After months of equity and bond markets adopting a "boy who cried wolf" mindset towards predictions of high, non-transitory inflation, investors finally seem to be a little worried that there might indeed be a wolf lurking in the hills.
That, together with high valuations for many names, supply-chain headaches, growing China uncertainty and all of the retail risk-taking and speculation that's been going on this year, is perhaps an argument for picking one's spots carefully right now when buying tech-sector pullbacks.
Not-So-Transitory Inflation and a Tightening Fed
Back in June, I argued that there are reasons to think inflation could remain a problem beyond 2021 even if prices for some supply-constrained goods and services cool off towards year's end. Among the reasons: Low interest rates, tight labor and housing markets, large increases in consumer savings/wealth, record bank deposits and the headroom that remained for consumer services spending to rebound.
Since then, consumer services spending has been more subdued than I expected, as Delta variant fears weigh on travel/hospitality spend. But on the flip side, inflationary pressures for goods and housing have on the whole become worse rather than better, thanks to a mixture of sky-high demand, rising commodity prices and assorted supply-chain bottlenecks.
Everyone from FedEx (FDX) and TSMC (TSM) , to Costco (COST) and Dollar Tree (DLTR) , to Unilever (UL) and Sherwin-Williams (SHW) has been signaling both that their costs are going up and that they're planning to pass on a substantial portion of those cost increases to customers in the coming quarters. Many of these firms have also mentioned that labor shortages are hurting their ability to meet demand.
Moreover, with vaccination rates having risen, COVID cases and hospitalizations moving lower again and foreign travel restrictions easing, it wouldn't be a shock to see consumer services spending rise meaningfully.
Taken together, these issues could lead the Fed's forecast for just 2.2% 2022 personal consumption expenditure (PCE) inflation to start looking far too low as the new year kicks off.
Finally, when weighing how the Fed will deal with such an environment beyond its current tapering plans, I think not enough attention has been given to the fact that Jerome Powell is up for reappointment and has been facing a lot of political pressure to maintain ultra-dovish monetary policies (various Fed presidents not facing such pressure have been far more vocal than Powell about expressing inflation concerns). If/when Powell is reappointed, that political pressure diminishes.
Potential Implications for the Tech Sector
For certain tech stocks, the risks posed by an environment featuring elevated inflation, rising Treasury yields and a tightening Fed are easy to see. Dozens of large-cap cloud software and Internet stocks have seen their forward sales multiples balloon well above 20 over the last 18 months, and (as Tuesday's selloff drives home) just a moderate increase in inflation/yield fears could be enough for multiples to come back to Earth a bit.
Some less-expensive tech stocks could be dragged lower in this environment as well. Though only a fraction of chip stocks sport truly high multiples, many of them have logged big gains over the last 12 months. And as recent selling pressure seen by the group demonstrates, worries about supply-chain issues and/or China could spark profit-taking at a time when investors are more broadly rotating out of tech.
Likewise, though they're not terribly expensive overall, the big-5 tech giants have seen some multiple-expansion since last fall (Amazon.com (AMZN) excepted) and have generally been viewed as safe havens in an environment of low yields and pandemic-related macro headwinds. As a result, they're also a little vulnerable to a yield-driven market rotation.
Meanwhile, the tech sector hasn't seen a significant correction since May, with dip-buyers ferociously pouncing on even modest pullbacks. And markets have seen an influx of new retail investors convinced that popular growth stocks will keep trekking higher, with many of them using margin and/or options to lever up.
It's not hard to see how a lot of those investors could panic if we do see a meaningful correction that isn't quickly ended by dip-buyers. Certainly, the fact that the Nasdaq failed to sustain a bounce on Wednesday following Tuesday's 2.8% drop can't be going over well with some of these newer investors.
None of this should be taken as a call to bail completely out of tech. As I wrote previously, I think deals do exist among cheaper software and Internet companies with little or no China exposure, and more generally among small-caps. And following two days of substantial declines, I think chip equipment stocks such as Applied Materials (AMAT) and KLA (KLAC) present interesting risk/rewards.
In addition, Amazon looks far from expensive at current levels, even if worries about higher labor and shipping costs could weigh on sentiment for a little while. Facebook (FB) , which trades for just 21 times its 2022 GAAP EPS consensus and has a slew of top-line growth levers it hasn't yet pulled, also looks pretty reasonably priced.
But with all that said, this does feel like a moment where it's worth being selective with one's buys, and to perhaps also hedge a little. An environment featuring rising yields, China-related headwinds and maybe also more jittery retail investors is one in which trades that have worked well since March 2020 can't necessarily be counted on to keep doing so.
