Tech stocks took a hit after the last two U.S. credit downgrades. Why this time could be different.

Despite Moody's recent downgrade of the U.S. government's credit rating from Aaa to Aa1, tech stocks are expected to be less impacted compared to previous downgrades in 2011 and 2023, as the market had largely anticipated the move. While the Nasdaq initially fell 1.4% on the news, it recovered, and attention is now focused on rising bond yields, which pose a greater risk to tech stocks by increasing the appeal of lower-risk government bonds; however, excitement around AI and strong earnings from several of the 'Magnificent Seven' companies may provide some support to the sector.

Analysis

Moody's recent downgrade of the U.S. government's credit rating from Aaa to Aa1, attributed to rising government debt and elevated interest-payment ratios, has elicited a more subdued market response compared to previous downgrades, such as S&P Global's in 2011 (which saw the Technology Select Sector SPDR Fund plummet 6.2% in the subsequent session) and Fitch's in August 2023 (resulting in a 2.3% drop for the same fund). The Nasdaq's initial 1.4% dip following Moody's announcement, followed by a swift recovery, underscores that the downgrade was largely anticipated, particularly after Moody's November 2023 shift to a negative outlook. The primary headwind for technology stocks now appears to be rising U.S. Treasury yields, with the 10-year yield briefly hitting 4.57%, as higher risk-free rates diminish the relative appeal of growth stocks. Conversely, the technology sector finds support from persistent enthusiasm for artificial intelligence, evidenced by significant planned AI infrastructure investments by hyperscalers, and strong first-quarter earnings from five of the 'Magnificent Seven' companies (Amazon, Alphabet, Apple, Meta, Microsoft), with Nvidia's results pending. Despite vague forward guidance from some large tech firms and the Roundhill Magnificent Seven ETF remaining down approximately 3.5% year-to-date, Goldman Sachs anticipates these key tech names will continue to outperform the broader market, albeit by a smaller margin than in previous years. A reported temporary reduction in U.S.-China reciprocal tariffs, announced by President Donald Trump, may also offer some short-term relief.

Key Decisions for Investors

• Investors should prioritize monitoring U.S. Treasury yield movements, as these present a more substantial risk to technology stock valuations than the recent, largely anticipated, credit downgrade.
• Maintaining selective exposure to technology, particularly within AI-centric themes and among 'Magnificent Seven' constituents exhibiting robust earnings, is advisable, albeit with moderated expectations for outperformance.
• The underlying fiscal concerns highlighted by the downgrade warrant consideration for long-term portfolio risk management, despite the market's immediate muted reaction.
• The temporary nature of the announced U.S.-China tariff reductions should be factored into assessments of specific tech companies' near-term prospects and potential volatility.