Recent resilience of mega-cap growth

Key takeaways

• Mega-cap technology stocks have proven to be the most resilient across equity sectors in the recent market volatility. 
• Historically this sector has had a negative correlation with interest rates, with a sharp drop in real rates typically benefiting technology companies.
• This status could be further supported if investor concern remains focused on an economic slowdown and the Federal Reserve hiking is curtailed.

Gains in mega-cap tech may seem odd, but Russ Koesterich, Managing Director and Portfolio Manager of Global Allocation explains why investors are favoring them.

Stocks have proved remarkably resilient during the worst financial scare in 15 years. But while the overall market has held strong, there have been pockets of pain. Value stocks fell roughly 8%, energy 21% and banks, the epicenter of the volatility, nearly 30%. Curiously, mega-cap tech stocks rose. Since the March 6^th close, the Nasdaq 100 Index of meg-cap tech and growth names has advanced approximately 3%. The index has been buoyed by gains in large-cap tech and communication names (see Chart1).

Global sector performance - 1 month

On the surface, the gains in mega-cap tech seem odd. Historically, the Nasdaq 100 has been modestly more volatile than the broader market. With equity volatility rising, this market segment should have underperformed. Why the resilience?

One explanation: Investor fears have rapidly shifted back to a potential recession. Under this scenario, investors tend to prefer highly profitable, cash-flow rich companies. That most of these companies tend to have low leverage and are less dependent on debt financing is an added benefit.

Rate beta trumps equity beta

That said, there is another reason tech and related names have outperformed: rate beta. While investors have been keeping one eye on the banks the other has been focused on how the disruptions in the banking sector are rippling through global bond markets.

After enduring pariah status for most of 2022, investors have, at least temporarily, rediscovered the relative safety of U.S. Treasuries. Renewed bond buying has pushed prices up and yields lower. In a matter of days, real or inflation adjusted 10-year yields plunged more than 0.50%. The drop in short-term yields was even more precipitous, with 2-year real yields falling from over 5% on March 8^th to an intra-day low of roughly 3.7% on March 20^th.

A sharp drop in real rates has typically benefited tech and growth names, but the relationship has grown stronger in recent years. Monthly changes in real rates have historically explained about 6% of the relative performance of mega-cap tech. However, looking at the last three years of data the explanatory power has risen to more than 25%! The strength of the relationship was on full display last year as the backup in real rates trashed both early and mature growth stocks. The recent reversal in real rates has played a large part in putting the bid back into mega-cap growth names.

While the market has stabilized in the short term, there are likely to be aftershocks as investors consider the impact on financial conditions, growth, and inflation. A month ago investors were wrestling with a resilient economy and stubborn inflation. Today the narrative has shifted to an impaired banking sector and an increased risk of recession. To the extent the Federal Reserve’s hiking is curtailed and investor concerns remain focused on an economic slowdown, tech may regain some of its status.

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