Momentum massacre: TSLA, NIO, ZM, & TDOC all dump on rising interest rates
March 5, 2021 12:22 PM
Why do high interest rates hit fast-growing, low-profit firms hardest? Read on to understand the technical and sentiment-driven explanations
For equity traders accustomed to cutting-edge technology stocks always outperforming the broader indices, the last couple weeks have been an eye-opening reminder of the concept of “market rotation.” Essentially, market rotation refers to the shift between different types of stocks leading in the market; to state a point that should be obvious, but that many have forgotten over the last decade, a strong business or industry doesn’t always lead to strong stock performance. In many cases, the shares of strong businesses in strong industries get so expensive that they’re essentially “priced for perfection” and any negative or even neutral developments can lead to a dramatic selloff.
That’s exactly what we’ve seen over the past month in previously white-hot momentum ETFs and stocks like the Tesla Motors (TSLA), NIO Inc (NIO), Zoom Video (ZM), and Teladoc Health (TDOC). These previous high-flyers have been absolutely clobbered this week, with the recent surge in interest rates prompting investors to reevaluate the appeal of these fast-growing, but low-profit firms.
Why do high interest rates hit fast-growing, low-profit firms hardest?
Finance 101 tells us that the value of any asset is equal to its future cash flows, discounted back to the present at an appropriate rate. In other words, when the discount rate is near zero, there’s little difference between profits earned today and profits expected to be earned in a decade. While firms like Tesla Motors and Zoom Video aren’t particularly profitable at the moment, investors have been betting that they’ll be far more profitable in the future, and with interest rates near 0%, those future profits may be nearly as valuable as those of a more profitable but slower growing company today.
Combined with that technical explanation, the underlying businesses are particularly reliant on their share prices rising, which allows them to attract top talent with offers of stock options and the ability to raise capital cheaply by issuing more shares. If this virtuous cycle comes to an end, they’re likely to see a simultaneous exodus of talent and a rising cost of capital, creating a self-fulfilling prophecy where future growth falls.
As the chart below shows, each of the stocks highlighted above have seen drawdowns ranging -40% to -50%, in most cases over the past couple weeks alone:
So what’s next for these momentum stocks?
There’s certainly more to the story than just one variable, but the path of interest rates over the next couple of weeks will be a big factor in determining whether stocks like TSLA, NIO, ZM, and TDOC are able to recapture their previous bullish momentum. With each of these names seeing their biggest declines since last year’s COVID-driven collapses, we’re skeptical they’ll regain their bullish mojo any time soon, so traders may want to look for selling opportunities on any short-term bounces.
Learn more about equity trading opportunities.
Disclaimer: The information on this web site is not targeted at the general public of any particular country. It is not intended for distribution to residents in any country where such distribution or use would contravene any local law or regulatory requirement. The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
Futures, Options on Futures, Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Losses can exceed your deposits. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex and commodity futures, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that we do not provide any investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. References to Forex.com or GAIN Capital refer to GAIN Capital Holdings Inc. and its subsidiaries. Please read Characteristics and Risks of Standardized Options.