XLK And TLT: 50 BPS Fed Rate Cut Would Be Horrible For Stocks, Great For Bonds

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XLK And TLT: 50 BPS Fed Rate Cut Would Be Horrible For Stocks, Great For Bonds

seekingalpha09-16

A 50 bps Fed rate cut could be detrimental to stocks, especially technology stocks, as it may drive lower P/E multiples and prompt a rotation into bonds.The inverse relationship between technology ...

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it could be horrible for stocks and technology stocks, specifically. The assumption is that lower rates will drive lower P/E multiples and allow the economy to see a soft landing. Well, this is precisely the opposite view of higher rates causing multiples to contract and the economy to have a hard landing, and that certainly didn't work out, that's for sure. The opposite happened, with higher rates leading to higher P/E multiples as the equity risk premium contracted. The equity market has been in a trade to buy mega-cap technology stocks, and this is apparent when looking at the relationship between the technology sector and the broader markets compared to rates and the yield curve. Technology Stocks Versus the Yield Curve When comparing a chart of The Technology Select Sector SPDR® Fund ETF (NYSEARCA:XLK) to the US 10-Year (US10Y) minus the US 2-Year (US2Y), it is clear that the two have an inverse relationship since May 4, 2023. That was followed by the May 3 FOMC meeting when the Fed raised the overnight rate by 25 bps, followed by a press conference concluding that rate hikes weren't finished. This led to the yield curve inverting, with the ten minus two dropping from -41bps to -108 by July 3. Over that same time, the XLK rallied by more than 20%. TradingView The easy answer is that was when Nvidia started the AI revolution, maybe. It was more likely that the market realized the Fed would be sticking with a restrictive monetary policy for some time. Owning bonds became too risky because it wasn't clear how high rates would rise, causing money to flow out of bonds into stocks as a safer alternative. Interestingly, after the yield curve bottomed in early July 2023, it began to steepen to -16 bps by October 31, 2023. Over that time, the XLK sank more than 12% and gave back nearly 2/3 of the gains it had seen since early May. From that point, the yield curve traded sideways, with some moves higher and lower. However, it was clear that when the yield curve steepened, such as it did in early January 2024, the XLK ETF declined. When the yield curve inversion deepened, stocks rallied, as they had done in early July 2024. It certainly is not a perfect relationship. It almost seems like the yield curve steepens first, and then the stock responds a few days later. TradingView This pattern continues even now. The stock market sold off sharply the first week of September as the yield curve steepened, but it bounced back last week as the yield curve inverted. TradingView The pattern suggests that if the yield curve continues to rise, technology stocks will likely struggle to advance. A Fed rate cut of 50 bps and the promise of more aggressive cuts are likely to accelerate the rotation out of technology stocks back into bonds. The TLT To Outperform The XLK One can see the rotation from the XLK vs. the iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) ratio. The ratio broke out of a trading range in May 2023. Now, that big uptrend that started back in May 2023 has been broken, and as the yield curve steepens, the ratio has been declining, showing that the TLT is now outperforming the XLK. TradingView  A Fed rate cut would arguably lead to the yield curve steepening faster over the near term, and a Fed that signals an aggressive rate-cutting campaign could result in that curve continuing to move higher over the balance of 2024. This would arguably unwind the rally in technology stocks that started in May 2023, leading to bond ETFs like the TLT outperforming the technology stocks and the broader S&P 500.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-1","news_tag":"Policy And Regulatory,analysis","news_rank":0,"symbols":[],"gpt_button":0},"commentList":[],"hasMoreComments":false,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false}}