High-growth technology stocks are having a terrible day on Monday with, some down over 20%. President Joe Biden announced he will nominate Jerome Powell for his second term as chair of the Federal Reserve and some parts of the market are reacting extremely quickly.
Asana (NYSE:ASAN) was one of the biggest movers early on Monday, falling as much as 22.7% and trading 18.4% lower at 3:15 p.m. ET. Cloudflare (NYSE:NET) also dropped 12% and is currently trading 9% lower, while Fiverr International (NYSE:FVRR) was down 10% and is now down 7.7% for the day.
The headline news is rising interest rates. It’s widely believed that Powell continuing to head the Federal Reserve means short-term interest rates will move higher sometime in 2022, which traders of long-term bonds are getting ahead of.
Higher rates lower the value of future cash flows and ultimately lower the value of growth stocks. For Asana, Cloudflare, and Fiverr, their value is in revenue and earnings five, 10, or 20 years from now, not what they’re making today, so a sell-off makes some sense.
In the U.S., 10-year Treasury rates jumped 9 basis points to 1.63%, which is a big increase for a single day. Rates were also up in Canada, Brazil, Mexico, Germany, and the U.K., so investors are certainly expecting interest rates to rise in the near future.
The reason these three stocks are reacting so violently is because they’re all highly valued by any measure. You can see below that Cloudflare’s price-to-sales ratio is over 100 while Asana and Fiverr are both well above the S&P 500‘s average price-to-sales ratio of 3.2 times.
When perfection is priced into stocks, even the smallest ripple in the market can send them lower in an instant.
There’s nothing fundamentally wrong with any of these companies today and that’s what we should remember as investors. The market is just pricing the future cash flows expected from each stock to be lower, which has a dramatic impact on a stock if most cash flow is expected many years in the future.
I think the market has gotten out ahead of itself in many areas and you can see from the high price-to-sales ratios above that these could be overvalued stocks ready for a pullback.
What we don’t know is how long the rise in interest rates will last. Rates rose earlier this year, which sent growth stocks lower, only to fall 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 worsen the sell-off. With that said, these are high-quality companies and I would look for opportunities to be a buyer of these stocks if they fall too far because the future is still bright for each.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.