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The inflation argument calling for a good decade for technology investment




TuSimple, partly owned by UPS, makes self-driving trucks, a technology that could be among the innovations to help reduce long-term inflation in the transportation sector.

Source: TuSimple

As inflation continues to flirt with 40-year highs, we know what the Fed is doing to fight back: raise interest rates. But what can companies do to fight back beyond raising prices for customers?

That question is recently 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 1[ads1]2 months ending in July, representing a much better leveling of inflation than in recent months, driven by falling gasoline prices after a rise that began in December 2020. Gas prices fell nearly 8 percent in July. The rate of inflation excluding volatile food and energy segments rose 0.3 per cent, down from 0.7 per cent in June.

But can corporate America and the markets count on the inflationary freeze to last?

“This is a much better report than 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 take it as a tick in the right direction.”

Ann Milleti, head of active equity at Allspring Global Investments, told CNBC on Wednesday that there is a sense of relief from the latest inflation data, but in the bigger picture, she warned that inflation is here to stay. “What you want to own are companies that can outperform, management teams that have lived through previous cycles before, cycles that are changing,” Milleti said. “Regardless of what the Fed does, we know interest rates are going higher. We know 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 responses 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 industry research director Josh Pokrzywinski, the report shows that there will be a big change in how companies think about allocating capital after the end of the low interest rate era.

“The cost of capital is rising, which we believe will push companies to invest for future growth as opposed to corporate buybacks and other financial developments,” the Morgan Stanley report said. “Physical [capital spending]when executed correctly, it tends to be deflationary.”

That belief led a team of 31 credited analysts to come up with a series of investments that companies — and investors — should focus on as executives allocate more spending to productivity gains and to drive inflation lower over the next few years.

The Morgan Stanley report is dominated by technologies whose names have become household names: artificial intelligence, clean energy, robotics, software innovation and even pure commercial heating and air conditioning that can quickly pay for themselves in efficiency savings. All these technologies are rapidly falling in price and increasing in efficiency, and this means that goods and services made with them will become significantly cheaper over the next few years.

Some of the examples Morgan Stanley mentions are well known; others much less.

AI, for example, has an underappreciated role in accelerating advances in biotech and pharmaceutical development, according to Morgan Stanley analyst Vikram Purahit, which allows companies to quickly eliminate unpromising experiments and more quickly hone in on compounds that hold clinical promise, reducing time for preclinical medicine. development as much as 75% and reduce early development costs by up to half.

Another is in the apparently low-tech industry of long-distance transport. Labor and fuel costs have driven shipping costs to new heights. The Labor Department reported that costs for delivery services such as United Parcel Service and FedEx have risen 14 percent in the past 12 months and wages in the sector have accelerated due to driver shortages.

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

“We believe that 70 percent of the cost savings are in play from adopting these technologies together,” Shankar wrote, adding, “We expect at least some of these to be passed on to shippers.”

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

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

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

“Clean energy could be disruptive in the long term for traditional electricity providers, particularly utilities with high and rising customer bills, above-average exposure to physical risk from climate change, and challenges in ensuring adequate power supply to customers,” Byrd wrote.

Arguing inflation and productivity gains

The report met with mixed reactions from outside experts. The basic idea is well known to those who follow innovation: Technology is deflationary by nature.

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

Mandel claims that inflation has increased in part due to low investment by companies during the Covid pandemic.

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

“Deflationary progress does not come from capital-intensive activities like the transition to renewable energy or electric cars,” Cantwell said. “Capital-light technology, such as card networks and social networks, has deflationary potential, but it is very difficult to measure.”

None of this means that policymakers and markets can turn a blind eye to near-term inflationary pressures, said Sylvia Jablonski, chief investment officer at Defiance ETFs, whose fund focuses on disruptions including quantum computing and hydrogen energy.

“Politics, Washington and the Federal Reserve arguably have the biggest impact on the state of inflation, and this cannot be ignored,” Jablonski said. “But there are many factors that can contribute to demographic trends, lead to a technological revolution and really change the way the economy and society work.”



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