What happened
Shares of enterprise software companies DocuSign (DOCU 0.10%), HubSpot (HUBS -2.40%), and Datadog (DDOG -1.43%) were soaring today, up 6.3%, 5.6%, and 5.6%, respectively, as of 3:39 p.m. ET.
There wasn't much company-specific news today. Datadog was maintained at overweight by analysts at Barclays, although they lowered their price target from $210 to $190. But given the rise in not just these three software-as-a-service (SaaS) stocks but across the tech world more broadly, it was likely macroeconomic or marketwide factors that played into each stock's ascent.
Ironically, it was likely the dour outlook for global growth issued by the International Monetary Fund that spurred buying in beaten-down growth stocks today. Here's why the bad news for the global economy may have been good news for software stocks.
So what
DocuSign, Hubspot, and Datadog were all huge winners during the pandemic, as the need to work from home spurred rapid digitization of the enterprise, which is where all three of these companies succeed. DocuSign allows for documents to be signed securely in a remote digital format, HubSpot is a leader in digital "inbound" marketing for small and medium-sized businesses, and Datadog allows companies to monitor their software applications for both security and performance.
Each is also a high-growth stock that doesn't currently make profits, and generally trades at a high multiple of sales. So not only have these companies seen a deceleration in growth after the pandemic-era boom, but valuations are compressing thanks to rising interest rates. Higher interest rates are bad news for growth stocks, which have much of their earnings power well out into the future, since those future earnings are discounted by a greater amount in today's dollars. As you can see, each stock has had quite a rough go of it over the past six months:
DOCU 6 Month Price Returns (Daily) data by YCharts
But on Tuesday, the International Monetary Fund cut its global growth outlook for 2022 and 2023 to 3.6%, down 0.8% and 0.2% from its January estimates, respectively. The downgrade is largely due to food and energy crises spurred by Russia's invasion of Ukraine. IMF Managing Director Kristalina Georgieva said in the presentation: "What has Russia's invasion of Ukraine cost? A crisis on top of a crisis, with devastating human costs and a massive setback for the global economy."
Why might this bad news actually be good for technology stocks? Because lower growth may mean that the Federal Reserve and other central banks may not have to hike interest rates so aggressively this year. In other words, the crisis may do some of the central bank's job for it in terms of slowing down demand, which has outstripped supply since the world began emerging from the COVID-19 pandemic. In a clue this may be true, oil prices fell 5% today, although they are still over $100 per barrel.
Fewer interest rate hikes may mean lower rates going forward than what was already priced into the market. As you can see, high-growth tech stocks were already down significantly on their valuation reset, so any relief on the interest rate front caused them to bounce big today. In a lower-growth environment, companies with steady secular growth and recurring revenue tend to do well, as is the case with these three names.
Image source: Getty Images.
Now what
Despite today's positive movement, it's not a sure thing the U.S. Federal Reserve will slow rate hikes, since the U.S. economy is generally faring much better than the developing world and Europe. Interestingly, the 10-year Treasury bond yield, which many stock investors use as a baseline for their discount rates, actually continued rising today to 2.91%, up from about 1.6% to start the year.
So, I wouldn't necessarily break out the champagne and celebrate that interest rate expectations will come down. In March, the market rallied hard, only to fall back toward the end of the month. The current inflationary and rate-hiking environment is still very much ongoing, at least here in the U.S.
That being said, if inflation does show signs of peaking, these stocks could continue moving upward. That's because each has been beaten down pretty significantly, and the market is forward-looking. Some think the recent March inflation number of 8.5% could be the peak, although no one really knows for sure. Therefore, now may be a good time to study your favorite growth stocks for a potential purchase, as they could take off in a big way if inflation slows. Just be aware that the environment is highly uncertain, with big up and down days likely ahead in the near term.
