Historic inflation and interest rates hike fears are sinking many high growth technology stock prices. Inflation in 2021 was the consequences of rapidly rebounding demand in a supply-constrained world.

The fear of inflation and the the fear of subsequent Federal Reserve interest rate hikes are creating concern and panic among some investors. Rising interest rate and skyrocketing inflation worries are pressuring stocks. And by the Fed signaling raising rates in the future, it unsettles and sends both Wall Street and Main Street into a panic.

But, what is inflation?

Inflation is when consumer prices rise, goods and services become more expensive, and money loses value. Inflation reduces your purchasing power, eats away at your investment returns, and chips away at your wealth. Currently, Americans are experiencing the pernicious effects of inflation, especially in the areas of escalating food and energy prices.

2021 was one of the worst years for inflation that Americans have seen recently, with a 7% increase, the highest since 1982. For consumers, this means $1 at the beginning of the year was roughly worth only $0.93 at the end. While the impact might seem small when examining it on a dollar level, it represents a change in the purchasing power of retirement savings from January 2021 to December 2021. The Wall Street Journal’s Gwynn Guilford writes: “U.S. inflation hit its fastest pace in nearly four decades last year as pandemic related supply and demand imbalances, along with stimulus intended to shore up the economy, pushed price up at a 7% annual rate.”

American economist and Nobel prize laureate Milton Friedman opined that: “Inflation is always and everywhere a monetary phenomenon.”  In other words, inflation is invariably a case of too much cheap money and capital chasing too few goods, services and assets.

In the last twenty years, the United States witnessed a large accumulation of federal public debt under Presidents Bush, Obama, Trump, and Biden administrations. Federal debt climbed from 55% of GDP in 2002 to 105% in 2019. Additionally, the U.S. has also endured a decade plus of loose monetary policy overseen by the Fed which has pumped up asset prices.

As a result of the escalating public debt and loose monetary policy, the Federal Reserve most important immediate task, of its dual mandates, must be to get inflation under control and reduced. Since 1977, the Federal Reserve has operated under a mandate from Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”—what is now commonly referred to as the Fed’s “dual mandate.”

The Labor Department stated that the consumer-price index — which measures what consumers pay for goods and services — rose 7% in December from the same month a year earlier, up from 6.8% in November. That was the fastest growth in inflation since 1982 and marked the third straight month in which inflation exceeded 6%.”

Three sectors–energy/materials, financials and technology–may be viewed as inflation beneficiaries or, at the very least, inflation-agnostic assets:

• Energy and materials are commodity-based, and oil, gas, and most commodities rebounded from prices that had fallen to a fraction of their pre-pandemic levels.
• Financials, especially banks, are often viewed as inflation hedges since interest rates historically climb when inflation heats up. This reflects the eroding effect of higher prices on a currency’s value in the future, which is remedied by rate hikes on debt.
• Technology is a more nuanced winner in the inflation game. The large tech players and most software companies have tremendous economies of scale. As their revenues scale, their costs, particularly labor, do not grow at nearly the same degree, cushioning profit compression from wage escalation.

In a book called “The Great Inflation”, the authors wrote, “Inflation is not an Act of God…inflation is man-made and can be started, prevented, regulated and stopped by human action.”

“To think that a stimulus of this magnitude wouldn’t cause inflation required believing either that such a huge adjustment was possible within a matter of months, or that fiscal policy is ineffective and does not increase aggregate demand. Both views are implausible”, says Jason Furman, former chair of President Obama’s Council of Economic Advisers.

Thus, slowing down in aggregate federal debt growth per capita, tightening monetary policy, and raising interest rates could be effective tools in stemming runaway inflation.

“If I was Darth Vader and I wanted to destroy the US economy, I would do aggressive spending in the middle of an already hot economy… What are you going to get out of this? You’re going to get a sugar high, the higher inflation, then an economic bust.” — Billionaire investor Stanley Druckenmiller, July 23, 2021

References:

1. https://www.cnbc.com/2021/12/13/op-ed-these-3-market-sectors-shone-even-as-investors-grew-weary-of-hearing-about-inflation.html
2. https://www.americanthinker.com/blog/2021/12/is_joe_manchin_right_about_inflation.html
3. https://seekingalpha.com/article/4479557-how-to-better-understand-inflation-and-predict-its-direction
4. https://www.marketwatch.com/story/why-did-almost-no-one-see-inflation-coming-11642519667