A systematic termination of bond buying will raise the yield of long-term government bonds, especially the 10-Year U.S. Treasury Note. Higher risk-free returns adversely impact the net present value of an investment in growth stocks like technology due to a higher discount rate. Furthermore, a hike in benchmark interest rate will affect growth stocks as these companies generally depend on easy access to cheap credit for their business expansion.

Surprisingly, on Jun 17, technology stocks rallied on Wall Street. The Technology Select Sector SPDR XLK, one of the 11 broad-sector ETFs of the S&P 500 Index, gained 1.2%, while reopening sectors like energy, financials, materials and industrials declined. The tech-heavy Nasdaq Composite rose 0.9% while the Dow, leaning toward reopening stocks, dropped 0.6%.

Likely Reasons for Technology Sector's Gain

One possible reason for yesterday's rally of the technology sector is that a rate hike (both risk-free interest rate and the benchmark lending rate) is already factored in this sector's valuation. Over the past one and half months, Wall Street was rife with speculation that the Fed may give the timeline as to when it will start tapering bond buying in its June FOMC meeting.

However, the central bank refrained from giving any indication of when it will start terminating the quantitative easing program and merely mentioned that it will give enough indications before actually implementing.

Moreover, despite projecting that the core PCE price index — Fed's favorite inflation gauge — will jump 3% year over year in the fourth quarter of 2021 compared with 2.2% forecast in March, Powell said, “Our expectation is these high inflation readings now will abate.” This means that the Fed still considers the ongoing inflationary pressure as transitory.

Second, the yield on the benchmark 10-Year U.S. Treasury Note that jumped to 1.569% just after Powell's post FOMC statement, settled at 1.509% on Jun 17, marking the steepest decline since Jun 4. This is significantly lower than its recent high of 1.778% recorded on Mar 30. A lower yield on government bond means lower risk-free returns that bode well for growth stocks like technology.

Meanwhile, the ICE U.S. Dollar Index that measures the U.S. Dollar against a basket of six major currencies, surged 1.6% over Jun 16 and 17, taking a cue from Fed's rate hike signal.

Higher dollar prices together with China's clampdown on commodity speculators resulted in a stiff decline of a range of commodity prices like copper, platinum, lumber, cotton, sugar, soybeans, corns and crude oil to name a few. Soaring commodity prices over the last three months was a major reason for higher inflation as most of these commodities are used as intermediary products or inputs for final products.

Finally, on Jun 17, the Department of Labor reported that weekly jobless claims rose higher than expected for the week ended Jun 12 after six consecutive weeks of improvement. Initial claims rose above 400,000 for the first time since the week ended May 12.

Additionally, the total number of people receiving unemployment benefits across all types of government programs remained elevated at 14.8 million for the week ended May 29. This shows that the job market has a long way to go before reaching the pre-pandemic level of February 2020. This may compel the Fed to delay the tapering of the bond-buying program.

Our Top Picks

Technology is the best bet in the long term with vast potential. Not all tech stocks will succumb to inflation. Even if the Fed changes its dovish monetary stance in the near future, pushing up the market's interest rate, technology giants are not likely to bear the brunt of inflation.

Technology bigwigs (market capital > $50 billion) have a robust business model across the world and command globally acclaimed brand values. Their strong financial position will help them to cope with a higher interest rate.

We have narrowed down our search to six U.S. technology bigwigs with strong growth potential for 2021 and beyond. These stocks have rallied nearly double digits or more in the past three months and have witnessed solid earnings estimate revisions in the last 30 days. Each of our picks carries either a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows the price performance of our six picks in the past three months.

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Zacks Investment Research

Image Source: Zacks Investment Research

NVIDIA Corp. NVDA has an expected earnings growth rate of 58.4% for the current year (ending January 2021). This Zacks Rank #2 company has a long-term growth rate of 17.6%. The Zacks Consensus Estimate for the current year improved 16.4% over the last 30 days. The stock price has soared 45.2% in the past three months.

Intuit Inc. INTU has an expected earnings growth rate of 19% for the current year (ending July 2021). This Zacks Rank #2 company has a long-term growth rate of 14.8%. The Zacks Consensus Estimate for the current year has improved 11% over the last 30 days. This Zacks Rank #2 company has a current dividend yield of 0.53%. The stock price has jumped 24.5% in the past three months.

Alphabet Inc. GOOGL has an expected earnings growth rate of 52.6% for the current year. This Zacks Rank #1 company has a long-term growth rate of 18.1%. The Zacks Consensus Estimate for the current year has improved 0.2% over the last 30 days. The stock price has climbed 20.1% in the past three months.

Applied Materials Inc. AMAT has an expected earnings growth rate of 56.6% for the current year (ending October 2021). This Zacks Rank #2 company has a long-term growth rate of 18%. The Zacks Consensus Estimate for the current year has improved 8.8% over the last 30 days. The stock price has appreciated 19.5% in the past three months.

Zoom Video Communications Inc. ZM has an expected earnings growth rate of 39.5% for the current year (ending January 2022). This Zacks Rank #1 company has a long-term growth rate of 15.6%. The Zacks Consensus Estimate for the current year has improved 27% over the last 30 days. The stock price has advanced 14.3% in the past three months.

Apple Inc. AAPL has an expected earnings growth rate of 57.6% for the current year (ending September 2021). This Zacks Rank #2 company has a long-term growth rate of 12.5%. The Zacks Consensus Estimate for the current year has improved 1.4% over the last 30 days. The stock price has surged 9.8% in the past three months.

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NVIDIA Corporation (NVDA) : Free Stock Analysis Report

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Applied Materials, Inc. (AMAT) : Free Stock Analysis Report

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Zoom Video Communications, Inc. (ZM) : Free Stock Analysis Report

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