Innovation vs. inflation is a real battle … why Luke Lango is betting big on innovation … but get ready for some market tantrums when inflation comes

We have a challenge …

On one hand, innovative tech stocks have been generating triple- and quadruple-digit returns in recent months.

On the other hand, these stocks are highly-sensitive to rising interest rates. The higher (and faster) that rates climb — which they’ve been doing — the more pain tech investors feel.

If you’re a tech investor, you’re already aware of this. Your tech stocks are probably still down from their mid-February highs.

The bottom line is that, right now, the big story is rising interest rates, and by extension, inflation.

As the threat of rising rates and inflation grows, the pressure on tech mounts. We’ve already been seeing a rotation away from tech into traditional value stocks in recent weeks.

So, investors face a critical question …

Is it time to bail on tech?

This is a major story we’re going to be tracking in the Digest in the coming months. Fortunately, we have the benefit of being able to tap the perspective of our hypergrowth expert, Luke Lango.

For newer Digest readers, Luke’s specialty is finding small, market-leading tech innovators that are pioneering explosive trends. Of course, this focus means he is highly-exposed to the recent weakness in the sector.

So, how is Luke viewing this threat of rising rates and inflation?

That’s what we’ll dive into today.

In short, expect volatility. Inflation is going to happen. But Luke believes it won’t rise to levels that will derail tech’s long-term, wealth-building potential.

It’s time to get mentally-prepared for a roller-coaster market. It’s coming, but a long-term focus on innovative disruptors is still the way to generate huge returns this decade.

 

***The slug-match between inflation and innovation

Let’s jump straight into Luke’s Thursday update to his Innovation Investor subscribers:

Are you ready for a blockbuster boxing matchup?

Because that’s exactly what’s in store for the stock market over the next few months.

In one corner, we have an economic headwind with a long record of trumping bull markets and stagnating growth: Inflation.

In the other corner, we have a gale-force tailwind of wealth creation, with an equally extensive history of minting millionaires and billionaires: Innovation.

Luke highlights the recent back-and-forth between these two dynamics, and how they’re impacting tech stocks.

He notes that the “same innovation-focused tech and growth stocks that were slammed in late February are rebounding furiously in March.”

To Luke’s point, as I write Monday morning, the Nasdaq is up 6% since its recent low one week ago today. Meanwhile, many small tech stocks are up double-digits over the same period.

 

***What’s the case for innovation winning out over inflation?

Back to Luke:

On Wednesday, we received a plethora of data which broadly underscored that inflation today remains muted and the “yield surge” we’ve seen in Treasury markets will cool off … for now.

First, the U.S. Department of Labor reported that the Consumer Price Index for All Urban Consumers (CPI-U) — a widely followed proxy for inflation — rose 0.4% month-over-month in February. That was in line with expectations, and in line with the 0.1% to 0.5% CPI-U gains we have seen since June 2020.

In other words, it was a “normal” reading … not an abnormal one … and broadly implied that — despite Wall Street’s fears — inflation today remains muted.

This is especially true if you back out energy prices. Excluding energy, CPI-U barely budged, rising just 0.1% month-over-month.

Again, this only further underscores the idea that inflation is NOT here today.

For Luke’s second point, he highlights the strong 10-Year Treasury auction from last week.

For context, the U.S. Treasury hosts auctions every-so-often, in which the Treasury sells bonds to buyers.

Demand is often viewed as a gauge for whether yields will move higher. In essence, bigger demand implies more buyers, which pushes Treasury prices up and yields down (prices and yields move inversely).

It works the other way too — weaker demand implies fewer buyers, which pushes Treasury prices lower and yields up.

Back to Luke for what happened last week:

Throughout February, we had a bunch of lackluster Treasury auctions in which demand was really weak. This weak demand is what spooked bond markets, sent yields flying, and caused a temporary meltdown in the stock market.

But on Wednesday afternoon, the U.S. Treasury’s 10-year auction went just fine. Demand rebounded to “normal” levels, with a bid-to-call ratio of 2.38, versus a one-year-average of 2.42 (that is, for every dollar of Treasuries sold, there were $2.38 worth of bids).

This rebound to normal auction demand shows that there is ample appetite for Treasury notes at their current prices. When coupled with the tame inflation data, this data increasingly supports the idea that the worst of the “yield surge” is over, and that the pace of gains in the 10-year Treasury yield will slow dramatically over the next month.

So, we can say that the recent edge has gone to innovation — but — get ready for inflation to punch back.

 

***Inflation numbers will surge this spring, which will put pressure on tech stocks

Luke is no wide-eyed optimist who sees nothing but blue skies ahead for tech.

He’s quick to say that investors need to prepare for more weakness. Adopting the right mindset is critical.

Back to Luke:

We are going to see some massive inflation numbers in April, May, and June.

That’s because a year ago, the global economy shut down, and CPI-U growth turned negative month-over-month for three straight months. We will likely see a string of CPI and PCE readings north of 2% in the second quarter.

This could freak out the stock market — and cause another mini-meltdown in tech stocks and in our portfolio in the coming months.

But guess what?

Much like this meltdown, those meltdowns will be golden buying opportunities.

 

***Three reason why staying the course with tech will pay off big

The first reason from Luke focuses on the mass change associated with disruptive innovators.

Cutting-edge technology companies are profoundly changing the way we eat, play, work, and shop — and, more broadly, making the world healthier, cleaner, faster, cheaper, and better.

They won’t stop changing the world because yields are rising or inflation creeps higher.

From Luke:

These innovators will continue to change the world over the next decade, regardless of what happens with yields here over the next few months.

And, as disruptive world-changers, these companies will unlock significant economic value throughout the 2020s.

Luke believes early investors will be rewarded, and will look back at this early 2021 volatility in much the same way early Amazon and Netflix investors look back at early 2000s volatility: nothing more than noise and imperceivable wiggles in the long-term trend.

The second reason behind “stay the course” is due to the huge valuation upside from a long-term perspective.

Now, it’s one thing to say that innovative stocks have bright futures. It’s another thing to actually build models that forecast cash flows, input various discount rates, and crunch the numbers to arrive at a range of probable growth. But that’s what Luke has done — which is likely a reason why he’s ranked #1 out of more than 15,000 investment experts according to TipRanks.

Back to Luke:

… we value our stocks by creating extensive and comprehensive 10-year profit-and-loss and cash flow models for each of our portfolio companies.

We essentially forecast each company’s revenues, profits, and cash flows out to 2030. We then plug those assumptions into various valuation models (EPS exit models, EBITDA exit models, DCF models, etc.), mathematically weigh the results, and produce a final price target.

We have extensively tested and fine-tuned those models over the past few weeks. The results? We’re more convinced than ever that our stocks are way undervalued.

Luke writes that when you fill your portfolio with leading, high-quality innovators, rising rates do not change the potential for multi-bagger returns.

Finally, the third reason why Luke believes innovation will trump inflation is that the inflation we see will be transitory.

From the Innovation Investor update:

This is the big one.

Sure. I get the inflation fears. Lots of fiscal and monetary stimulus. Lots of pent-up demand. Those two will couple in 2021, and lead to a huge surge in consumer demand for “things.” Supply for those “things” will remain relatively low since supply chains aren’t up-and-running at 100% capacity yet.

Big demand + limited supply = higher prices …

But that cursory analysis misses the most important factor in the “inflation equation”: Technology.

Luke points out how technology broadly makes everything more cost- and time-efficient. In doing so, it actually results in deflationary pressure.

Back to Luke:

Don’t believe me?

Believe the numbers.

The first website was published on the World Wide Web in August of 1991. That’s basically when the public-use internet was “born” — and when the internet started to take over the world.

Before then, the U.S. was averaging core PCE growth north of 3%. But, since 1995, core PCE growth has never sustainably stayed above 2.5%.

Even further, since 2010, the U.S. has not sustainably held even 2% core PCE growth.

Luke writes that the most important thing here is that technology’s deflationary impact on the U.S. economy is only going to accelerate for the near future.

Given this, he believes that market-tantrums about inflation are short-sighted …

Any inflation we do see here in Q2 will be transitory. We’re due for a lifetime of generally muted inflation …

Net net, we aren’t worried at all. Instead, we’re as bullish ever.

 

***This “boxing match” will have a few more rounds over the next several months

And, according to Luke, each time inflation lands a punch, he’ll be recommending his subscribers buy the dip.

He believes the pay-off for this courage and longer-term focus will be huge:

… by the mid-2020s, we will be sitting on enormous gains, much as early Amazon and Netflix investors are sitting on huge gains today and laughing at the folks who let early 2000s volatility scare them out of revolutionary world-changers.

As I said in last month’s issue … those who don’t learn from history, are doomed to repeat it.

Wrapping up, if you’re invested in tech, get ready for some drops. They’re coming.

But Luke believes that what’s on the other side are massive, portfolio-changing gains.

Here is with the final word:

Let’s learn from the mistakes of prior investors. Let’s stick with the world-changers. And let’s help define a better future.

Have a good evening,

Jeff Remsburg