Fact 1: According to the OECD, there are millions of vacant homes around the world. Houses sit empty while prices appreciate aggressively and are in dangerous bubble territory in some places, like Toronto.
Fact 2: As a proportion of the housing stock, Japan has the highest rate of vacant homes. In North America, over 11% of homes in the US and 8% in Canada are vacant. That’s 15.6 million and 1.3 million empty homes respectively. While there’s some debate over the method used to obtain these estimates, if even remotely accurate they signify that a lack of housing stock isn’t necessarily the primary driver behind rising real estate prices. It appears like speculators are hoarding homes like people hoarded toilet paper in March 2020.
Fact 3: So how does anyone afford to buy a house in cities experiencing intense real estate price appreciation? Many get help from the bank of mom and dad. In Toronto, for example, about 25% of first time home buyers receive an average of $175,000 from their parents. Similarly, in Vancouver (second chart) 23% of first time home buyers receive an average of $210,000 from their parents.
While the parental instinct to support their children is understandable, home ownership is increasingly becoming dependent on familial wealth, exacerbating societal wealth inequality.
If you look up Professor Jeremy Siegel’s work you’ll find one thing: He firmly believes that stocks are the best long-term asset class.
In 1994, Seigel published a classic book that helped shape his investing view and asset allocation decisions for millions investors around the world. “Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies” continues to be a top-selling investment book. His conclusions are based on stock market data going back about 200 years.
New research has compiled stock market data going back to 1793, adjusts for some erroneous methodologies and reaches a different conclusion – one that contradicts Siegel’s long-standing belief that stocks are the preferred asset class over the long run.
When Jeremy Siegel published his Stocks for the Long Run thesis, little information was available on stocks before 1871 or bonds before 1926. But today, digital archives have made it possible to compute real total return on stock and bond indexes back to 1793. This paper presents that new market history and compares it to Siegel’s narrative. The new historical record shows that over multi-decade periods, sometimes stocks outperformed bonds, sometimes bonds outperformed stocks, and sometimes they performed about the same. More generally, the pattern of asset returns in the modern era, as seen in the Ibbotson SBBI and other datasets that begin in 1926, emerges as distinctly different from what came before. Contrary to Siegel, the pattern of asset returns seen in the 20th century does not generalize to the 19th century. A regime perspective is introduced to make sense of the augmented historical record. It argues that both common stocks and long bonds are risk assets, capable of outperforming or underperforming over any human time horizon.
Source: New Lessons from Market History: Sometimes Bonds Win, Edward McQuarrie
For most investors, it’s not news that bonds sometimes outperform stocks. Indeed, this is why we hold bonds within a portfolio – to diversify sources of risk and return. However, for most that’s as deep as the asset allocation decision goes, and bonds – particularly Treasury bonds – are simply viewed as a safety mechanism for short periods of risk asset downside. It remains that, over the long-run, the common view is one that aligns with Siegel’s thesis that equities is the better asset class over long periods of time.
McQuarrie disagrees: Simply, he finds that there are long periods of time during which bonds outperform stocks. The particularly troubling finding is that bonds can outperform for the duration of a human lifespan. It is therefore financially dangerous to adhere to the ideology that stocks are always the better choice.
History is an important guide, but it cannot predict the future. The purpose of this research is not to identify what will outperform over the next decade. Rather, it is to shift portfolio construction from a monolithic to multi-faceted choice.
The crux of Siegel’s case for stocks is exhibited by the following chart. Looking at this alone, it is understandable that someone might conclude that stocks are the better investment. McQuarrie, however, argues that Siegel’s methodology was misleading and the reality is that stocks and bonds performed in parallel until the post-war period (second chart below). Moreover, much of the final stocks-bonds cumulative performance variance is explained by a single time period from post WWII to around 1982, with bonds subsequently resuming parallel performance. (I.e. if you re-started the chart from 1983, the stocks and bonds lines would follow a similar path.) The difference flips the investing paradigm on its head.
It is critical to understand why the results are so different.
McQuarrie’s explanation for the superiority of his bond data is as follows:
Explanation: I observe municipal bond prices from 1857 to 1897 as compiled by the Boston stockbroker, Joseph G. Martin. Siegel relied on a tertiary source, the summary table in Sidney Homer’s History of Interest Rates. Homer does not state there that the municipal bond index he had tabled represents a theoretical construction erected by Macaulay upon Martin’s compilation rather than an observed portfolio. I also adjust for the greenback price of interest paid in gold coin—a distinguishing feature of Federal and some municipal bonds between 1862 and Finally, I use an aggregate bond portfolio up to 1897, and corporate bonds after that point. Corporate bonds returned more than the government bonds used by Siegel, especially when government bond yields were depressed by tax and other privileges.
Essentially, McQuarrie used actual bond portfolio data, whereas Siegel used computed theoretical data.
McQuarrie’s data also adjusts for the striking survivorship bias found within Siegel’s stock market data:
Here most of the variation comes before the Civil War, and this deviation is readily explained: Siegel’s sources omitted the largest single stock that traded before the Panic of 1837, the 2nd Bank of the United States. At the peak before the Panic hit, the 2nd BUS accounted for almost 30% of total market capitalization. It failed spectacularly as the Panic proceeded, with shares dropping in price from $120 to $1.50, and never recovered. To duplicate this omission in the contemporary stock market, it would be necessary to drop Microsoft, Apple, Amazon, Alphabet/Google, and Facebook from the S&P 500; and even these five would not account for as high a percentage of S&P 500 capitalization as did the 2nd BUS at its peak. Omission of the BUS is the single most glaring error I found in Siegel’s stock market sources. More generally, I found and corrected survivorship bias. Banks failed during panics, turnpikes and canals succumbed to railroads, and struggling railroads went bust in the 1840s and 1850s to an extent not previously understood. In short, Siegel’s sources had left out the bad parts, producing an overly rosy picture of antebellum stock returns.
Few probably realize that Siegel’s data contains such biases – especially when it’s standard practice to adjust accordingly. For example, modern fund performance evaluation, like Morningstar’s SPIVA reports, always account for survivorship bias. To read that Siegel excluded failed companies in his analysis is material. To be fair, however, this survivorship bias exists in many historical analyses as it is an embedded feature within index data.
Let’s not make hasty conclusions and throw out all of Siegel’s conclusions. Stocks do outperform bonds during a meaningful range of time periods and scenarios. Stocks are still a core component to an investing portfolio. McQuarrie’s analysis simply illustrates that the probabilities have shifted away from stocks’ favour. This is an important consideration for professional asset allocators and Joe Smith saving for retirement.
Using McQuarrie’s new data, the table below shows the odds of stocks outperforming bonds across a range of rolling 1, 5, 10, 20, 30 and 50 year periods. The odds remain in stocks’ favour across all rolling periods between 1793-2019, and those odds increase with the length of period. However, it is critical to observe that these results are time-period sensitive. The pre-war experience is markedly different, especially prior to the US Civil War.
Modern-day assurances that stocks always outperform over the long run are based on post-war data (1943-2019). In contrast, the full history shows there’s a 32% chance that someone investing in stocks over 30 years – a lifetime of investing – would underperform bonds.
Why did stocks outperform during the post-war years?
During that period, the US dominated the world with military and economic hegemony acting as the global arbiter and enforcer of transnational trade and globalization, creating a ‘peace dividend’ for risk assets around the world. As that power fades, it’s quite possible the structural forces that created that environment will someday no longer exist.
The following chart shows something similar to the table above, focusing on rolling 10yr performance differentials between stocks and bonds. Again, it is apparent that stocks can underperform for life-altering periods of time.
How bad can stock market returns get?
If one asset goes up by 20% and the other by 10%, the second asset underperformed but still provided a decent return. Unfortunately, history shows that the stock market can provide dismal returns for very long periods of time.
The table below shows the worst 20, 30 and 50 year real total returns for stocks. The results show that stocks can perform poorly in both relative and absolute terms over investing lifetimes.
The standardization of time periods in the previous chart, however, doesn’t show the true extent of weak stock market performance potential over long periods of time. One only has to go back to the 13 year period ending 2013 to have witnessed one of the worst periods ever for US stocks. The table below shows the worst six periods for US stocks.
The implications for asset allocation decisions are immense, yet intuitive: Don’t rely on history alone to guide asset allocation decisions.
Investors must look at the prevailing environment to determine how to construct portfolios, understanding that long-term performance characteristics can change. Perhaps the most challenging part of this effort is understanding the relative variability of stocks and bonds, as illustrated by long-run correlations. Correlations change markedly over time, so the idea that one simply dumps a portion of a wealth into bonds with the purpose of creating a portfolio ballast is wrong. Stocks don’t always outperform and bonds don’t always move opposite to stocks. This is strikingly apparent (but shockingly rarely discussed) during the recent Covid-19 market crash, when US Treasuries (using TLT as a proxy) declined by almost 10% from March 1st to March 8th, while US stocks simultaneously declined by 8.8%. US Treasuries soon recovered and rallied as stocks continued to plunge, but this relative performance aberration – when the correlation between stocks and risk-free assets moved to 1 – is an example of how historical relationships can and do change. It is a critically important example of how expectations based on long histories can be false.
Will bonds outperform stocks? Are bonds still a good tool for diversifying portfolios?
Without spending considerable amounts of time and effort deciphering the current economic regime and its implications on forward asset prices, a more pragmatic approach to asset allocation might be to ensure broad representation across assets that have fundamentally different risk exposures. Stocks are probably still good to hold for the long run. Probably so are bonds (both corporate and a variety of sovereign). But it’s entirely possible that neither will perform as you expect.
Did you know that during any given year when the market is rising, up to 42% of stocks may simultaneously be declining?
Simply being ‘in the market’ during an up year doesn’t guarantee positive performance. Some years are worse than others, but history shows stock-pickers can easily lose money despite being right about market direction.
The chart below demonstrates this phenomenon over the past 20 years. The blue bar shows calendar year performance for all positive years dating back to 2002. The red line shows the % of stocks that were negative during the same year.
Lesson: unless you have the golden touch, it’s best to tap into market gains by building exposure to a broad basket of stocks. The easiest and cheapest way to achieve that is by using a low cost index fund.
Inflation is a hot topic right now. Understandably so, as prices for a range of commodities (lumber, copper, etc.) have risen substantially over the past several months.
Chart: Google Search Trends for ‘Inflation’ in the United States
Raw materials price pressures are now showing up in consumer prices with CPI rising 4.2% year over year ending April 2021. This level of CPI has not been seen since the early days of the 2008 global financial crisis.
However, it is becoming increasingly clear that this inflationary burst is temporary. The conditions simply don’t exist to support long term inflation, like that seen during the 1970s.
There are several reasons.
1) Milton Friedman once said that “inflation is always and everywhere a monetary phenomenon”. I’d argue that he is only half right. Central banks can increase the money supply all they want, but to have an inflationary effect the velocity of money must remain stable or rise. Real world experience clearly shows that money velocity is not constant and tends to have an inverse relationship with the level of a country’s indebtedness. And as you all know, we are drowning in debt right now.
The relationship between indebtedness and money velocity is clear in the following chart. As the level of indebtedness of the US economy started to significantly rise in 2008, money velocity declined. Ultimately, money velocity plummeted to new lows during the Covid-19 crisis and has yet to recover, despite an improving economy.
Effectively, what this means is that new money entering the system (generally to fund new debt) is simply tucked away, mitigating any inflationary effects of monetary expansion.
This phenomenon is also illustrated by the declining marginal economic benefit created by new debt. The economic impact of additional debt today is much lower than it was in decades past. Therefore much more money needs to enter the economic system to have the same impacts it did in the past. Of course, more new money means more debt. By now you’ve probably noticed this is a vicious cycle.
2) The current inflationary pulse was triggered by the partial paralysis of the global supply chain. Exports out of low-cost producing countries grinded to a halt, forcing Western countries to purchase from more expensive domestic suppliers or compete over dwindling supply.
As vaccines are delivered the mechanisms for global trade – offshore manufacturing + shipping – can resume. Imports into the US are already back to pre-pandemic peaks and it’s only a matter of time until renewed competition from cheaper sources pushes prices down.
3) Labour productivity tends to rise coming out of recessions. Higher productivity offsets higher wages, thus putting a cap on unit labour costs that can flow into prices. I believe this phenomenon will be even stronger as we exit the pandemic.
The nearly immediate and widespread adoption of new software and methods of working have compressed a decade’s worth of productivity gains into the present. Not only that, but companies that maintain a remote workforce can benefit from labour cost arbitrage across geographic regions. Over the long run, both of these advances will keep a lid on unit labour costs. This is disinflationary.
4) Population growth in the US continues to be very weak and will be for the foreseeable future. 20-something year olds simply can’t afford to have kids. Or they are choosing not to bring new people into the world for ethical reasons.
The point is that forward demand driven by new consumers entering their prime spending years continues to decline. When demand declines prices fall.
While nobody can predict the future, one can use data and hard evidence to create a guide. Evidence suggests that those calling for a shift in the economic regime – from disinflationary to inflationary – could be wrong. I believe, as a diversified investor, it is important to prepare for the possibility that the pundits are wrong.
While I won’t know if I’m right or wrong until some point in the future, it appears that the bond market might agree with my thesis, as the yield on the 10yr has flatlined since March 2021.
Many people point to the US stock market performance after the 1929 crash as evidence that stocks can go nowhere for decades.
The argument usually points to the chart below, which shows the Dow Jones Industrial Average failing to retake its August 1929 peak until November 1954. In other words, people make the argument that someone investing in US stocks at the 1929 peak would have had to wait until November 1954 just to break even.
This is false.
The above chart shows the commonly used Dow Jones Industrial Average – an index based on price-returns.
What people completely miss is that investors would have received dividend payments during this entire period. Below, I adjust market returns to include dividends.
According to the calculation below, when including reinvested dividends, an investment at the 1929 peak would have returned on average 5.58% per year ending November 1954. That’s equivalent to a cumulative total return of just under 300%.
While it’s true that the buy-and-hold investor would have ridden a financial rollercoaster along the way, even the worst market timer would have done OK if they simply invested a lump sum and did nothing.
Of course, it took time for dividends to compensate for price declines. It wasn’t until 1945 that investors started to experience a positive total return. That’s still a long time to wait – and still implicit evidence that stock markets can take a long time to recover.
However, the stagnation narrative is significantly undermined, as this shows it took far less than a quarter-century for the worst market timer to break even.
The above examples show a worst case scenario – someone who’s only decision was to invest at the peak of a stock market bubble and then sit on their hands. This isn’t a realistic scenario for most of us.
Most people invest periodically (i.e. not all at once) as they stash away savings over time. So the more realistic illustration would show how someone performed if they started investing in 1929 and added to their investment over time.
The following chart shows the portfolio value for someone who spread their investment over a 40 month period, starting at the end of 1929. In this example, the person invests a total of $20,000. As you can see, their account is positive (i.e. above $20,000) from the end of 1933 onward.
This more realistic scenario again shows the myth of secular stock market stagnation narrative is largely misleading.
After constructing a well-diversified portfolio of Canadian and US companies – using a combination of individual stocks and ETFs – you look at your portfolio’s currency exposure and wonder: “Should I hedge or not?”
Fact 1: Over the past 12 months alone, Tesla’s market capitalization grew by more than a full Berkshire Hathaway! Growth’s outperformance is well known and documented, but the speed of this outperformance is jaw-dropping. Fact 2: Residential investment as a proportion of GDP in Canada skyrocketed during the pandemic and remains at extraordinary levels. The Canadian economy […]
Fact 1: According to the OECD, there are millions of vacant homes around the world. Houses sit empty while prices appreciate aggressively and are in dangerous bubble territory in some places, like Toronto. Fact 2: As a proportion of the housing stock, Japan has the highest rate of vacant homes. In North America, over 11% of homes […]
Fact 1: Corporate insiders have historically had a knack for buying near market bottoms. Fact 2: Investor bullishness has declined during 2021. However, sentiment has recently recovered. Fact 3: Over the past decade, small cap tech stocks have underperformed small cap cyclicals. Technology leadership has clearly been limited to big cap indices. Fact 4: A sign of a liquidity […]
It has been a long time since labor has had so much power
I believe there are reasons for and against hedging US dollar exposure, many of which investors fail to consider.
Most investors incorrectly base their decision to hedge US dollar exposure on their view of the US dollar. While it makes intuitive sense that if one is bullish on the US dollar they’d want unhedged exposure, I believe this is the wrong way to execute on this view.
Some Canadian investors might have 30, 40%+ of their equity holdings allocated to a diverse basket of US companies. They’ve committed a lot of time to ensure individual exposures aren’t excessive and spread across a range of sectors to reduce the risk of one individual weak holding making a significant impact on portfolio performance.
Yet, after all that careful effort they leave their entire US equity position exposed to a single factor: the US dollar. While there may be some nuances (e.g. some US companies will benefit from a weak US dollar), a decline in the US dollar would negatively affect the entire 30, 40%+ US equity position. This is a massive overexposure to a single risk factor.
By leaving a large portion of a portfolio exposed to a single factor investors are taking on significant risk. Many people fail to recognize this.
Historical Canadian dollar performance
If you were to ask Canadian investors during the mid 2000s about US stocks, most would say they stay far away. Why? Because during that time the Canadian dollar appreciated significantly against the US dollar, wiping out investment returns. At that time, currency risk was at the forefront of their minds because they had just experienced its painful effects. Between 2002 and 2007 (a 5 year period!) the Canadian dollar appreciated roughly 60% against the US dollar.
Note: Many investment practitioners argue that CAD/USD is a wash over the long run. The chart below shows that today’s level is close to where it was almost 30 years ago. What this argument fails to appreciate is that not all investors have a 30 year time horizon. An investor with a 5 year time horizon (note that many investors behave like they have 1 year time horizons) would have either experienced a massive tailwind or a massive headwind due to USD exposure. Not a gamble people should take as they approach real-world liabilities, like retirement. Also, the argument that CAD/USD is a wash over the long run erroneously assumes that exchange rates are mean-reverting and deviations are temporary. This is false.
Nobody knows where the USD/CAD exchange rate will head over the long run. Smart people have great guesses, but nobody truly knows. And it’s quite possible that CAD appreciates considerably again, for one reason or another. My point is the risk still exists and it always will.
As with everything in finance and investing, there are multiple considerations. Nothing is black and white, and currency exposure is one of those things.
USD performance during crises
While overexposure to a single risk factor should be avoided in all portfolios, some exposure to the US dollar – due to its safe-haven status – does provide a portfolio cushion in times of crisis.
The chart below shows the level of CAD/USD during the recent crash. From December 2019 to March 2020, the Canadian dollar depreciated roughly 10% against the US dollar. This means that Canadians holding unhedged US assets would have benefited from a buffer.
Below, I’ve shown the performance of two TSX-listed US equity ETFs during that time period. Both are Vanguard S&P 500 Index ETFs, but VSP is currency hedged while VFV is not. You can see how the unhedged version of the ETF declined about 10% less than the hedged version, due to US dollar exposure. A similar narrative played out during the 2008 financial crisis.
So should I hedge or not?
Personally, when given the simple option I hedge. But overall, I might only be about 50% hedged.
My US exposure is attained using a combination of ETFs and individual stocks. Because it is much more time consuming to create my own hedges (e.g. using FX derivatives) my individual US stock holdings are unhedged. However, most TSX-listed US ETFs offer hedged and unhedged versions. In those cases, I buy the hedged ETF.
Typical ESG investing (aka socially responsible investing, SRI investing, responsible investing, etc.) is a waste of time. It doesn’t achieve what many hope and believe.
Instead, many ESG funds only serve to pacify anxious investors who wish to decorate their portfolios with feel-good products. It’s sad to say because both ESG investment product manufacturers and investors usually have the best intentions. They want to do the right thing. Unfortunately, many fail to recognize their efforts are probably counterproductive and likely worsen the issues they are meant to fight.
As global interest in ESG investing rapidly grows, it is critical that investors understand how many ESG investment funds fall short of their implied objectives.
ESG funds are investment products (like mutual funds or exchange traded funds) that are constructed to feature environmental, social and corporates governance factors into their investment process.
Many ESG investment funds attempt to do this by excluding certain categories of sin stocks: guns, tobacco, porn, and so on. With growing concern about climate change, oil is increasingly at the top of the sin list.
The first problem with oil company exclusion is it’s very limited in scope. Oil companies don’t operate in a vacuum and are highly integrated within all sectors of the economy. They are financed by banks. They supply petroleum to chemicals and plastics manufacturers. Plastics are used in the production of millions of products. If boycotting oil companies, why not also their best customers and financiers?
It’s true that oil companies are at the heart of CO2 emissions and shutting down oil companies would stop the flow of petroleum based products throughout the economy. But excluding oil companies from ESG portfolios fails to shut anything down.
Companies have always had to work with various strata of investors who exclude certain investments based on a variety of characteristics. Value investors shun momentum stocks. Most of the world doesn’t invest in Canadian companies. Tobacco and gun stocks have been excluded from many large portfolios for decades. Yet, tobacco stocks, gun stocks and Canadian stocks have continued to perform as expected. Altria (formerly Phillip Morris) has a stellar long-run track record.
Is ESG investing profitable?
The exclusion of companies or sectors doesn’t affect performance. Research from South Africa’s period of Apartheid has shown that boycotting certain companies, sectors or countries is ineffective at altering share price performance.
Companies simply don’t need 100% of investors to be interested in their stock. There will always be a class of investors who don’t care about what they invest in as long as the returns are good.
In fact, the exclusion of certain companies from ESG portfolios may actually improve return prospects for those excluded companies. Perversely, if 80% of investors shunned Altria, for example, causing its share price to decline Altria’s expected future return would rise, attracting the remaining 20% of investors. A smaller pool of potential investors doesn’t change a company’s business prospects, and thus its intrinsic value. There will always be investors willing to capitalize on this. Moreover, without the burden of ESG-related business expenses, Altria’s intrinsic value may actually rise relative to other ESG-friendly companies.
Does ESG investing make a difference?
As conscientious investors abandon a company, the remaining class of financiers care less-and-less about the company’s practices. All things equal, this leaves the offending company to continue as it pleases, perhaps even creating a disadvantage for the ‘good’ companies that must operate under greater constraints.
Investors looking to force change would do better by adopting methods used by activist investors, like Carl Icahn. Activist investors take large stakes in companies they want to change. Shareholders, as company owners, have a right to board representation. The board hires company executives who then run the company.
To create change, investors must not distance themselves from companies with weak ESG practices. Instead, they must directly engage the companies they wish to change.
We study the nature of and outcomes from coordinated engagements by a prominent international network of long-term shareholders cooperating to influence firms on environmental and social issues. A two-tier engagement strategy, combining lead investors with supporting investors, is effective in successfully achieving the stated engagement goals and is followed by improved target performance. An investor is more likely to lead the collaborative dialogue when the investor’s stake in and exposure to the target firm are higher, and when the target is domestic. Success rates are elevated when lead investors are domestic, and when the investor coalition is capable and influential.
Given this perspective, ESG scores for investment funds (provided by various rating agencies) can be totally misleading. Based on current methodologies at many ratings agencies, to get a high score a fund must have minimal exposure to offending companies. As shown above, this can have a counterproductive result.
Don’t divest. Engage.
None of this is easy. However, if institutional investors (which represent individual investors) combine efforts and own enough of a company to engage the board they can enact real change. This is not an unusual practice, as investors have banded together many times in the past.
As public concern over climate change grows, there will likely be enough energy to make a real difference. However, it is critical that efforts are directed correctly, away from feel-good ESG products and into activist ESG funds.
Another set of data visualizations provided by AnrepViz.com. This time data visualizations feature railroad stocks such as CN Rail, CP Rail, Union Pacific, Norfolk Southern, CSX Corp, Wabtec Corp and Kansas City Southern.
Since the end of Q3 2020, there has been a marked rotation from ‘pandemic stocks’ (mainly tech) to ‘recovery stocks’ (industrials, financials, consumer discretionary, etc.). Many tech stocks – like Amazon, Facebook Netflix, Zoom – are flat-to-down while the broader market hits new all time highs.
While there might be some intuitive sense to this as return to normal approaches, many people are pointing to rising yields as the cause.
Why Rising Yields Impacts Some Stocks More Than Others
Many people understand that rising yields have a negative impact on the prices of bonds. A bond represents a series of cash flows in the future. The higher the discount rate (of which the risk free rate is a part) the lower the present value of those cash flows.
The sensitivity of a bond’s price to changes in yield is neatly wrapped up in a single data point called ‘duration’. Higher duration bonds have a greater sensitivity to changes in yields.
Duration can be sort of described as a weighted average of time to receive cash flows. The longer it takes to receive cash flows, on average, the higher the duration.
Therefore, a zero coupon bond will have a higher duration than a coupon-paying bond. All things equal, a 30 year bond will have a higher duration than a 10 year bond. And so on.
While many people understand how duration impacts bond prices, they forget that the same concept applies to stocks.
You can look at a stock like an infinite-term bond. In doing so, it becomes clear that a non-dividend paying stock (like most tech stocks) have a higher duration than more traditional dividend-paying stocks.
Going even further, because many tech companies don’t generate positive EBITDA or cash flow they trade on the expectation of a potential cash flow in the future. In comparison, most recovery stocks are tried and true, generating reliable cash flows quarter-after-quarter. So when considering the cash flows generated by the firm itself, a business that might generate cash sometime in the future clearly has a higher duration than a business generating cash today. For these reasons, most tech stocks have a higher duration than most traditional stocks, and are therefore more sensitive to rising yields.
Yields are a component of the cost of capital. A rising risk free rate raises the cost of capital for all businesses. While tech stocks operating on promises of future cash flows might do well when money is virtually free, they face rising challenges when capital becomes more scarce or expensive. In comparison, businesses that can fund capital investment via retained earnings and current assets (i.e. through realized earnings and cash on hand) and don’t have to tap into capital markets to stay afloat may start to outperform when yields start to rise.
With all that said, let’s be real. As a proportion of where they were last August, yields have risen a lot. But in absolute terms, yields are basically near the bottom of a 10 year range. The 10 year US Treasury yield is essentially where it was a week before the pandemic started.