Apple (AAPL) and Amazon (AMZN), two of the biggest companies in the world by market capitalisation, are releasing their quarterly corporate results on Thursday after market close. As of August 3, 2021, Apple was the most valuable company globally, with Amazon coming up as the fifth-largest company in the world, according to Global Finance.
Other than being among the largest companies on the planet, Amazon and Apple have another thing in common. They are both technology firms. How will they fare in an environment in which high inflation is seen to favour cyclical sectors, industries that are sensitive to the business cycle, at the expense of growth?
Growth and Value Stocks During Inflation
After cyclical stocks underperformed in the last decade, they have given growth stocks, such as technology companies, an edge. However, now that inflation is persistent, and Treasury Secretary Janet Yellen conceding it's been the highest "in a long time" value stocks were given the edge in this high-inflation environment. The inflation theme tends to benefit cyclical for several possible reasons. Here are two basic ones.
One, after growth stocks like technology companies led the broader market higher, investors may wish to lock in profits and seek undervalued stocks, which provide more "value," and hence the term "value stocks". The reopening economy and its brick-and-mortar shops suggest that big tech won't repeat the same windfalls of 2020 during the height of the pandemic and social restrictions. Additionally, risks may increase for technology stocks as lawmakers call for stricter and higher regulations, which may accelerate profit-taking as this horse gets tired and investors jump onto a fresh horse, value stocks.
Two, the higher inflation increases the chances for higher interest rates, as lenders demand higher compensation for the loss of buying power when they don't have access to their money till it is repaid. Also, the Fed uses interest rates to manage inflation, typically lowering interest rates when the inflation is too low and increasing borrowing costs when inflation starts moving higher. Additionally, higher interest rates tend to be bad for technology stocks in two ways.
First, because technology stocks generally fall on rising interest rates. This negative correlation probably exists because when borrowing costs increase, it becomes more expensive and, therefore, more difficult for technology firms to keep the same rate of future earnings. In contrast, value stocks are expected to maintain a more reliable cash flow, as these companies can rely on steady business, irrespective of the state of the economy. An example is the food industry. While people may cut back on discretionary spending, they will likely keep spending on consumer staples. They need to eat.
Second, value sectors tend to benefit during an environment in which inflation rises. As previously mentioned, interest rates typically rise along with inflation, which helps banks where the primary source of income is loans. Also, since inflation tends to rise along with economic growth, it is expected to benefit sectors whose demand rises during rebuilding, such as energy and basic materials. An example of energy assets is Oil (CL), and an example of basic materials is Kumba Iron Ore (KIO.JO).
Inflation Hits 30-Year High
Moreover, U.S. inflation hit a 30-year high in August due to bottlenecked supply chains. The core personal consumption expenditures price index rose by 0.3% for the month and increased 3.6% on a year-over-year basis. This read is the highest since May 1991. This inflation measure is essential because it excludes food and energy costs, where short-term fluctuations may provide a picture that is not representative. Probably, this is why it's the Fed's preferred inflation gauge.
So, if technology stocks are expected to underperform amid rising inflation, what are Wall Street's expectations for Amazon and Apple, two of the most significant technology stocks, which have outperformed during the pandemic?
Analyst Forecasts For Amazon and Apple
A Tipranks survey of 31 analysts over 12 months provided Amazon with a "Strong Buy" recommendation, an average price target of $4,180.13. 0 analysts recommended Hold, and 0 recommended Sell. Why would analysts still be bullish about Amazon despite the high inflation? Polen Capital acknowledged the unfair comparison of last year's profit when the tech giant grew revenue by more than 40%. However, it still expects it to expand as Amazon has continued growth, even amid this high inflation environment. Perhaps, because some analysts don't believe inflation will persist. Moreover, some believe that inflation will subside once global supply chains resume smoothly and that technology itself will increase productivity, likely creating deflationary pressure.
Tipranks also gave Apple a "Strong Buy" recommendation, with an average price target of $170.09 during the next 12 months. However, unlike Amazon, six analysts provided a Hold recommendation. Like Amazon, 0 recommended selling. Apple's iPhone is likely to be in the limelight, as smartphones make up half of the company's revenue. Now, they are expected to get a boost after two successful product launches in the past year, including the 5F-ready iPhone 12 and iPhone 13. However, supply chain disruption is likely to be an issue.
Research covering the last 20 quarters indicates that Apple stock rose a median of almost 5% in two weeks after an earnings report. Will the tech behemoth's stock follow true to form during a complex market environment?
Will two of the most significant technology stocks manage to keep growing despite these headwinds, as analysts predict?