Bets that the Federal Reserve will continue cutting interest rates have fueled a rally in one of the riskiest corners of the technology sector, raising concerns about a potential reversal in the stocks.
A basket of unprofitable tech companies tracked by UBS Group AG has jumped 22% since the end of July, compared with a 2.5% advance for its profitable counterpart and the Nasdaq 100 Index’s 5.9% advance. The run-up has sent the group, which includes lesser-known companies like SoundHound AI Inc. and Unity Software Inc., near its highest since late 2021, when rock-bottom interest rates were fueling a bubble in speculative assets that popped the following year.
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The basket of loss-making tech firms rose 0.7% Wednesday, while the profitable equivalent rose 0.4%.
The potential of a hard landing for the stocks was highlighted on Tuesday, when the group sank 2.1%, underperforming the market after Fed Chair Jerome Powell reiterated his view that policymakers face a difficult road ahead as they weigh further rate changes. Even if the central bank follows through with two more cuts this year, the benchmark rate will likely remain above 3%, a far cry from the zero-interest-rate policies during the pandemic that fueled equities.
The move in unprofitable tech stocks marks “a phase of speculative over-exuberance because the expected rate-cut cycle is leading to animal spirits being revived,” said Ted Mortonson, a tech strategist at Robert W. Baird & Co. “The rally looks extremely frothy and risky, and all the speculation from the Reddit and Robinhood crowds makes it feel like a casino, which makes me think this will end with disillusionment.”
With inflation still a problem and artificial intelligence weighing on the labor market, it’s “extremely tricky” to analyze the value of money-losing companies based on what the Fed may or may not do, Mortonson added. Lower borrowing costs are crucial for money-losing firms that need to finance fast-growing operations at valuations based on profit expectations that might take years to hit.
Of course, there are plenty of other areas of the stock market where speculation is running rampant amid prospects for lower rates. Riskier biotech plays are surging and the Russell 2000 Index of small caps recently hit its first record since 2021. However, the move in tech has been pronounced.
[SRC] https://finance.yahoo.com/news/frothy-risky-rally-profitless-tech-110509532.html
