With rate hikes looming, investors are dumping money-losing company stocks
Moonshot actions return to Earth.
As the Federal Reserve nears an interest rate hike, investors are reassessing their bets on one of the riskiest corners of the market: stocks of companies that aren’t making money. Money-burning tech companies, biotech companies without any approved drugs, and startups that quickly listed via mergers with blank check companies — some of which have soared during the pandemic — have fallen sharply.
An analysis of Wall Street Journal data shows that as signals from Fed officials and continued high inflation readings made it more clear that rate hikes were imminent, stocks of unprofitable companies in the Nasdaq composite index slipped while their profitable counterparts traded nearly flat. On average, loss-making companies in the analysis have slipped 28% since the September 30 market close through Tuesday. Profitable companies in the index fell slightly by an average of 0.7% over the same period.
The Journal’s analysis identified loss-making companies as having less than zero earnings per share for at least the past four quarters combined. It excluded blank check companies that did not merge with a target and some companies for which FactSet did not identify earnings per share figures for the past four quarters.
Fed officials have indicated they are accelerating their schedule of interest rate hikes, potentially as early as March, to combat runaway inflation. Many investors value stocks based on the present value of future corporate earnings. When interest rates rise, eroding that future value, it becomes less attractive to make high-priced bets on businesses that may not be profitable in years to come.
“Within our team, we’re thinking, ‘Should we ditch some of these high-growth areas that may be sensitive to rising rates and focus on battered and undervalued areas of the market?’ said Emerson Ham III, senior partner at Sound View Wealth Advisors.
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The performance of riskier growth stocks, which aim to deliver strong earnings growth going forward, also lagged broader indices in the latter part of 2021. The Nasdaq CTA Internet Index, for example, fell 18% from September 30 to Tuesday. The Nasdaq Composite gained 0.4% over the same period, while the S&P 500 gained 6.3%.
The Fed’s hawkish policy is driving a rotation into stocks that generate above-average dividend yields, like areas like banks and insurance, said Jonathan Garner, chief Asia and emerging markets strategist based in Hong Kong at Morgan Stanley.
“It’s playing out globally, and we expect it to continue,” Garner said.
Portfolio managers may also seek exposure to economically sensitive companies, said Jordan Kahn, chief investment officer of ACM Funds.
“There will be a little more accountability with some of these very high value stocks,” Kahn said.
Shares of some unprofitable companies had soared earlier in the pandemic when their business was boosted by shutdowns and social distancing measures. Shares of electronic signature software maker DocuSign Inc.,
which surged at the start of the pandemic as businesses adapted to remote and paperless environments, hit an all-time closing high of $310.05 on September 3 but has since fallen 59%. DocuSign has posted a loss every quarter it has reported as a public company since its April 2018 IPO.
Shares of electric vehicle manufacturer Rivian Automotive Inc.,
which went public in November and posted revenue of $1 million and a loss of $1.23 billion for the third quarter, peaked at $172.01 in mid-November but has since fallen 57% .
Robinhood Markets Inc.,
which became popular among individual investors during meme-stock mania, maintains a loyal fanbase and its stock has been volatile since its debut. After its IPO in July, shares soared to $70.39 in August, but have since fallen 80%.
The global race to vaccinate the world against Covid-19 had biotech stocks rallying at the start of the pandemic. But in the world of biotech, where clinical trials and regulatory decisions can make or break a company’s value, companies can lose money for years waiting for treatments to move through their pipelines. Many may never make any money at all. The Nasdaq Biotechnology Index has fallen 17% since September 30.
Accommodative monetary policy has partly fueled the rush into growth stocks, making it easier for companies to borrow cash at low rates.
“In a rising rate environment, it’s more difficult for them to borrow money and do other things to invest in growth,” Greg Bassuk, managing director of AXS Investments, said of the growing businesses.
The rout has also particularly pushed down companies making their public market debut through special-purpose acquisition companies, also known as blank check companies, which raise funds in an effort to seek out a target. with which to merge and become public. Although one of the hottest trades on Wall Street at the start of 2021, SPACs have fallen from their highs.
Starting Nikola Electric Trucks Corp.
, which went public via a SPAC, was down 35% last year and down 13% since Sept. 30. , has fallen around 26% in 2021 overall and is down 17% since Sept. 30.
“For some of them, it could be bad fundamentals; some might be pre-revenue companies that just aren’t profitable yet,” said Sylvia Jablonski, co-founder and chief investment officer of Defiance ETFs, of the forces behind some companies’ stock sell-offs in growth. Some investors who have driven the prices of these companies higher, such as retail traders, have also taken a break from SPAC investments and turned to other assets like cryptocurrencies, Ms Jablonski added.
Unprofitable traditional IPOs also generated lower first-day returns in 2021, according to analysis by University of Florida finance professor Jay Ritter. About three-quarters of the more than 300 operating companies tracked by Prof Ritter that went public in the US had earnings per share below zero, and they delivered an average first-day return of 30% in 2021, compared to 45.3% among a smaller pool of companies in 2020.
With valuations still frothy, the bar is high for unprofitable companies to deliver the results they promised, said Tim Murray, financial markets strategist at T. Rowe Price Group. Inc.
multi-asset division. Investors are likely to be more selective in investing in growth companies, profitable or not, in 2022 in a tougher economic environment, Murray added. He said he favored certain sectors, such as consumer staples and utilities, which would do well as the economy moves past its pandemic rebound and moves towards normalization.
“We’re probably even more selective and more concerned about that right now,” Murray said of unprofitable growth stocks. “These stocks used to be a bit cheaper than they are now, and now the bar for them is already very high.”
Write to Dave Sebastian at [email protected]
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