What happened
Shares of Snowflake (SNOW 2.53%), Datadog (DDOG 0.50%), and DocuSign (DOCU 1.02%) plunged on Thursday, down 4.8%, 7.5%, and 5.2%, respectively, as of 2:53 p.m. EDT.
There wasn't any company-specific news for these three stocks today, but a toxic combination of slowing growth from two enterprise software peers who reported last night, along with rising long-term interest rates, hit these highly valued stocks hard.
So what
Last night, a couple of fellow enterprise cloud software companies reported earnings, including MongoDB (MDB 0.81%) and Okta (OKTA -0.65%). Both of those stocks are down severely today, shedding 25% and 35%, respectively.
While each actually beat estimates on their top and bottom lines, MongoDB did notice some marginal slowdown in its Atlas database-as-a-service consumption due to macroeconomic headwinds, and Okta forecast growth to slow, not only from the macroeconomic environment, but also a troubled integration with its Auth0 acquisition.
Both Snowflake and Datadog hit it out of the park in their recent earnings reports last month, as they seem to be mission critical to companies. However, MongoDB's database and Okta's cloud identity products were also thought to be fairly mission critical. And like MongoDB's Atlas product, Snowflake works on a consumption-based model. That could be a tailwind in good times but could also be a headwind if the economy markedly slows down.
Also not helping matters is the fact that while recession fears are in the air, the yield on long-term bond rates are creeping back up again. The 10-year Treasury bond yield rose nearly 13 basis points today to 3.26% as of this writing.
That could be for a number of reasons but likely has to do with increased quantitative tightening. Starting in September, the Federal Reserve is increasing the pace of roll-offs of Treasury bonds from its balance sheet. So less demand for Treasuries could push up yields on government bonds. The Fed has forecast this for quite some time, but it still could be affecting things as the roll-offs take effect.
Higher long-term yields tend to cause sell-offs in long-duration assets such as growth stocks, because high-growth stocks tend to have the bulk of their earnings power well out into the future. The higher the long-term interest rate, the lower the value of future earnings. That's likely another reason for the outsized sell-off in high-growth software companies today.
Now what
It's hard to know exactly where these stocks go from here. While Snowflake and Datadog have each reported stellar earnings results of late, they are still quite expensive by just about any measure, trading at 32.5 and 22.4 times sales, respectively. Therefore, their businesses could continue to do quite well, but their stocks may not respond, due to fears of an economic slowdown, as well as investors using a higher discount rate on future earnings.
DocuSign is much cheaper, at just 4.9 times sales; however, its earnings results have seen a sharp slowdown this year. In June, CEO Dan Springer announced he would be stepping down, with board chair Maggie Wilderotter stepping in as interim CEO. Investors will get more color on the situation there when the company reports second-quarter earnings on Sept. 8.
If inflation cools down and long-term interest rates revert to lower levels, it's possible these stocks could rally. After all, it appears the Federal Reserve is determined to get inflation back down to its 2% target, no matter what happens with the economy. That may actually benefit these high-growth stocks eventually, since they are likely to continue to grow even in a recessionary environment.
However, we also may be in a new era that more resembles the pre-2008 interest rate regime. If that's the case, it may be difficult for stocks with no profits and high price-to-sales ratios to rally.
