- 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.
Will stocks be affected by inflation?
Consumers, stocks, and the economy may all suffer as a result of rising 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.
What impact does inflation have on technology stocks?
Points to Remember. Inflation can drive up a company’s costs while lowering its pricing power. Rising interest rates, which fight inflation, will lower future earnings predictions for a high-growth tech corporation. Although the current environment is difficult for tech companies, investors should not dismiss the industry entirely.
How do you protect yourself from inflation?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
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.
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.
Why is technology declining?
For the same reasons as before, tech stocks are being hammered. Worries about greater inflation, expectations of tighter monetary policy from the Federal Reserve, andmost recentlya significant increase in bond yields can all be blamed by investors.
The Nasdaq Composite index, which is heavily weighted in technology, fell 1.8 percent on Tuesday. Apple (ticker: AAPL), Microsoft (MSFT), and Tesla (TSLA) were all down, with 1 percent, 0.6 percent, and 0.1 percent losses, respectively.
What happens to the stock market in a hyperinflationary environment?
Inflationary periods, such as those seen in the United States in the late 1970s and early 1980s, are generally not considered beneficial economic times, as prices often rise faster than salaries. Hyperinflation is considerably worse because it is accompanied by a sharp increase in prices. The most well-known instance of hyperinflation occurred in Germany shortly after World War II, when a loaf of bread was said to require a wheelbarrow full of paper money. During hyperinflation, stock prices will soar just like other prices.