Shares of leading content delivery network Cloudflare (NYSE:NET) are tumbling Wednesday. NET stock slumped 10% in early Wednesday trading, adding to its losses from Tuesday’s trading session. The stock has now dropped $20 per share over the past week. So what’s driving the move? The biggest factor appears to be the rapid rise in interest rates as the market prepares for additional Federal Reserve rate hikes. And a key former member of the Fed added to these worries Wednesday.
On Wednesday, Bill Dudley, former president of the New York Federal Reserve Bank, published a provocative editorial stating: “If Stocks Don’t Fall, the Fed Needs to Force Them.” In it, Dudley argues that the Fed needs to push much tighter financial conditions to get inflation under control. The runaway rise in the prices of things such as tech stocks and houses has created a wealth effect that is causing consumers to spend at a record rate. That, in turn, has helped fuel unprecedented inflation. By tightening the screws on credit quickly, Dudley argues the Fed can get inflation under control. But that would require lower stock prices, with speculative high valuation tech stocks such as Cloudflare taking the worst hit of all.
Cathie Wood, the popular tech investor who heads Ark Invest, recently warned about the Fed’s more aggressive stance. In a recent series of tweets, Wood said it “will be a mistake” for the Fed to raise interest rates. Wood cites evidence that consumer sentiment has already plunged to near historic lows and that past such drops in sentiment typically lead to bad outcomes for the economy. Wood concludes her discussion warning that: “The Fed seems to be playing with fire.” Wood’s warnings came even before the latest volley from Dudley, which sent tech shares spiraling lower once again.
It’s clear why tech bulls such as Wood are worried about more rate hikes. In an environment of sharply higher interest rates, investors tend to dump companies such as Cloudflare that don’t generate much profit or cash flow today. Instead, they rotate into companies that generate high profits today and are able to withstand rising periods of inflation. Wood’s exchange-traded funds (ETFs) such as the ARK Next Generation Internet ETF (NYSEARCA:ARKW) are right in the line of fire if Mr. Dudley gets his wish and stocks prices sink. And since the Next Generation Internet ETF owns NET stock, as investors sell Wood’s funds, it puts selling pressure on individual names such as Cloudflare.
Bulls might argue that NET stock is still worth buying regardless of macroeconomic factors. After all, Cloudflare is growing at a tremendous pace. However, Cloudflare’s closest rival, Fastly (NYSE:FSLY), was growing at a triple-digit rate not that long ago. As growth slowed, Fastly shares collapsed, dropping more than 85% from their highs. Fastly stock is down to six times revenues today. Cloudflare is still selling for around 50 times revenues, which is a simply massive valuation, especially in a world where Fed officials are actively talking down the market.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.