This article is written exclusively for Investing.com
Many technology stocks have soared in 2020 as prices plummeted, and investors have sought safety in their significant sales and earnings growth. By adding extra fuel to the fire, the idea was that these stocks showed accelerated growth due to the pandemic. But that trade may be at the end of the road now as prices are slowly rising and expectations are hard to beat.
Many of these long-term growth stories fell apart this week, such as Zoom (NASDAQ :), Salesforce (NYSE :), and Splunk (NASDAQ :), each of which fell sharply due to earnings results
Earnings Yield Game
Salesforce stock saw their gains, which is the inverse of the P / E ratio, falling to its lowest level since 2018 – about 1.4% on September 2nd. The chart below shows how Salesforce's revenue yield has historically averaged around 1.85%. But when 10-year yields fell to record levels, it gave investors the ammunition they needed to lower Salesforce's earnings returns in an effort to keep the yield spread around historic standards that drove the stock price sharply higher.
]
Salesforce Earnings Yield V 10-year Treasuries
It is essential to understand that the story of the Earnings yield is partially the driving force behind some of these claims. Because if stocks have risen on the concept of lower interest rates making them more attractive, rising rates will likely mean the exact opposite, causing these stocks to go lower.
Revenues Can Increase Dramatically
Investors may need to pay more attention to this trade now than ever before. Interest over the 10-year-old may be about to break out as it tests a critical downtrend that began in 2018. The only thing standing in the way of a sharp rise in interest rates is a resistance level of around 1%. Should the 10-year interest rate exceed 1%, this could result in an increase of up to 1.3%. As measured by the relative strength index, the momentum also shows that yields can continue to rise, with a clear upward trend.
It's not just rates that can end the party. It appears that some of these stocks have high valuations, which are now being put to the test. Zoom, for example, reported better than expected earlier this week. However, the stock was still hit hard, falling more than 15% due to concerns about shrinking margins. Splunk is another example of a stock that has performed exceptionally well this year, falling about 20% following analyst expectations.
Exuberance
Perhaps these stocks have sold hard because yields have already risen by about 40 basis points since the summer, making them difficult to hold on to. If companies cannot deliver the big profits that investors have become accustomed to, then it becomes more difficult to justify the lofty multiples that investors have given to these stocks. If consensus earnings expectations are not rising fast enough to offset rising bond yields, that makes the justification for owning these stocks much more challenging.
It may as well be that investors are finally waking up, as valuations for some of these companies have simply reached a level where expectations have become too exuberant. Be that as it may, it seems pretty clear that some of the exuberance is starting to wane.
