DeepSeek delivered a jolt to the tech sector that no one was expecting.
As we covered earlier this week, the startup made headlines with its high-performing artificial intelligence (AI) model at a fraction of the cost of other models in use.
That sent share prices in key AI stocks careening lower. Nvidia grabbed a record that no company wants to hold. Following Monday’s plunge, the company lost nearly $600 billion in market value in a single day… the largest in history.
But while DeepSeek catches the blame for the flash crash, shares in technology stocks were already primed for a pullback.
That’s because an even more powerful market force is making tech stocks vulnerable.
And it has nothing to do with AI or DeepSeek.
Here’s what you need to keep a close eye on instead…
Tech Stocks Are Vulnerable
AI stocks’ nosebleed valuations should concern investors.
Broadly speaking, tech stocks are “priced for perfection.” In other words, any missteps – anything other than perfection – could have dramatic, painful consequences for these stocks.
Based on expected earnings over the coming year, the technology sector trades at a price-to-earnings (P/E) ratio of 28.9. (The P/E ratio essentially tells you how much you are paying for each dollar of earnings.) That’s the highest sector P/E in the S&P 500 and is 59% higher than the long-term average.
And the one market force that impacts valuations more than anything is… interest rates.
High interest rates make future profits worth less in today’s terms. Since growth stocks’ earnings potential is often way off in the future, their valuations are even more susceptible to interest rate changes.
High interest rates also present competition for investor capital. A higher interest rate on a less volatile Treasury can draw investor funds from risky tech stocks.
And some of the worst sell-offs in tech stocks over the past several years have occurred alongside a jump in long-term rates.
For instance, the 2022 bear market saw the 30-year Treasury yield rise from 1.9% to 4.3%. The Nasdaq dropped by 36%.
Another big correction in the Nasdaq took place from July to October 2023. That’s when the Nasdaq dropped by 12%.
Over the same time frame, the 30-year yield went from 3.8% to 5.0%.
That’s why you should stay wary if interest rates surge higher again…
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A Key Level
Not every push higher in the 30-year yield causes a pullback in the stock market.
But a large breakout to new 52-week highs should concern you. Those types of moves have pressured stocks in the past.
With that in mind, let’s check the trend of the 30-year yield in the chart below:
The black line shows the 30-year yield. The blue line is the 50-day moving average.
The 30-year jumped to the 5% level in late 2023. That coincided with the last big tech sell-off.
Since then, the 30-year Treasury yield has been mostly rangebound (the shaded box). The 30-year has traded between the 4% and 5% level.
But it’s testing the upper end of that threshold once again.
Take another look:
You can see in the chart that the 30-year yield rose from 4% in mid-September and recently tested 5% just a couple of weeks ago.
The 30-year yield is coming off that level and falling toward the 50-day moving average (the arrow at the blue line).
When the 30-year has been in an uptrend, the 50-day will often serve as support on pullbacks.
If the 30-year turns back higher, though, watch for a breakout over 5%. That would put the 30-year Treasury yield at its highest level since 2007.
If that occurs, tech investors could have a much bigger issue to deal with than DeepSeek.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict