What happened
Shares of big-cap tech giants Apple (AAPL 0.19%), Amazon (AMZN -0.40%), and Nvidia (NVDA -0.16%) were down big on Friday, declining 3.4%, 5.6%, and 5.5%, respectively, as of 1 p.m. ET.
There wasn't much material news out of any of these three technology giants today. However, each of these companies trades at above-average valuations, and were therefore battered by today's higher-than-expected inflation reading.
So what
This morning, the Bureau of Labor Statistics reported May's consumer price index, which tracks price movements to end consumers. While many had hoped the March reading had marked peak inflation, May's numbers disappointed with the highest inflation print since 1981.
The headline inflation number came in at 8.6%, versus expectations of 8.3%, while "core" inflation, which strips out volatile food and energy prices, came in at 6%, versus the 5.9% estimate. What was especially troubling was that it wasn't just one item that appeared to surprise to the upside, such as energy, which was known to be pushing higher. The bureau wrote inflation was "broad-based," with food costs and shelter costs also rising sharply. Surprisingly, even prices for items such as apparel and used vehicles, which appeared to be rolling over to the downside last month, increased once again.
Investors may ask themselves, "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 price-to-earnings (P/E) ratio. Even after today's decline, Apple trades at a 22.4 P/E ratio, with Amazon at 52.4 and Nvidia at 45.7 -- all higher than the market average.
If inflation is higher and more persistent than expected, investors may have to price in higher long-term interest rates. For instance, 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 greater amount. The further out in the future those earnings are, the more they get discounted. Therefore, rising rates hit growth stocks especially hard, as their valuation ratios compress.
On the other side, when the Federal Reserve hikes rates, there is also the fear it will go too far, causing a recession in order to get 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 seen as discretionary. If this scenario occurs, not only will these companies see lower P/E multiples, but their financial metrics could suffer in the near term.
Now what
Though technology has traditionally been seen as discretionary, one could argue these names are less discretionary than they used to be. After all, more and more of our lives are conducted now through our phones and laptops, so Apple's results may not be quite as cyclical than they were, say, five years ago. On the other hand, consumers may delay upgrades for longer.
Similarly, Amazon's retail site is currently getting hit with higher shipping costs, and consumers may buy less discretionary items. On the other hand, Amazon is also known for low prices, and higher fuel costs could entice consumers to order more from the e-commerce giant rather than driving to a store.
Nvidia is a tricky one, as semiconductors have been known to be highly cyclical. However, while gaming and laptop sales may turn down, Nvidia's strong position in enabling artificial intelligence (AI) could allow it to grow through an economic downturn. AI is becoming more and more useful for a wider swath of businesses, and is a key competitive advantage for many. Furthermore, automating more processes could help lower labor costs and increase efficiency.
With each of these names already down by large amounts from their highs, and with each stock benefiting from strong competitive advantages, I wouldn't advocate long-term investors rush to sell any of these names in a panic. After all, these companies survived the dot-com crash and the Great Recession of 2008, and they will survive this bout of inflation. On the other hand, there is a lot of uncertainty right now, so I would also be cautious about adding or piling into these names just because they are down.
These three therefore look like "holds" at the moment for long-term investors. However, those without a position and who are interested in these best-in-class tech names may wish to think about starting a position at these marked-down prices for the long term. Just be prepared for more downside if the Fed has to raise rates more than expected. Keep allocations within your risk parameters in a diversified portfolio, and perhaps think about dollar-cost averaging through what should be a volatile summer.
