How Technology ETFs Defy the Pull of Higher Rates

Technology ETFs continue to defy the gravity of inflation and higher rates. 

Growth stocks, particularly those within the technology sector, have historically been interest-rate sensitive, meaning that prices have tended to have an inverse relationship to interest rates. 

But despite the fastest rate hike campaign in history and stubbornly high inflation, growth stocks have risen nearly 70% since October 2022, as measured by the growth stock proxy Invesco QQQ Trust (QQQ). 

In 2024, the growth-tilted Nasdaq index crossed an all-time high, while the tech-driven Magnificent 7 stocks have propelled the S&P 500 index to its own records, including another high mark this week even as the Consumer Price Index (CPI) rose.  

Why is this growth remarkable? It’s not normal.

How Growth Stocks Are Sensitive to Interest Rates 

Growth stocks’ value is based on the expectation of future earnings, and higher interest rates decrease the present value of those future earnings. This makes them less attractive to investors compared to other investments offering more immediate returns, leading to a decline in their stock prices.

The explanation for growth stocks’ defiance of higher rates is that investors are expecting an economic soft landing, where inflation and interest rates will presumably decline, while simultaneously expecting artificial intelligence to further support higher prices.

Technology ETFs vs Interest Rates

Growth stocks are inherently more sensitive to interest rate fluctuations due to their reliance on future cash flows and the impact of higher discount rates. Technology ETFs, which are generally tilted toward high-growth stocks, can be even more sensitive to interest rates, but multiple other factors can contribute to prices over time. 

Here's how technology ETFs can show gains despite inflation and high interest rates: 

• AI's potential to fuel future growth: Companies heavily invested in artificial intelligence research and development have the potential to disrupt industries and achieve significant future earnings. This long-term growth narrative can outweigh short-term interest rate concerns for some investors. 
• AI fueling innovation: Artificial intelligence applications like machine learning and deep learning require substantial computing power. This has driven demand for specialized chips like GPUs (Graphics Processing Units) and TPUs (Tensor Processing Units) designed to handle complex AI workloads efficiently. 
• Semiconductor companies catering to this demand: As the use of AI expands across various industries, companies like Nvidia Corporation (NVDA) and Advanced Micro Devices, Inc. (AMD) are focusing on developing and manufacturing powerful AI-specific chips. This surge in demand directly translates to increased revenue and potential stock price appreciation for these companies. 
• Cloud computing: The demand for cloud-based services often remains strong even during economic downturns as businesses look to optimize costs and improve scalability. 
• Cybersecurity: With the increasing reliance on technology and data, the need for cybersecurity solutions continues to rise regardless of the economic climate. 
• Valuation adjustments: While high-growth tech stocks might have experienced corrections due to rising interest rates, some may have become more attractive due to valuation adjustments. This could position them for potential future gains. 

Bottom Line on Tech ETFs and Interest Rate Sensitivity

Technology is a diverse sector with varying sensitivities to interest rates. Innovation, long-term growth prospects, and strong sub-sectors like artificial intelligence, cloud and cybersecurity can contribute to gains even during periods of inflation and rising rates. However, not all technology companies or tech ETFs will perform well in an inflationary, high interest rate environment.

The technology sector is still susceptible to broader economic conditions and historically high interest rates. Selection within the tech sector and a focus on underlying fundamentals are vital for navigating this economic landscape.