Wall Street's Euphoria About Tech Stocks Would Be Justified Only If Fed Cuts Rates By 300 Bps — Yes, You Read It Right!

Wall Street traders appear to be overlooking signs that rally in technology stocks might be overdone as is reflected by the significant surge in the S&P 500 Information Technology Index as well as high equity valuations.

What Happened: Expectations that the Federal Reserve will pivot from its interest-rate hiking cycle has pushed the S&P 500 Information Technology Index up 19% in 2023 compared with a 7.7% gain for the S&P 500 Index, reported Bloomberg.

This is the strongest start to a year for the index relative to the S&P 500 since 2009, the report said.

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Another instance that shows optimism is likely to have reached greater heights is the fact that tech stocks in the S&P 500 are trading at close to 25 times prospective earnings. Such a multiple would only be justified if the central bank would cut rates by at least 300 basis points, data compiled by Bloomberg Intelligence show. That's over five times what the swaps market is pricing in for rate cuts this year, it said.

The SPDR S&P 500 ETF Trust SPY has gained over 8% while the Invesco QQQ Trust Series 1 QQQ has risen over 19% since the beginning of the year.

However, options traders aren't as optimistic as equities investors. The cost of contracts protecting against a 10% fall in the Invesco QQQ Trust is now 1.7 times more than the cost of options that gain from a 10% rally — the most in a year, reported Bloomberg.

Expert Take: Quincy Krosby, chief global strategist at LPL Financial, told Bloomberg that traders are betting on a big about-face in the Fed's interest-rate policy, but there is no certainty as to whether, and when, this will happen.

"Longer-term, the sector's growth prospects are attractive, but not at the current valuations," Krosby said.

Last week, two Federal Reserve officials reiterated the need for more interest rate hikes to rein in inflation just as the central bank is set to enter a silent period from April 22 to May 4, ahead of its next monetary policy announcement.

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