In the month since I blogged that tech looks like it could be in a bubble, there have been plenty of headlines to suggest that it is:
- Jonathan Weil/Bloomberg: Cupcake Capitalism Offers Hope for New Bubble
- Robert Cyran/Breakingviews: Web bubble 2.0?
- Dennis Berman/WSJ: "Cartoonishly high valuations" for tech firms
- And just today, the WSJ ran a story titled Twitter as Bubble Barometer
A rise in interest rates will throw a little cold water on the tech fire. Writing in Breakingviews, Martin Hutchinson points out that low rates make capital spending attractive, but capital investments made to improve productivity (e.g., business investment in technology) stifles business hiring. He goes on to explain that the contrary is also true: when capital is more expensive, hiring becomes more attractive than investment. Interest rates may rise for any number of reasons, not the least of which to stifle inflation which may very well be on the rise. When they do, business preference will gradually change from productivity investments to hiring. It behooves the tech exec, particularly in captive IT, to pay close attention to what the Fed does.
Tech firms, particularly start-ups, are less vulnerable to a rate rise than captive IT. As Robert Cyran points out in Breakingviews, the tech entrepreneur calls the shots these days as cloud technology allows the tech firm to rent, as opposed to own, sophisticated infrastructure. This makes tech far less capital intensive. If anything, as Mr. Cyran notes, tech firms have just the opposite problem: excess capital desperately seeking yield is trying to find a way into tech, only to find tech has little use for it. When liquidity declines with QE2 expiry (provided there's no QE3), tech valuations may decline, but tech firms are less likely to suffer from financial starvation.
Not so captive IT, which still owns more than it rents, and thus remains very capital intensive. Last month I mentioned that the tech exec should sweat their revenue. Interest rates are a leading indicator of revenue durability, particularly for captive IT. Know your firm's cost of capital, and know the yield of those tech investments in your stewardship, and you'll know how resilient your revenue is to Fed decisions.