Inflation can drive up a company’s costs while lowering its pricing power.
What effect does inflation have on technology stocks?
- 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 do higher interest rates harm 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 do equities fall when inflation rises?
Inflation is defined as an increase in the cost of goods and services, which reduces the purchasing power of the currency. Consumers can buy fewer things when inflation rises, input prices rise, and earnings and profits fall. As a result, the economy slows until the situation stabilizes.
Why are tech stocks on the decline?
According to JPMorgan Asset Management, the top 10 businesses accounted for 30% of the value of all 500 companies in the Standard & Poor’s 500 index at the end of January, one of the largest concentrations ever.
It’s difficult to picture a world without more telephones, software, computers, online retail, electric vehicles, and other innovations, and no one expects them to go away anytime soon.
However, the market’s leaders are potentially so expensive that they may provide muted promise in the future. Many prominent tech stocks have fallen in recent weeks, possibly hinting that investors are paying greater attention to previously overlooked areas including smaller companies, value bets, and international shares. Inflationary pressures, increased interest rates, and reduced government stimulus could all contribute to this.
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.
Is rising inflation beneficial to growth stocks?
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.
Is it true that rising interest rates are harmful 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.
Where should I place my money to account for inflation?
“While cash isn’t a growth asset, it will typically stay up with inflation in nominal terms if inflation is accompanied by rising short-term interest rates,” she continues.
CFP and founder of Dare to Dream Financial Planning Anna N’Jie-Konte agrees. With the epidemic demonstrating how volatile the economy can be, N’Jie-Konte advises maintaining some money in a high-yield savings account, money market account, or CD at all times.
“Having too much wealth is an underappreciated risk to one’s financial well-being,” she adds. N’Jie-Konte advises single-income households to lay up six to nine months of cash, and two-income households to set aside six months of cash.
Lassus recommends that you keep your short-term CDs until we have a better idea of what longer-term inflation might look like.