Higher for Longer: Adapting Stock Selection for Higher Inflation/Rates

By Dan Zolet, CFA


  • We expect inflation and rates to remain higher than the last decade.
  • We favor tech within growth and cyclicals within value.
  • Specifically, we focus on cash flow generation in both groups.

As we discussed earlier this month in our “3 Rules” update, we believe that the Federal Reserve will remain hawkish in their rate targets, despite falling inflation. Last week, the July CPI report saw a slight increase compared to June, but the 3.2% year-over-year number is a far cry from the increases the economy was experiencing last year. Taking the current level of both interest rates and inflation into account, this week we want to shine light on how both affect growth-oriented stocks and value-oriented stocks. Given that we believe economic growth in the US will remain positive and interest rates and inflation will remain at more elevated levels for longer than the consensus expects, our goal is to connect recent headlines on Inflation and the Fed to our equity positioning.

Technology Stocks Thrive on Normalized Interest Rates

To understand growth investing today, we must first discuss how growth stocks have changed over the past decade. In July 2013, Information Technology made up approximately 19.6% of the S&P 500 Growth index. Fast forward to July 2023 and the sector now consists of 36.9% of the same index. Thus, we believe understanding the technology sector has become the key to growth investing.

With our focus set on the tech sector, we think the yield on the 10-year Treasury note has a big impact for two reasons. First, tech stocks generate a greater proportion of their earnings in the future, and rising interest rates allow investors to earn more from bonds and cash immediately making those future earnings comparatively less valuable. Second, the earnings of these stocks have benefited substantially from share buyback activity, which is often funded through debt which becomes more expensive to service as rates rise. Now that Fed tightening is almost over, this source of earning-per-share growth for Tech stocks has abated. Chart 1 illustrates the relationship between Tech stocks and interest rates.

Chart 1: S&P 500 Technology Returns vs US 10-Year rates – 2022 to Present.

S&P 500 Technology Returns vs US 10-Year rates – 2022 to Present