Shares of cloud software stars Datadog (DDOG -0.41%), MongoDB (MDB -0.04%), and DocuSign (DOCU -2.50%) were all falling hard today, down 4.1%, 4.4%, and 4.8%, respectively, as of 2:07 p.m. EDT.
The decline marks a reversal from the past week when most high-growth software stocks rallied as the unfolding banking crisis caused short- and long-term yields to fall significantly.
However, as the U.S. government and large U.S. banks took aggressive action to contain the fallout from the demise of Silicon Valley Bank and other regional banks, and as Europe forced the acquisition of troubled bank Credit Suisse by UBS Group, investors seem to be betting on a stabilization in the financial system and the economy.
In a bout of "good news for the economy is bad news for profit-less tech stocks," long-term yields bounced back higher, which can be a headwind for unprofitable growth stocks even if the economy turns out to be in less bad shape than feared.
Some may be confused as to why economic troubles in the banking sector may be good for tech and vice versa. After all, each of these stocks fell after their recent earnings reports as all three revealed the hyper-growth they experienced through the pandemic would slow markedly this year, with each of these stocks' management teams giving rather tepid full-year outlooks.
A lot of the recent moves in these software-as-a-service (SaaS) stocks really comes down to interest rates. While each of these companies is no doubt seeing a material deceleration in their outlook, each should still grow at a faster pace than the economy over the medium-to-long term, as cloud-based digitization will be an ongoing trend, albeit at a slower pace.
However, none of these companies makes material profits today. Given that the intrinsic value of any stock is the present value of all future cash flows, and that these stocks' profits are all well out into the future, one could say that the long-term Treasury bond yield may even have a larger impact on these stocks than the near-term economic environment. This is because the higher long-term yields are, the less these companies' 2030 profits are worth in present-day terms.
Today, investors appeared to reverse last week's skittishness that we are going into some sort of recession. The 10-year Treasury bond yield, after falling from about 4% to 3.4% in less than two weeks, bounced higher to 3.5% today. The bounce seemed to be a sigh of relief after regulatory action in both the U.S. and Europe appeared to stem the banking crises -- at least for now.
The synchronous moves across all three of these companies therefore likely come from the moves in interest rates and a rotation from investors back into more cyclical sectors like banks, industrials, and energy that sold off hard last week despite much lower valuations.
DDOG PS Ratio data by YCharts.
It remains to be seen whether the banking crisis is in fact fully contained, if a recession will occur, and how severe it will be if it does.
Still, it seems like a long shot interest rates will go back to the lows seen in 2020 and 2021 in response to the pandemic, or even back to where they were in the pre-pandemic period. These high-growth software stocks have only really operated in a low-rate environment, and they still aren't "cheap" by conventional metrics.
None of the companies mentioned have generally accepted accounting principles (GAAP) profits today, and at least Datadog and MongoDB still have very high price-to-sales (P/S) ratios of 12.7 and 11.2, respectively. DocuSign is a bit more reasonable at 4.5 times sales, but DocuSign's new management team only forecasts a tepid 8% growth this year, down from 19% in 2022.
In order for these stocks to get back to their 2021 highs, growth would have to reaccelerate, which would likely require the economy to improve, while interest rates would also need to remain low. Given recent inflation trends, that doesn't appear to be in the cards any time soon.