Recently the "I" word seems to be resurfacing. Starting with Mr. Bernanke's semi annual testimony, he referred to a temporary increase in inflation due to rising oil prices, while most recently, Saint Louis Federal Reserve bank president James Bullard warned of risks for elevated inflation unless monetary easing is halted. If inflation does indeed move higher from its current annual level of 2.9% for the Consumer Price Index ("CPI"), could technology share prices move substantially lower?
We examined recent CPI data starting in 1990 to determine how recent cycles of rising inflation have affected the shares of Apple Inc. (AAPL), International Business Machines (IBM), Intel (INTC), Hewlett-Packard (HPQ), Dell (DELL), Microsoft (MSFT) and Cisco (CSCO).
Annual U.S. CPI Chart 1990-2012 (Click on chart to enlarge)
We identified cycles of rising inflation whereby CPI clearly exceeded 3%. From the above chart, it is evident that during the past 22 years, there were five such cycles:
1990-1992 (with 6.29% peak)
2000-2002 (3.8% peak)
2005-2006 (4.7% peak)
2008 (5.6% peak)
2011 (3.9% peak)
Calculations derived from split and dividend adjusted data provided by Yahoo Finance
It is evident from the above table that whenever inflation had risen to a range of 3% to 6.3%, there is no clear indication that such inflation increases had resulted in a consistent drop in the stock price of the examined shares. It should be noted that there was a noticeable drop in share prices in 2000 and 2008, whereby the cause had less to do with inflation, and more to do with the bursting of the internet bubble in 2000, as well as the subprime lending crisis in 2008.
It should also be noted that when shares of specific companies did drop while others did not, such as Hewlett-Packard (HPQ) in 2011, and Cisco/Dell/IBM in 2005, such drops were not necessarily triggered by inflation, but possibly by other factors (Hurricane Katrina aftermath, etc...).
Finally, it is also important to note that established technology companies with businesses that have matured, such as IBM in the early 1990's, could be more adversely affected by rising inflation and a slowing GDP growth rate than businesses in new growth technology sub-sectors, such as Microsoft, Dell and Cisco in the early 1990's.
As all seven technology companies examined currently have deep market penetration in mature markets, their share prices could be at risk in case of a substantial economic slowdown or contraction, rather than a scenario of elevated inflation. However, for companies that are continuing to expand into new popular products, such as Apple with its iPad and potential future Apple TV, such companies could be better insulated against a drop in economic growth, as long as such drop is modest and not severe.
How about an environment of severe inflation, where annual CPI inflation can exceed 7.5%, as opposed to elevated inflation, where inflation is between 3% and 7%? Examining data starting from 1914, we identified six cycles of severe annual inflation.
|Cycle||Year||Inflation||DJ Index||Cycle||Year||Inflation||DJ Index|
DJ Index calculation derived from data provided by Yahoo Finance
It is interesting to note that during the cycles R, S, and V, the Dow Jones Industrial average performed quite well despite severe inflation. Meanwhile, during Cycle Q, 1916 to 1920, the market had mixed performance, although the index did end 1920 at $90.04, above its 1915 level of $74.4. Meanwhile, more recently, in cycle T, the market dropped substantially in 1974, and then recovered in 1975. Finally, in cycle U, the index ended 1981 at $875, above its 1977 level of $831.17, while it actually peaked at $963.99 in 1980.
Although data is not available for Cisco, Microsoft, Intel, Apple and Dell, prior to 1980, we were able to examine data for IBM and Hewlett-Packard for severe inflation cycles T and U.
In the case of severe inflation, while IBM fluctuated from year to year, Hewlett-Packard appreciated noticeably despite annual drops in 1974 and 1981.
Unless inflation is accompanied by severe contraction in GDP, it does seem that in the long-term, technology shares exhibit only temporary drop if at all, especially if the increase in inflation turns out to be temporary and short-lived. In addition, other company specific factors are much more likely to affect technology share prices than inflation. In the case of technology shares experiencing strong growth as a result of new products, it is also more likely that they would have some protection against higher inflation.
There is a resurfacing of the "I" word. But, given reasonable forward PE ratios for most technology shares discussed herein such as Apple, Hewlett-Packard, Microsoft, Intel and Cisco, in addition to the positive prospect for upcoming new products such as the iPad, Windows 8, Ultrabooks, 4G, and more, such stocks may still present good value for long term investors.