Inflation cooled for a year, and it helped the tech sector find some heat.
Tech is incredibly sensitive to inflation trends, because it’s especially sensitive to interest rate fluctuations. When inflation is high, the Federal Reserve feels compelled to raise rates (and vice versa), which can affect the valuations of growth stocks, such as tech.
“Inflation is not necessarily negative for technology,” Spear Invest founder Ivana Delevska said. “It’s more about what inflation implies for the direction of interest rates. … All tech sub-sectors will benefit from lower interest rates. A roughly 50 basis point move in interest rates is [about a] 10% impact for stocks.”
Market participants largely expect the Federal Reserve to maintain its current benchmark rate at September’s FOMC meeting, the CME FedWatch Tool shows. And the Fed’s latest dot-plot projection indicates Fed officials aren’t looking for lower rates until the end of 2024.
“Cooling inflation suggests less need to raise rates, which have an inverse relationship with tech valuations given the long duration,” Wells Fargo analyst Michael Turrin told Yahoo Finance. “Most tech companies are still in growth mode, hence investors are valuing [free cash flow] well into the future.”
“The lower long-term real interest rates, the less difficult it is to justify the valuations currently observed at many tech and other digital stocks,” DWS Americas chief investment officer David Bianco added.
Tech’s pricing power
It’s also worth considering how inflation affects pricing. Some tech is often seen as having a “deflationary effect” due to improvements in productivity, and the chance to lower prices could spur growth for consumer-facing tech companies.
“Inflation also helped stress test which vendors have pricing power,” Turrin said. “Lower inflation likely allows companies to moderate price increases, leaving more room for price-driven growth in future periods as needed.”
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Of course, the inflation picture isn’t without its complications, as companies now have to adjust to a mixed environment for prices.
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