TMCnet Feature
November 24, 2021

How will upcoming inflation affect tech stocks?

The past few months have been problematic for investors, especially those in the US. In October 2021, the consumer price index went up by 6.2%, which is the highest inflation rate in the past 30 years. On the one hand, this means that prices are spiking, from gasoline to consumer goods. On the other hand, stocks are fluctuating, and tech isn’t invulnerable.

Experts are still unsure whether high inflation is transitory or here to stay, so, in the meantime, traders are looking towards the famous “hedges against inflation” – the stocks that continue to perform even throughout economic turmoil. However, not all tech stocks respond in the same way to inflation, which calls for a more methodical approach. For example, many seasoned investors are turning to Big Tech stocks to hedge against inflation – hyper-growth companies that continue to sell even during economic slowdowns. Let’s have a look at these high-performing stocks and why they respond this way to inflation.

What tech stocks can work as a hedge against inflation?

In these uncertain times, experienced investors tend to gravitate towards Big Tech – the most dominant and most prestigious tech companies. Also known as “The Big Five,” the group includes Google, Facebook, Apple, Microsoft (News - Alert), and Amazon. For these companies, the spike in commodity prices doesn’t have any impact on margins.

And yet, there are voices who say that the age of Big Tech is over and that you needn’t limit yourself to them when considering investment options. Of course, there are many things you should consider when analyzing tech stocks, but, in general, these are the four factors that indicate they could be a hedge against inflation:

  • A software-based business model (this way, the company isn’t sensitive to the cost of raw materials)
  • Pricing power
  • Low debt
  • Reasonable valuation
  • Flexibility. The best example in this regard is Google’s (News - Alert) parent company, Alphabet, which is now a multi-industry conglomerate that does everything from web search and online advertising to smartphones and life sciences. This way, no matter how the market fluctuates, Alphabet shrugs off the crisis.

Based on this model, we can pinpoint other tech sub-sectors that are impervious to economic hardships:

  • Software-based businesses, such as Salesforce and Adobe (News - Alert). These work for two reasons. On the one hand, they don’t rely on raw materials, unlike hardware manufacturers. On the other hand, even in times of inflation, the digital transformation trend continues. As companies are making the permanent shift to remote and hybrid work, they need productivity and remote collaboration tools to stay competitive. This way, there’s always a demand for these products.
  • Cloud and online commerce companies. Following the same digital transformation, many companies have decided to branch out into e-commerce, aware that the reliance on physical sales isn’t sustainable in the long run. Thus, companies that provide cloud and e-commerce services are less likely to dwindle due to inflation. In 2021, notable examples include Alibaba group, Amazon, and Shopify. According to a recent report, the global e-commerce market is on track to reach $7 trillion by 2024. Shopping online has become a “learned behavior” due to the pandemic, and retailers don’t plan to stop investing in IT and supply chain automation anytime soon.
  • Digital payments. Another trend strengthened by the pandemic, digital payments are here to stay, and the demand for them isn’t expected to decrease anytime soon. Offering seamless transactions, digital payments are an integrated part of modern commerce, and, according to a Visa survey, nearly half of consumers will refuse to shop at a store that doesn’t offer them contactless payments. Digital payment processing is one of the fastest-growing FinTech sectors, along with financial software, P2P lending, and mobile banking. Some of the stocks that have shown resilience include PayPal (News - Alert), Square, and MercadoLibre.

It’s very important to point out that your investment strategy should depend on the geographic region. Companies in the US have responded in a certain way to the crisis, but that may not apply everywhere. For example, if you plan to invest in tech companies in Sweden, for instance, you should get local insights from platforms like Investing in tech companies from multiple countries can be a great way to diversify and minimize risks, but only if you know the local market very well.

Tech stocks that are potentially at risk

Not all tech stocks are hedges against inflation. Some are quite vulnerable, especially if they depend on the price of raw materials and the costs can’t be passed on to the consumer. For example, a company like Apple (News - Alert) won’t be affected by rising hardware costs because its products always generate hype, and customers aren’t necessarily worried about price hikes. However, Peloton, a once thriving exercise equipment and media company, is struggling with supply-chain issues, and it doesn’t have enough pricing power in order for customers to cover the extra costs.

The same applies to hard drive manufacturers. The PC market is hit by inflation due to chip shortages, and experts don’t expect this problem to be solved earlier than mid-2022. In order to maintain the prices of lower-end computers, manufacturers often have to sacrifice features like memory and storage, which may prove detrimental from an investment standpoint in the long run.

Some analysts are also placing Tesla in the high-risk category. Although Tesla is a carmaker, it is often treated as a tech stock, which has pushed its share price to a dangerously high level, turning it into an investment ticking time bomb. To sustain its margins, Tesla needs access to cheap metals, car parts, batteries, and wiring – and there’s a shortage of that, in addition to a shortage of chips. At the same time, Tesla has a debt-to-equity ratio of 53%, which means that it could be vulnerable to interest rate spikes.

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