The extraordinary rally in markets, since their plunge in the very first stages of the coronavirus pandemic, was based on two reasonable assumptions. One was that lockdowns would permanently change how we live our lives — benefiting, above all, the technology giants. The other was that central banks would be unable to raise interest rates from emergency levels, at least for the foreseeable future. The fall in the value of the tech-heavy Nasdaq Composite index during the past few weeks demonstrates that both are now being tested. That might be bad for tech investors but, ultimately, it reflects good news for everyone else.
Since its peak in November last year the index has fallen by over 10 per cent, meeting the technical definition of a market “correction”. This has been led by lockdown-sensitive stocks. On Thursday, reports that luxury exercise bike maker Peloton — a diversion for those confined to their homes — was halting production due to falling demand led to a sharp drop in its shares. Then after the market closed, Netflix, the streaming service, warned investors that subscriber growth was set to slow. Falling share prices for the two companies mean they are joining other previous pandemic winners such as Zoom, the videoconferencing software maker.
A broader sell-off in riskier assets also reflects the changing stance of major central banks, especially the Federal Reserve. Investors have lost interest in lossmaking technology companies, in particular, since Fed chair Jay Powell indicated that the central bank would begin to withdraw its emergency pandemic support earlier than first predicted. Growth companies of this sort are the most sensitive to changes in interest rates.
Yet poor results for companies that profited from lockdowns are a bullish signal for society more generally. Fears over the Omicron variant have subsided and so investors who anticipated further lockdowns, and consumers being confined to sofas rather than cinemas and Pelotons rather than gyms, will be disappointed. Those of us who prefer a busy social calendar to social distancing should be pleased. The Fed’s more hawkish tilt, too, is ultimately good news, reflecting the relatively swift return to something approaching full employment in the US. Even the snarled-up supply chains are partly an indicator that consumers are feeling confident to spend, rather than pile up savings.
Even after the recent sell-off, markets and technology stocks in particular are still up significantly from two years ago. The “correction” is aptly named: valuations of some of these companies got out of hand relative to their underlying earnings. A minor fall will add some needed discipline to the market, reminding investors that share prices can go both ways. Bitcoin, an obvious indicator of speculative frenzy, has fallen to its lowest level for five months.
Others may see the recent drop as a buying opportunity. While the Fed is embarking on a tightening cycle in response to higher inflation, long-term equilibrium interest rates are still likely to end up low by historic standards, supporting equity values. The fundamental demographic and technological drivers of the secular decline in long-term interest rates, such as ageing populations putting away more to save for their retirement, will only change slowly. Tech companies, too, have often proved resilient. The changes provoked by the pandemic, whether it is how we shop, work or relax, may take longer to bed in than first predicted. Markets may have got ahead of themselves with the bull market but they should not overdo the correction either. With or without Netflix they can chill.