Stocks of large-cap tech giants Apple (AAPL -3.23%), Amazon (AMZN -5.50%)Y nvidia (NVDA -5.26%) were down sharply on Friday, falling 3.4%, 5.6%, and 5.5%, respectively, by 1 pm ET.
There wasn’t much material news from any of these three tech giants today. However, each of these companies trades at above-average valuations and thus have been affected by today’s higher-than-expected inflation reading.
This morning, the Bureau of Labor Statistics reported the May Consumer Price Index, which tracks price movements for end consumers. While many expected the March reading to have marked an inflation spike, the May figures disappointed with the highest inflation figure since 1981.
The headline inflation figure was 8.6%, versus expectations of 8.3%, while “core” inflation, which excludes volatile food and energy prices, was 6%, versus the 5.9% estimate. What was especially worrying was that it wasn’t just one element that seemed to surprise to the upside, such as energy, which was known to be pushing up. The bureau wrote that inflation was “broad-based,” with food costs and housing costs also rising sharply. Surprisingly, even the prices of items such as clothing and used vehicles, which seemed to be falling last month, rose once again.
Investors may be asking, “What does this have to do with Apple, Amazon, and Nvidia?” Well, each of these stocks is a growth stock with a higher than average P/E ratio. Even after today’s drop, Apple is trading at a P/E ratio of 22.4, with Amazon at 52.4 and Nvidia at 45.7, all above the market average.
If inflation is higher and more persistent than expected, investors may have to discount higher long-term interest rates. For example, the 10-year Treasury bond yield rose 12 basis points today to 3.17% as of this writing, surpassing levels last seen in October 2018.
A higher long-term interest rate could cause investors to discount future earnings by a larger amount. The further into the future those earnings are, the more they are discounted. Therefore, rising rates hit growth stocks particularly hard as their valuation ratios are compressed.
On the other hand, when the Federal Reserve raises rates, there is also a fear that it will go too far and cause a recession to drive prices back down. That wouldn’t be good for discretionary names, or really any stock that isn’t a staple whose products are bought in good times and bad. Traditionally, technology products have been viewed as discretionary. If this scenario unfolds, these companies will not only see lower P/E multiples, but their financials could be affected in the short term.
Although the technology has traditionally been viewed as discretionary, it could be argued that these names are less discretionary than they used to be. After all, more and more of our lives are now conducted through our phones and laptops, so Apple’s results may not be as cyclical as they were, say, five years ago. On the other hand, consumers can delay updates longer.
Similarly, Amazon’s retail site is currently plagued by higher shipping costs, and consumers are able to purchase less discretionary items. On the other hand, Amazon is also known for its low prices, and higher fuel costs could entice consumers to order more from the e-commerce giant instead of going to a store.
Nvidia is tricky, as semiconductors are known to be highly cyclical. However, while gaming and laptop sales may decline, Nvidia’s strong position to enable artificial intelligence (AI) could allow it to grow during an economic downturn. AI is becoming increasingly useful to a wider swath of businesses and is a key competitive advantage for many. Additionally, automating more processes could help reduce labor costs and increase efficiency.
With each of these names already down from their highs in large numbers, and with each stock enjoying strong competitive advantages, I would not recommend that long-term investors rush into selling any of these names in a panic. After all, these companies survived the dot-com crash and Great Recession of 2008, and they will survive this bout of inflation. On the other hand, there’s a lot of uncertainty right now, so I’d also be cautious about adding or stacking these names just because they’re down.
So these three seem to be “holding” at the moment for long-term investors. However, those without a position who are interested in these top tech names may want to consider starting a position at these discounted prices in the long run. Just be prepared for more snags if the Fed has to raise rates higher than expected. Keep allocations within your risk parameters in a diversified portfolio and perhaps consider dollar cost averaging during what should be a volatile summer.