Tech Stocks Face Downgrade: Will This Time Be Different?

On May 19, 2025, Moody’s made headlines by downgrading the U.S. government’s credit rating from Aaa to Aa1, the first downgrade in over a decade. This move has sparked renewed interest in how tech stocks will react to changes in government credit ratings, particularly in light of previous instances where significant downgrades triggered sharp declines in the market. Given the circumstances, many analysts believe the response this time around will be markedly different.

Understanding Moody’s Downgrade

Moody’s rationale behind the downgrade centers on the escalating government debt over the last ten years and rising interest-payment ratios that surpass those of similarly rated countries. This has led to a cautious sentiment among investors, especially regarding sectors that rely heavily on market confidence, such as technology.

In historical context, the last major credit rating downgrade occurred in August 2011 when S&P Global reduced the U.S. credit rating from AAA to AA+. It resulted in significant turmoil within the markets, primarily due to investors’ uncertainty about the implications of the downgrade. As Charles-Henry Monchau, the chief investment officer of Syz Group, has pointed out, when faced with uncertainty, investors often resort to selling before they fully understand the situation. This pattern was evident during the 2011 downgrade when the Technology Select Sector SPDR Fund (XLK) plummeted by 6.2% immediately following the downgrade, while the tech-heavy Nasdaq dropped by 7.8% in the same session.

Comparative Analysis of Past Downgrades

Fast forward to August 2023, another credit downgrade by Fitch saw the Technology Sector SPDR drop by 2.3%, and the Nasdaq falling by 2.6% in the following days. These historical declines serve as benchmarks to gauge the anticipated reactions in current markets following Moody’s recent action, which Monchau noted was not entirely unexpected given prior indications of a negative outlook.

Market Reaction to Recent Downgrade

The immediate market reaction to Moody’s downgrade was mixed. On the Monday following the downgrade, the S&P 500 opened lower, down 0.9%, while the Nasdaq fell by 1.4%. However, both indexes rebounded by the end of the trading session, highlighting a potentially more resilient tech sector compared to past downgrades. The Technology Select Sector SPDR Fund, which fell 0.8% earlier in the day, managed to recover much of its losses.

The Role of Rising Bond Yields

One major factor weighing on tech stocks remains the rising bond yields. The yield on the 10-year Treasury reached an intraday high of 4.57%, while the 30-year Treasury peaked above 5%. As bond yields rise, so does their attractiveness, pulling investors away from high-growth tech stocks that often require consistent capital infusions for innovation and development. In today’s climate, government bonds, boasting yields of 4.5% to 5%, may offer a safer alternative for investors wary of tech stock volatility.

Tech Stocks Riding the AI Wave

Despite the external pressures from rising yields and credit downgrades, there are emerging positive factors driving the tech sector forward. The excitement surrounding artificial intelligence (AI) is one such catalyst. Major tech corporations, particularly those within the “Magnificent Seven”—a colloquial term referring to leading tech giants including Amazon (AMZN), Alphabet (GOOG, GOOGL), Apple (AAPL), Meta Platforms (META), and Microsoft (MSFT)—appear committed to extensive investments in AI infrastructure development.

Recent first-quarter earnings reports indicate these companies are demonstrating healthy fiscal performance despite a challenging macroeconomic environment. However, analysts have noted that many firms have been vague in their guidance, which may fuel some uncertainty among investors. Yet, a glimmer of optimism surfaced when former President Donald Trump announced a temporary reduction in reciprocal tariffs between the U.S. and China, potentially supporting tech companies heavily reliant on international supply chains.

Outlook for Tech Stocks

As of mid-May, the Roundhill Magnificent Seven ETF (MAGS) was down approximately 3.5% for the year. Yet, analysts from Goldman Sachs expressed a belief that these seven stocks could still outperform the broader market based on anticipated earnings growth, albeit at a reduced margin compared to previous periods.

So, could the current environment signal a distinct departure from the turmoil seen in previous credit downgrade scenarios? The confluence of resilient performance from major players, enthusiasm surrounding AI initiatives, and a more experienced investor base may suggest that this time could indeed be different for tech stocks. As the economic landscape evolves, investors must remain vigilant to changes in yield, sentiment, and market dynamics, especially in the swiftly changing realm of technology.