September 25, 2022
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The inflation argument calling another good decade for tech investing

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TuSimple, partly owned by UPS, makes self-driving trucks, a technology that may be among the innovations to help lower longer-run inflation in the transport sector.

Source: TuSimple

As inflation keeps flirting with 40-year highs, we know what the Fed is doing to fight back: raise interest rates. But what can businesses do to fight back beyond raising prices on customers?

That question is newly relevant with the latest inflation data on Wednesday. It was a sign that the economy is making progress against inflation. The Labor Department said consumer prices rose 8.5 percent for the 12 months that ended in July, which represented a leveling off of inflation much better than in recent months, driven by the falling price of gasoline after a surge that began in December 2020. Gas prices dropped nearly 8 percent in July. The rate of inflation excluding volatile food and energy segments climbed 0.3 percent, down from 0.7 percent in June.

But can corporate America and the markets count on the inflation lull to last?

“This is a much better report than what I expected,” former Obama administration chief economist Jason Furman told CNBC’s Squawk Box on Wednesday. “This could easily be the false dawn that we saw in September 2021, but for now I’ll take it as a tick in the good direction.”

Ann Milleti, Allspring Global Investments head of active equity, told CNBC on Wednesday that there’s a sense of relief from the latest inflation data, but in the bigger picture, she cautioned that inflation is here to stay. “What you want to own are companies that can outperform, management teams who have lived through previous cycles before, cycles that are changing,” Milleti said. “Regardless of what the Fed does, we know rates are going higher. We know that inflation is likely to be higher than it was over the last decade in the next decade. So you want to pick companies that are better positioned for that type of environment than the previous environment we have lived through.”

Companies will spend more on technology

One set of answers to the higher-for-longer inflation argument circulating on Wall Street comes from Morgan Stanley, in the form of a 60-page report released this summer called “The Deflation Enablers.” Led by industrial research director Josh Pokrzywinski, the report makes the case that a big change is coming in how corporations think about allocating capital after the end of the low interest rate era.

“The cost of capital is on the rise, which we think will push companies to invest for future growth as opposed to corporate buybacks and other financial engineering,” the Morgan Stanley report says. “Physical [capital spending], when executed right, tends to be deflationary.”

This belief led a team of 31 credited analysts to come up with a series of investments that companies – and investors – should be focusing on as executives allocate more spending for productivity gains and to drive inflation lower over the next several years.

The Morgan Stanley report is dominated by technologies whose names have become familiar: artificial intelligence, clean energy, robotics, software innovation and even clean commercial heating and air conditioning advancements that can quickly pay for themselves in efficiency savings. All of these technologies are dropping quickly in price and ramping up in effectiveness, and that implies that goods and services made with them will be significantly cheaper over the next several years.

Some of the examples Morgan Stanley cites are familiar; others much less so.

AI, for example, has little-appreciated importance to accelerating the advance of biotechnology and pharmaceutical development, according to Morgan Stanley analyst Vikram Purahit, letting companies eliminate unpromising experiments quickly and hone in faster on compounds that are clinically promising, cutting time for preclinical drug development as much as 75% and reducing early-stage development costs by up to half. 

Another is in the seemingly low-tech business of long-haul trucking. Labor and fuel costs have been driving freight costs to new highs. The Labor Department reported that costs for delivery services like United Parcel Service and FedEx have risen 14 percent in the last 12 months and wages in the sector have accelerated amid a shortage of drivers. 

But trucks that use autonomous-driving technology and electric engines can solve both problems, according to Morgan Stanley analyst Ravi Shankar. Near-fully autonomous driving should be available by late next year from San Diego-based TuSimple, which went public in 2021 and is partly owned by United Parcel Service. FedEx chairman Fred Smith told CNBC’s Jim Cramer in March that his company wants to introduce driverless trucks in 2022, and Fedex announced a pilot AV program in May.

“We believe 70 percent of cost savings are in play from the adoption of these technologies together,” Shankar wrote, and he added, “We expect at least some of these to be passed along to shippers.”

But the biggest bucket of investment to fight inflation may occur in energy. 

There’s an emerging split between “inflationary” traditional energy and “deflationary” clean energy, wrote Morgan Stanley utility analyst Stephen Byrd, a split highlighted by this year’s surge in oil and natural gas prices. One example: Futures prices for electricity supplied to Texas in 2023 are up 65 percent this year, while fuel cell manufacturer Bloom Energy is cutting manufacturing costs as much as 10 percent a year. Electricity supplied by Bloom to commercial customers is now almost 20 percent cheaper than the national average, Byrd said.

Similarly, power generated by Sunrun’s rooftop solar systems in California is now cheaper than juice from the local utility, thanks to a big jump in utility inflation in the last year. The new inflation data did not show a deceleration in utility prices, partly because the market price of natural gas remains three times higher than pre-pandemic levels, complicated by disruptions in Russian supplies.

“Clean energy can, in the long term, be disruptive to traditional electricity suppliers, especially utilities with high and rising customer bills, above-average exposure to physical risks from climate change, and challenges in ensuring adequate power supply to its customers,” Byrd wrote.

Arguing inflation and productivity gains

The report met with a mixed reaction from outside experts. The basic idea is well-known to those who follow innovation: technology is by its nature deflationary.

“[It’s an] interesting piece,” said Michael Mandel, chief economist of the Progressive Policy Institute and lead author of its Innovation Heroes reports, highlighting companies that invest heavily to chase productivity gains. “[It] fits very closely to our Investment Heroes report, and [with] low inflation in the digital sector.” 

Mandel argues that inflation has spiked partly because of low investment by corporations during the Covid pandemic. 

But less impressed was Robert Cantwell, portfolio manager of the Compound Kings ETF in Nashville, who thinks Morgan Stanley’s analysts went too far in the number of technologies cited.

“Deflationary advancements don’t come from capital intensive activities like the renewable energy transition or EVs,” Cantwell  said. “Capital-light technology, like card networks and social networks, have deflationary potential, but it’s really hard to measure.”

None of this means policy makers and markets can take their eye off short-term inflation pressures, said Sylvia Jablonski, chief investment officer at Defiance ETFs, whose funds focus on disruptions including quantum computing and hydrogen energy.

“Politics, Washington, and the Federal Reserve have arguably the largest impact on the state of inflation, and this cannot be ignored,” Jablonski said. “However, there are a lot of factors which can contribute to demographic trends, lead to a technological revolution and really shift the way that the economy and society operate. “



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