High-growth equities have struggled throughout 2021 and this amazing start to 2022, owing to fears that the Fed may raise interest rates to battle inflation, putting pressure on their valuations. Professor Vittorio de Pedys criticizes all three pillars of the mainstream argument in this contribution based on his impact paper.
The Fed is unquestionably behind the curve when it comes to dealing with inflation. The M2 money supply indicator, which increased by 40% from 2019 to 2021, is a clear indicator of price pressure. Today’s supply chain bottlenecks are the outcome of economic limitations being countered with a significant shift in demand for products vs services, rather than a global economy unraveling. Companies are addressing this issue by re-engineering their supply chains and constructing factories (see Intel, Taiwan semiconductors). The IHS Markit PMI indices in emerging markets have all recently increased considerably, indicating that manufacturing capacity is improving. Money’s velocity is decreasing: because to productivity-enhancing technology, businesses are spending money less fast. Prices will continue to fall as a result of this secular trend. Finally, comparisons will be easier: inflation will be recorded in the second quarter of 2022 versus the substantially higher numbers witnessed throughout 2021. In 2022, tougher comps will inevitably hold down headline inflation. Market data backs up this assertion: the 5×5 years forward-forward in Libor/inflation swaps, a leading indication of market expectations, indicates that market dealers estimate inflation to be 2.5 percent in five years.
Fed funds rates will aim 2.5 percent in 2024 under the most extreme scenario. It’s hardly a frightening figure. Given the high quantity of business and student debt and its low quality, if the Fed hikes rates above the inflation peak, it risks halting the economic growth and unleashing a cascade of bankruptcies, resulting in an economic crisis. The cost of government debt servicing might soar, pushing out other, more vital public spending. On the other hand, if the Fed decides to maintain its current policy, its dovish posture will further fuel inflationary expectations. As a result, the inflate or die trap appears to be the best option. A strong US dollar will also assist in the long run. Because the real rate is minus 5.5 percent, the government can sit back and watch its mountain of debt (now at 136 percent of GDP) shrink. When looking at Fed Funds Future deliveries for the end of 2022 on the CBOT, the market is pricing a 0.874 percent O/N rate one year from now with three rate hikes. A similar message can be found in the EuroDollar Futures, with the expected 3-months rate for June 2024 trading at an unimpressive 1.37 percent. Chairman Jerome Powell is no Paul Volcker, so the Fed will put on a hawkish mask to gain time, then back down as inflation starts to fall in the second half of 2022.
According to Vittorio de Pedys, 2022 will be a stronger year than 2021 since rate hikes are beneficial to hypergrowth stocks. It’s the “roaring technological twenties”!
Since their all-time high in March 2021, high-growth technology stocks have been steadily declining. According to this logic, the higher the interest rate, the higher the discount rate employed in valuation models such as DCF and CAPM, and the lower the value of a growth stock. Higher inflation, on the other hand, has not historically sunk markets. Rates that are higher do. To destroy growth stocks, substantially higher rates than those proposed by the Fed will be required. Even if most people are unhappy, the economy is essentially in good shape. SPACs, Reddit investors, “meme” stocks, cryptocurrencies, and IPOs are all showing signs of froth. In terms of rates, the “danger” zone begins at 5%. According to studies, there has never been a recession with a rate of less than 4%. Over any 19-year period, US stocks have outpaced inflation 100% of the time, according to Goldman Sachs. The market is telling us that the Fed raised rates eight times between 2016 and 2018, and that growth companies prospered throughout that time: just look at Cathie Wood’s flagship ARK Innovation ETF (ARKK), which soared 90 percent during that time. Growth stocks are damaged by the worry of rising interest rates: the pain is limited to the prospect of higher rates. Once this occurs, these equities benefit because their greater growth potential is accurately valued above a minor multiple compression due to somewhat higher discount rates. The adoption of technology by a larger number of people is unstoppable. Hypergrowth stocks are at the heart of these factors, and they will gain from a strengthening economy.
Do tech stocks fare well in the face of inflation?
- When inflation is high, technology equities have typically underperformed.
- In the past, inflation has had a greater impact on the performance of technology stocks than the state of the economy.
- Following periods of high corporate earnings, tech equities have historically underperformed.
- Despite the sector’s potential difficulties, value tech stocks may offer possibilities.
While equities have historically served to shield well-diversified portfolios from the effects of inflation, not all stocks have performed well when prices have risen. When inflation rises, stocks in the technology sector have historically struggled. This is important in today’s inflationary environment since tech companies have been among the best performers in the S&P 500 over the last decade, and their high gains over that period mean they may now account for a bigger part of many investors’ portfolios than they realize. Companies like Facebook, Apple, Alphabet, and others have outperformed other tech stocks in recent years, even within the tech growth stock category.
While inflation has been very low by historical standards, tech growth stocks have largely generated market-leading results. The current tech stock bull market began in 2009, when the US consumer price index (CPI) fell, and inflation averaged only 1.7 percent per year from 2010 to 2020. In 2021, the CPI (which includes food and energy) increased by 7%. “This shift to an inflationary environment may have significant repercussions for sector performance, and technology is particularly vulnerable,” says Denise Chisholm, Director of Quantitative Market Strategy.
The faster inflation has grown in the past, the lower tech’s returns have been in comparison to the entire market. Periods of falling or slower-growing inflation, on the other hand, have produced better relative results for the industry. Regardless of the state of the economy, technology has underperformed during inflationary eras. Indeed, since 1962, technology has underperformed the broader market not only during inflationary economic booms, but also during periods of high inflation despite weak economic growth, a phenomenon known as stagflation.
Why are rising interest rates harmful to technology stocks?
What’s at stake: The stock market is off to a bad start due to a big hike in rates in early 2022. Rates could rise as the Federal Reserve makes noises about trying to keep inflation under control.
The yield on the 10-year Treasury note, the most widely followed indicator of interest rates, hit 1.87 percent on Tuesday, the highest since January 2020.
- Stocks are down around 4% so far this year, marking the worst start to a year for the S&P 500 since 2016.
The big picture: Conventionally, rising rates are regarded to represent more of a danger to bonds than to stocks. However, Wall Street analysts have noticed that equities have begun to behave more like bonds, which fall as interest rates rise.
The impact of internet companies is reflected in equities’ greater sensitivity to rates in the United States.
- Because they have high price-to-earnings ratios and often pay little in the form of dividends, technology stocks are more exposed to interest rate movements.
- The increasing market weight of Big Tech in indices like the S& has linked the markets’ fate to these rate-sensitive behemoths. (Apple, Alphabet, Microsoft, and Tesla accounted for more than a quarter of all stock market returns last year.)
Go deeper: The term “duration” is a phrase used in the art world to express such sensitivity to interest rates.
- Duration is measured in years and is based on the number of years it would take for investors to return their investment through dividend payments.
- Don’t be alarmed by this. Duration is also a rough estimate of how much Wall Street experts believe an investment’s price would fall or climb if benchmark yields shifted by 1%. (Learn more here.)
- With example, for every one percent increase in interest rates, the price of a ten-year investment is predicted to reduce ten percent.
According to BofA Global Research, the S&P 500’s length has increased to roughly 37 years as of the end of 2021. (check out the chart below).
- That means a one-percentage-point hike in rates would send stocks down about 37%, wiping away the previous year and a half’s gains.
Yes, but keep in mind that these forecasts are based on Wall Street models, which are known for having a skewed link with reality.
- After all, no one expects benchmark yields to rise that much in the near future. According to FactSet statistics, the 10-year note is expected to yield around 2% by the end of the year in 2022.
On the other hand, recent experience reveals that in the face of increased rates, the market has obviously swayed.
- Long-term Treasury yields jumped 0.25 percentage points in mid-2015, and the S&P 500 lost as much as 11% in the following 12 months. (This is a more significant drop than the duration model would have expected.)
The bottom line: For the time being, the stock market’s direction is largely determined by the course of interest rates.
Why is inflation detrimental to stocks?
Investors attempt to predict the elements that influence portfolio performance and make decisions based on their predictions. One of the issues that can affect a portfolio is inflation. Stocks should, in theory, provide some inflation protection since, after a time of adjustment, a company’s revenues and earnings should grow with inflation. Inflation’s variable impact on equities, on the other hand, tends to raise equity market volatility and risk premium. In the past, high inflation has been linked to lower equity returns.
Is it a smart idea to invest in technology stocks?
Returns are boosted by growth enterprises. Investing in technology stocks allows investors to raise the risk in their portfolios while increasing their profits. Buying fast-growing tech names is a particularly effective technique of enhancing profits in a low-interest rate environment, while risk is always present.
Constantly evolving. Tech companies are at the forefront of innovation. Investing in shares allows investors to partake in the benefits of technological discoveries that affect the computing and internet goods that people use every day.
Indexing is in high demand. The S&P 500 stock market index currently includes more than 20% of technology businesses. Hundreds of billions of dollars being poured into index funds each year, helping to keep shares of the biggest IT companies growing.
What should you do if inflation occurs?
As a result, we sought advice from experts on how consumers should approach investing and saving during this period of rising inflation.
Invest wisely in your company’s retirement plan as well as a brokerage account.
How can I plan for inflation in 2022?
With the consumer price index rising at a rate not seen in over 40 years in 2021, the investing challenge for 2022 is generating meaningful profits in the face of very high inflation. Real estate, commodities, and consumer cyclical equities are all traditional inflation-resistant assets. Others, like as tourism, semiconductors, and infrastructure-related investments, may do well during this inflationary cycle as a result of the pandemic’s special circumstances. Cash, bonds, and growth stocks, on the other hand, look to be less appealing in today’s market.
Do you want to learn more about diversifying your investing portfolio? Contact a financial advisor right away.
What should you buy before hyperinflation takes hold?
At the very least, you should have a month’s worth of food on hand. Depending on your budget, it could be more or less. (I cannot emphasize enough that it must be food that your family will consume.)
If you need some help getting started, this article will show you how to stock up on three months’ worth of food in a hurry.
Having said that, there are some items that everyone will want to keep on hand in the event of a shortage. Things like:
- During the early days of the Covid-19 epidemic, there were shortages of dry commodities such as pasta, grains, beans, and spices. We’re starting to experience some shortages again as a result of supply concerns and sustained high demand. Now is the time to stock your cupboard with basic necessities. Here are some unique ways to use pasta and rice in your dinners. When you see something you like, buy it.
- Canned goods, such as vegetables, fruits, and meats, are convenient to keep and can be prepared in a variety of ways. Individual components take more effort to prepare, but also extend meal alternatives, which is why knowing how to cook from scratch is so important. Processed foods are more expensive and have fewer options. However, if that’s all your family eats, go ahead and stock up! Be aware that processed foods are in low supply at the moment, so basic components may be cheaper and easier to come by.
- Seeds
- Growing your own food is a great way to guarantee you have enough to eat. Gardening takes planning, effort, and hard work, but there’s nothing more delicious or rewarding than eating something you’ve grown yourself. If you’re thinking of starting a garden this year, get your seeds now to avoid the spring rush. To get started, look for videos, books, or local classes to assist you learn about gardening. These suggestions from an expert gardener will also be beneficial.
Buy Extra of the Items You Use Everyday
You may also want to stock up on over-the-counter medicines, vitamin supplements, and immune boosters in case another Covid outbreak occurs. Shortages of pain relievers and flu drugs continue to occur at the onset of each covid wave, which is both predictable and inconvenient.
Are higher interest rates bad for technology stocks?
As interest rates rise, it’s expected that safer investments will become more appealing, while more speculative assets will become less so. Closer to home, it’s widely assumed that rising interest rates will result in a generally unfavorable environment for public tech values. The fact that stocks are down substantially in pre-market trade in the wake of today’s strong inflation print supports the notion, with tech firms leading the flop.
Why are technology stocks falling in value?
Slowing economic growth and rising interest rates have accounted for the majority of the sell-off. Because of the extended duration of their earnings, growth and many technology stocks have been particularly heavily affected.