Tricky times for tech stocks

History suggests inflation, earnings, and the economy could pose challenges in 2022.

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Key takeaways

  • Technology stocks have historically underperformed when inflation has been high.
  • Inflation has historically mattered more for tech stocks' performance than has the health of the economy.
  • Tech stocks have historically underperformed following periods of high corporate earnings.
  • Value tech stocks may offer opportunities despite potential headwinds facing the sector.

While stocks have historically helped protect well-diversified portfolios from the ravages of inflation, not all stocks have fared well in times of rising prices. History shows that stocks of companies in the technology sector have tended to struggle when inflation has risen. That matters especially in today's inflationary environment because tech stocks have been among the strongest performers in the S&P 500 over the past 10 years and their big gains over that time mean that they may now count for a larger share of many investors' portfolios than they might realize. Even within the tech growth stock category, companies such as Facebook, Apple, Alphabet, and others have gained far more than have other tech stocks in recent years.

Tech growth stocks have mostly delivered their market-leading performance while inflation has been exceptionally low by historical standards. The current tech stock bull market began in 2009 when the US consumer price index (CPI) actually declined, and from 2010 through 2020, inflation averaged only 1.7% per year. In 2021, by contrast, the CPI (including food and energy) rose 7%. Director of Quantitative Market Strategy Denise Chisholm says, "This change to an inflationary environment may have important ramifications for sector performance and technology looks particularly vulnerable."

Historically, the faster inflation has risen, the worse tech's returns have been relative to the overall market. By contrast, periods of declining or slower-growing inflation have seen better relative results for the sector. Tech has also underperformed during inflationary periods regardless of the health of the economy. Indeed, since 1962, technology has performed poorly relative to the overall market not only during inflationary economic booms, but also at times when inflation has been high despite slow economic growth, an unusual situation referred to as stagflation.

It's not the economy

While a growing economy may seem like the ideal environment for stocks to deliver strong returns, history shows that tech has tended to perform better or worse, not depending on whether the economy has been strong or weak, but more on whether inflation has been high or low. In fact, technology has often sputtered when the economy has appeared to be at its strongest. In the past, tech stocks have fared very poorly when leading indicators that measure economic growth have been at their highest. After those indicators have reached the peaks of their gains, technology has underperformed the market by an average of more than 10% over the following 12 months. While growth is expected to continue in 2022, the leading economic indicators recorded their biggest year-over-year improvement since the late 1970s, though it's unclear whether that will represent the peak of the current economic expansion.

And don't overlook earnings

Besides their history of stumbling when growth and inflation data have resembled current conditions, tech stocks also have often underperformed after the sort of big earnings gains that many tech companies have enjoyed over the past few years. Says Chisholm, "Powerful fundamentals have helped drive performance in recent years, as the growth in tech company profit margins reached the top 10% of its historical range. In the past, the sector has struggled after margins improved this much." When tech-sector margin expansion has this same territory in the past, technology stocks have underperformed the market by an average of 0.7% over the next 12 months. Now with the strong results of the past few years in the rear-view mirror, the tech sector may face another headwind.

That being said, it's important to remember that past performance is no guarantee of future results.

Look for value

Higher inflation and economic growth may vex some previously high-flying technology growth stocks in 2022. However, the tech sector may still hold opportunities for investors with longer time horizons by offering them exposure to long-term trends that may continue even as the economy moves through the business cycle and inflation rises or falls.

Investors may also want to consider how their technology investments may fit into their broader financial plans. Naveen Malwal, Institutional Portfolio Manager with Fidelity's Strategic Advisers LLC, says, “While it can be tempting to chase recent performance, I take a more measured approach to positioning client accounts. I believe a mix of stocks that is diversified across a variety of sectors, industries, and countries may help investors experience less volatility as they move towards their financial goals."

Malwal says that proactively managing risk may also help. "For example," he says, "The team rebalances our clients' accounts after periods of stock market volatility. We also gradually adjust our mix of investments over time based on the US business cycle and fundamentals such as valuations and earnings expectations.”

Finding ideas

Investors who want to find long-term opportunity in technology stocks may want to consider professionally managed accounts, mutual funds, and exchange-traded funds (ETFs).

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