Chip stocks are plunging this month as investors react to surging interest rates and concerns over weakening business trends in the semiconductor industry.
iShares PHLX Semiconductor ETF has declined nearly 5 percent this month through Tuesday versus 1 percent fall for the S&P 500. The chip sector ETF is down another 2.7 percent Wednesday.
Earlier this week, Raymond James reduced its 2019 earnings estimates for eight chip stocks, predicting companies will announce weakness in business activity. After spending a week in Asia talking to chip supply chain companies, the firm also downgraded several semiconductor stocks in late Sept., saying the sector has entered a “cyclical downturn.”
Interest rates are surging with the benchmark U.S. 10-year Treasury note yield hitting levels not seen in years. The 10-year Treasury note yield traded around 3.23 percent a day after hitting its highest level since 2011.
Rising rates tend to hurt high-flying growth stocks like AMD and Nvidia as investors adjust to the new environment. Both these names are still among the best performers this year with AMD up around 150 percent year to date and Nvidia up more than 30 percent.
The spike in rates make higher equity valuation multiples less attractive because investors use U.S. government bond yields as their “risk-free” discount rate in financial models to value stock investments.
Warren Buffett explained last year the importance of interest rates for valuing investments.
“The most important item over time in valuation is obviously interest rates,” Buffett said last year. “Any investment is worth all the cash you’re going to get out between now and judgment day discounted back. The discounting back is affected by whether you choose interests rates like those of Japan or interest rates like those we had in 1982 …. When we had 15 percent short-term rates in 1982, it was silly to pay 20 times earnings for stocks.”