The Danger Zone

Chad Padowitz

Talaria Asset Management

The prevailing narrative in markets recently has been that rising interest rates would not be an issue for investors, given growth is accelerating and a pick-up in inflation would actually be a good thing.

As discussed over many months now, our view has been this is wrong when it comes to technology stocks because:

  1. They represent a significant risk to investors given positioning;
  2. They represent a significant risk to the market as a whole given technology’s outsized weighting in the index.

It is equally true that some funds, like Talaria, have a process which will benefit were this to come to pass.

Given the duration of technology stocks (aka high valuation stocks), any rise in inflation expectations and long end rates would see the sector under pressure from a valuation perspective. For while it may be true that rising rates are not bad per se – it’s the relative relationship that matters.

For context, going back to 2017 (see chart below) when the spread between the 10-year treasury yield and the prospective earnings yield of the technology sector (inverse of forward p/e) approaches or moves below 280bps (using S&P Global 1200 Index) - markets as a whole have sold off. 

Source: Bloomberg, S&P, Talaria

As of yesterday the 10-year treasury yield was 1.41 and the earnings yield of tech sector 3.86, meaning the spread is 245bps – below the danger zone.

So to take this spread back to 280bps earnings yield gap (the prior danger level) the world technology sector would need to decline 8.2%.

These are still the same great businesses, just potentially risky investments.

So to recap:

  • A modest pick-up in inflation will leave the majority of investors significantly exposed to de-rating risk of the order of around 10%

  • Fiduciaries should be actively diversifying portfolios to cover a wide range of eventualities.

  • It is a warning to anyone taking care of client money to recognise the risks they are running and move decisively to reduce this. The potential for this to go a very long way in certain scenarios is very real. And in a benign scenario – 10%. 

In our view, best to stay away from the danger zone.  

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The information in this article is general information only and is not based on the objectives, financial situation or needs of any particular investor. In deciding whether to acquire, hold or dispose of the product you should obtain a copy of the current Product Disclosure Statement (PDS) for the Fund and consider whether the product is appropriate for you. Wholesale Units in the Talaria Global Equity Fund (the Fund) are issued by Australian Unity Funds Management Limited ABN 60 071 497 115, AFS Licence No. 234454. Talaria Asset Management Pty Ltd ABN 67 130 534 342, AFS Licence No, 333732 is the investment manager and distributor of the Fund. References to “we” means Talaria Asset Management Pty Ltd, the investment manager. A copy of the PDS is available at australianunity.com.au/wealth or by calling Australian Unity Wealth Investor Services team on 13 29 39. Investment decisions should not be made upon the basis of the Fund’s past performance or distribution rate, or any ratings given by a rating agency, since each of these can vary. In addition, ratings need to be understood in the context of the full report issued by the rating agency itself. The information provided in the document is current at the time of publication.

Co-Chief Investment Officer
Talaria Asset Management

Chad is the Co-Chief Investment Officer and co-founder of Talaria Asset Management. He has more than 20 years’ experience in the financial services industry in the UK, South Africa and Australia. Talaria's investment strategy seeks to increase the...

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