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Here we go again. Another article about inflation and this one addresses the specter of rising consumer prices being more persistent than transitory.
“Persistent” and “transitory” are subjective and one can sit here all day arguing that inflation will be transitory (it will be because it will end at some point), but the reality is it's already proving more persistent than many so-called experts were expecting.
Dealing with that reality begets another: Clients are pondering what asset classes and sectors could be damaged by and thrive amid a period of extended inflation.
“Signs are growing that inflation may be more tenacious than originally expected. We don’t believe a return to 1970s-style inflation is likely, but there is a worrisome scenario in which persistently sharp increases in prices could be a factor to reckon with—and if history is any guide, they could have an impact on sector performance,” says David Kastner of Charles Schwab.
Not Surprisingly, Time to Talk Tech with Clients
It's rarely a bad time to talk technology with clients. After all, that's the largest sector weight in a slew of pure beta broad market funds and it's the sector clients most readily associate with stellar returns.
However, what many clients may not be aware of is that tech has a dubious track record in periods of extended inflation. Good thing they have advisors to inform of that. Likewise, advisors can detail to clients that of the 11 GICS sectors, consumer discretionary, financial services, industrials and materials are the groups vulnerable to prolonged periods of rising consumer prices.
Conversely, consumer staples, healthcare, energy, real estate and utilities are the sectors that perform well when inflation hangs around awhile. That leaves two groups to be considered: Communication services and technology. For the purposes of this piece, I won't get carried with communication services – the sector that's home to Alphabet (NASDAQ:GOOG) and Facebook (NASDAQ:FB), among others. The reasons being are that the sector is barely more than three years old, meaning it hasn't been around for an extended bout of inflation, and because many of its components previously resided in tech.
Alright, so let's get back to tech. It's inflation reputation isn't great, but this time could be different. Seriously. It could be.
“This sector historically performed poorly when inflation was high, owing to its previous cyclical nature,” adds Kastner. “In the past, consumer and business spending would decline when higher inflation and/or Fed rate hikes slowed economic growth. However, the sector has become less cyclical in recent years, likely due to the evolving nature of demand for Information Technology equipment and devices.”
Said another way, as advisors know, history doesn't always repeat and the tech sector of today is much different than the one that endured previous bouts of extended inflation.
Tech Essential Nature Could Provide Inflation Buffer
Clients know that they don't have to buy a Tesla or spend time on Twitter, but they also know they spend a lot of time on mobile devices, Zoom meetings and shopping online.
Likewise, advisors know there's considerable momentum for cloud computing and cybersecurity, among other tech necessities. In other words, tech is more essential, to both consumers and businesses, than ever before. That “essentialness” could be an advantage in these inflationary times.
“As seen during the COVID-19 crisis, demand for technology increased amid the decline in economic growth,” says Kastner. “While that was a unique event, consumer electronics have become integral to social interaction and entertainment. Meanwhile, businesses must invest in technology to remain competitive, as well as increase productivity to counteract labor shortages and higher wages. While the sector has extremely high valuations, its historical underperformance might not repeat itself if inflation does turn out to be persistent.”