How rising interest rates could hurt big tech stocks

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

Now, a new working paper from the National Bureau of Economic Research, a US think tank, suggests record interest rates have been critical. In “Falling rates and Monting superstars,” Thomas Kroen, Ernest Liu, Atif Mian and Amir Sufi analyzed market data dating back to 1962. They compared the market performance of companies in the top 5% of their industry with returns of a portfolio made up of only their small rivals. They found that when interest rates fell, dominant companies outperformed. “Lower 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 larger amounts than their smaller competitors, so they benefit more from lower rates. In turn, this means they can buy back more stocks and also benefit from their balance sheets (both of which tend to rise in valuations when rates fall). Preferred access to cheap money also means they can more easily invest in expanding or buying from competitors. Indeed, lower rates give big companies the ammunition to consolidate their domination.

What does this mean in concrete terms for investors? If the cut in rates spurred the valuations of larger stocks up, it implies that they could struggle if rates rise, especially since it would mean that investors would place less importance on future earnings. So if inflation is not transient (even central bankers find it hard to support this argument), betting on big tech – and by extension, the US market in general – may no longer be a thing. so sure.

Of course, rates can stay low. However, as recent events in the United States and China amply demonstrate, governments do not like a group of companies appearing too powerful. So if rates don’t rise, tough regulation can step in to topple big tech from its roost. Somehow, superstars end up falling to earth. All of this is worth considering when considering your asset allocation. Don’t throw away your tech assets that have worked so well. But make sure you have some exposure to assets that can benefit from a changing environment – as the right column indicates, having some exposure to commodity producers probably makes sense.

About Nicole Harmon

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