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 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.
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.
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. Stock prices, like all other prices, will soar under hyperinflation.
Do stocks offer inflation protection?
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 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.
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 is creating 2021 inflation?
As fractured supply chains combined with increased consumer demand for secondhand vehicles and construction materials, 2021 saw the fastest annual price rise since the early 1980s.