- 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.
Is inflation beneficial to technology stocks?
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.
Why is inflation detrimental to growth stocks?
Inflationary pressures, on the other hand, might be problematic for growth stocks. Because higher interest rates and bond yields are expected as a result of inflation, growth stocks’ promised future cash flows become less appealing. Traders, in turn, tend to rebalance their portfolios to include other investments that will benefit from higher interest rates.
According to a government study released this month, the consumer price index rose 6.2 percent year over year in October, the fastest rate in three decades. Investors responded by taking more than $2 billion out of U.S. tech-focused mutual and exchange-traded funds in the two weeks ending Nov. 17, according to fund-flow tracker EPFR, whose data covers largely institutional investor behavior. This is the worst stretch since early January 2019, when a two-week span ended.
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.
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.
Are stocks a good way to protect against inflation?
You might not think of a house as a smart method to protect yourself against inflation, but if you buy it with a mortgage, it can be a great way to do so. With a long-term mortgage, you may lock in affordable financing for up to three decades at near-historically low rates.
A fixed-rate mortgage allows you to keep the majority of your housing costs in one payment. Property taxes will increase, and other costs will climb, but your monthly housing payment will remain the same. If you’re renting, that’s definitely not the case.
And, of course, owning a home entails the possibility of its value rising over time. Price appreciation is possible if additional money enters the market.
Stocks
Stocks are a solid long-term inflation hedge, even though they may be battered by nervous investors in the near term as their concerns grow. However, not all stocks are equivalent in terms of inflation protection. You’ll want to seek for organizations with pricing power, which means they can raise prices on their clients as their own costs grow.
And if a company’s profits increase over time, so should its stock price. While inflation fears may affect the stock market, the top companies are able to weather the storm thanks to their superior economics.
Gold
When inflation rises or interest rates are extremely low, gold has traditionally been a safe-haven asset for investors. When real interest rates that is, the reported rate of interest minus the inflation rate go below zero, gold tends to do well. During difficult economic times, investors often look to gold as a store of value, and it has served this purpose for a long time.
One effective way to invest in gold is to acquire it through an exchange-traded fund (ETF). This way, you won’t have to own and protect the gold yourself. Plus, ETFs provide you the option of owning actual gold or equities of gold miners, which can provide a bigger return if gold prices rise.
Do stocks rise in response to inflation?
When inflation is high, value stocks perform better, and when inflation is low, growth stocks perform better. When inflation is high, stocks become more volatile.
Why do rising interest rates harm technology stocks?
Because as interest rates rise, growth industries such as technology must provide considerably higher growth rates to justify the risks investors are willing to take in exchange for a larger return. Rising rates also affect the value of future cash flows, lowering present stock values.
Why do value stocks perform better when inflation is high?
“Investors should continue to keep equities since stocks normally outperform in times of inflation, especially if it is accompanied by growth.” Consumer staples stocks, such as food and energy, perform well during inflation because demand for staples is inelastic, giving these companies more pricing power because they can increase their prices more quickly than other industries.”
Opt for stocks and TIPs, says Leanne Devinney, vice president of Fidelity Investments
“Diversifying between different sorts of investments is a solid idea.” For example, equities, rather than bonds, have a better track record of keeping up with inflation over time. Consider Treasury Inflation-Protected Securities (TIPS) and high-yield bonds, which are both inflation-resistant fixed income investments. It may also assist in reducing exposure to more inflation-sensitive investments, such as some treasury bonds.”
Change up how you deal with your cash, says Pamela Chen, chartered financial analyst at Refresh Investments
“When there is a rise in inflation, it is more vital to invest funds. During inflationary periods, when prices for things rise, cash loses purchasing power, and one dollar buys less than it used to. Invest your money to generate a return that will help you avoid the inflationary bite, or to achieve a return that will stay up with or exceed inflation.”
Are tech stocks dangerous?
Yields fluctuate depending on the state of the economy. When making an investing selection, yield is just one thing to think about.
The price of equity securities can change in response to news about firms, industries, market circumstances, and the overall economy.
Interest rate risk exists for bonds. Bond prices decline when interest rates rise; the longer a bond’s duration, the more vulnerable it is to this danger. Bonds may also be exposed to call risk, which is the risk that the issuer will redeem the debt, in whole or in part, before the planned maturity date at its discretion. Due to changes in market conditions or changes in the issuer’s credit quality, the market value of debt instruments may fluctuate, and revenues from sales prior to maturity may be more or less than the amount originally invested or the maturity value. Bonds are vulnerable to the issuer’s credit risk. This is the possibility that the issuer will be unable to make timely interest and/or principal payments. Bonds are also exposed to reinvestment risk, which refers to the possibility of a specific investment’s principle and/or interest payments being reinvested at a lower interest rate.
In deteriorating financial markets, asset allocation and diversification do not guarantee a profit or safeguard against loss.
In declining financial markets, rebalancing does not guarantee against a loss.
With a rebalancing plan, there could be tax implications.
Before executing such a strategy, investors should speak with their tax professional.
Sector investments are more volatile than investments that spread across multiple industries and companies due to their restricted concentration.
Stocks in the technology sector can be very volatile.
When opposed to investing in the United States, international investing includes greater risk as well as bigger potential benefits. These dangers include foreign country political and economic uncertainty, as well as the risk of currency swings. These dangers are amplified in emerging market countries, which may have relatively unstable governments and less developed markets and economies.
Investing in overseas emerging markets carries a higher level of risk than investing in home markets, including political, currency, economic, and market hazards.
Commodity investing includes substantial risks. Commodity prices can be influenced by a variety of factors at any time, including I changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) commodity trading activities and related contracts, (vi) pestilence, technological change, and weather, and (vii) the price volatility of a commodity. Furthermore, due to a variety of reasons such as a shortage of liquidity, speculative engagement, and government action, the commodities markets are prone to transitory distortions or other disturbances.
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