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Feb. 22, 2021, 2:40 p.m. EST

Productivity will calm inflation this year — these are the types of stocks you’ll want to own

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By Michael Brush

President Biden’s desire to “go big” on spending has instilled big fears in some investors.

They’re worried too much stimulus will spark excessive inflation, which can hurt stocks in three ways.

1. If companies can’t pass along rising costs, margins and profit growth crumbles.

2. If they do pass on rising costs to customers, widespread inflation can make the Federal Reserve tighten monetary policy — a main cause of bear markets.

3. If neither happens, rising inflation can lead to higher bond yields. As a result, fixed income as an asset class becomes more attractive. And rising rates erode the present value of future earnings. Valuation models must then use a higher discount rate, typically the 10-year Treasury yield, which has already doubled in the past few months.

Don’t brush off the fear of inflation. But be mindful of three other powerful forces that will negate pressure on higher prices — more on that below, along with stocks that stand to perform well this year.

Where inflation fears come from

Inflation is a bigger risk than you might think now, because inventories are the lowest since 2009. The sharp pickup in economic growth ahead — it might reach 8.5% in the second quarter, says Goldman Sachs — could propel prices as buyers scramble for scarce goods.

You already know about this if you’ve recently bought appliances, and household paper and cleaning products. Prices are up 9%-23% compared to a year ago.

Likewise, tech companies face chip shortages.

“With virtually no inventory and some of the fastest growth in decades, price inflation could certainly rise,” says Jim Paulsen, chief market strategist at Leuthold Group.

Given all of this, it’s no surprise Ed Yardeni of Yardeni Research says the biggest concern among investors in client Zoom calls is inflation from “excessively stimulative fiscal and monetary policies.” A recent Deutsche Bank survey of clients confirms this.

But everyone needs to just calm down about inflation for a simple reason. No, not technology, trade or the aging of the population — the commonly cited factors keeping a lid on prices. Those are valid.

Instead, three other factors will save stocks from the perils of inflation.

1. Productivity to the rescue

This is the big one. Covid-19 has compressed years’ worth of tech adoption into one year, to paraphrase Microsoft /zigman2/quotes/207732364/composite MSFT -0.19% CEO Satya Nadella. This means we’re about to see the biggest productivity boom in 20 years. Productivity is the great inflation killer.

Why? Because it neutralizes the impact of rising costs for inputs like raw materials among manufacturers and food producers, and for labor (the $15 minimum wage continues to gain traction).

When productivity is rising, companies can squeeze more products or services out of the same amount of labor. So they don’t have to pass along higher costs to their customers. Upstream inflation is stopped in its tracks.

Despite what your intuition may tell you, productivity isn’t about people working harder. It’s about companies spending more on capital goods like technology, software and machines, relative to employees. This helps workers get more done in the same amount of time.

Companies, such as Microsoft, are telling us tech adoption hit warp speed during the pandemic. A recent McKinsey survey confirmed that companies sped up the adoption of digital technologies by several years. “Respondents expect most of these changes to be long-lasting and are already making the kinds of investments that all but ensure they will stick,” says McKinsey.

/zigman2/quotes/207732364/composite
US : U.S.: Nasdaq
$ 258.26
-0.48 -0.19%
Volume: 19.72M
April 20, 2021 4:00p
P/E Ratio
38.46
Dividend Yield
0.87%
Market Cap
$1957.21 billion
Rev. per Employee
$877,393
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