By: Steve Sosnick, Chief Strategist at Interactive Brokers

One of the market’s supposed truisms is that there is a clear inverse relationship between tech stocks and interest rates. Supposed may be the operative word here.

There is a solid rationale that relates stocks to bonds. Standard financial asset pricing models key off the risk-free rate, and in that means T-bill rates in the US. Thanks to the recent rate hike, those rates are a number greater than zero the first time in two years, at least in nominal terms. Longer-term yields, which reflect market expectations for future rates and inflation, have risen at a much faster pace – something we noted yesterday. In theory, this should be problematic for stocks, though the market seems quite unconcerned for now.

As we all know, “in theory” and “in practice” can be vastly different. In theory, the current price of a stock reflects the market’s best estimate of the present value of a company’s future earnings, cash flows, and/or dividends. Higher rates mean lower present values, thus lower stock prices. Even though most mega-cap tech stocks conduct businesses that are not particularly sensitive to interest rate changes, their lofty valuations should be quite sensitive to rising rates. That is why we frequently heard the narrative that tech stocks were hurt by rising rates as the NASDAQ 100 (NDX) was falling this year. Yet the evidence of that correlation is modest and essentially non-existent over the past week.

3 Month Daily Bars, 10 Year T-Note Futures (ZN, red/green) vs NASDAQ 100 Mini Futures (NQ, blue)

(Click on image to enlarge)

Source: Interactive Brokers

6 Days, 5 Minute Bars, 10 Year T-Note Futures (ZN, red/green) vs NASDAQ 100 Mini Futures (NQ, blue)

(Click on image to enlarge)

Source: Interactive Brokers

We see that for the most part, NDX (graphed using NQ futures as a proxy) followed the 10-Year futures lower for the last three months until last week. On a daily basis, they may have diverged, but the trends followed reasonably well. According to Bloomberg data, the R-squared correlation between the daily values of these items over the three months period ending on March 14 was 0.631. That’s good, not great, but it fits the narrative. When we change the period to the three months including today, the R-squared dips to .554.The relationship flipped on its head last week and the lower correlations reflect that. 

Some traders might see this as an opportunity. A linear regression shows that over the past three months, 10-Year futures have never been cheaper relative to NQ. Notice the red asterisk in the graph below:

Linear Regression Between 10-Year T-Note Futures and NQ, 3 Month Daily Data

(Click on image to enlarge)

Source: Bloomberg

This is hardly a risk-free trade though. The logic behind a trade of this type is that the relationship will return to the mean, but mean regression trades don’t always work as planned. Correlation is not causation, even if the causation seems rooted in reality. Furthermore, this is not a particularly robust relationship and the timeframe is rather short. 

The simple explanation is probably the best one to describe the recent outperformance of stocks versus bonds. Although there should be a solid relationship between the two, it is not ironclad. The two can diverge, especially when markets are going through adjustment periods. The recent Fed moves and rhetoric require the repricing of assets and risks. Bond traders remain nervous. Stock traders decided that they had enough bearishness for a while and have been quick to jump on a rebound. This enthusiasm could certainly persist until next week’s quarter-end, yet it could just as easily exhaust itself without warning. For now, at least, exuberant stock traders are disinclined to let the gloomy bond traders dampen their mood.