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Why tech stocks plunged on Monday


What happened

High-growth tech stocks are having a terrible day on Monday, some dropping more than 20%. President Joe Biden has announced that he will appoint Jerome Powell for his second term as Federal Reserve chairman and parts of the market are reacting extremely quickly.

Asana (NYSE: ASAN) was a major driver of activity on Monday morning, falling as high as 22.7% and trading down 18.4% as of 3:15 p.m. ET. Cloudflare (NYSE: NET) also fell 12% and is currently trading down 9%, while Fiverr International (NYSE: FVRR) was down 10% and is now down 7.7% for the day.

Image source: Getty Images.

So what

The big news is rising interest rates. It is widely believed that Powell’s continued leadership of the Federal Reserve means short-term interest rates will rise sometime in 2022, something long-term bond traders are anticipating.

Higher rates decrease the value of future cash flows and ultimately decrease the value of growth stocks. For Asana, Cloudflare, and Fiverr, their value is revenue and profit five, 10, or 20 years from now, not what they’re doing today, so a sale makes sense.

In the United States, 10-year Treasury yields jumped 9 basis points to 1.63%, a sharp increase for a single day. Rates have also increased in Canada, Brazil, Mexico, Germany and the UK, so investors are sure to expect interest rates to rise in the near future.

The reason these three stocks react so violently is that they are all highly valued in every way. You can see below that Cloudflare’s price / sales ratio is above 100 while Asana and Fiverr are both well above S&P 5003.2 times average price / sales ratio.

ASAN PS Ratios Graph

ASAN PS Ratio data by YCharts

When perfection is valued in stocks, even the smallest ripple in the market can bring them down in an instant.

Now what

There is nothing fundamentally wrong with any of these companies today and this is what we as investors need to remember. The market simply rates the expected future cash flows of each stock as lower, which has a dramatic impact on a stock if most of the cash flows are expected many years into the future.

I think the market has taken a lead in many areas and you can see from the high price-to-sell ratios above that it could be overvalued stocks ready for a downturn.

What we don’t know is how long the interest rate hike will last. Rates rose earlier this year, pushing growth stocks down, then falling again, pushing growth stocks higher. Given a tight labor market and signs of inflation, it wouldn’t be surprising to see rates rise, which could make the sell-off worse. Having said that, they are high quality companies and I would look for opportunities to be a buyer of these stocks if they fall too much as the future is still bright for each.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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