Inflation Is Coming, and Big Tech Won't Protect You

(Bloomberg Opinion) — Over the past decade, it’s almost been too easy for Americans to manage their wealth. A textbook 60/40 portfolio — in its simplest incarnation, exposure to the S&P 500 Index and Treasury bonds — was an effortless winner. The U.S. boasted the world’s best stock market, and bonds, apart from offering interest income, provided a nice hedge against equity risks.

Now we live in extraordinary times that demand a reshuffle. Swapping out some bonds for gold and some U.S. technology stocks for Chinese ones could offer a better hedge: Both can be considered credit default swaps against President Donald Trump’s chaotic policymaking. 

You could argue that the wreckage left by Covid-19, combined with what’s quickly shaping up to be a cold war between the world’s two largest economies, is the closest we’ve come to World War III. And just like wartime episodes of the past, we’re seeing disrupted global supply chains, border lockdowns and restricted movements in labor. 

War is inflationary. The cheap car parts made in China’s inland city of Wuhan can no longer land in the U.S., and your French wine could cost more as transportation logistics get trickier. Moreover, the Federal Reserve has been flooding its financial system with cash. In just three months, assets held by the central bank ballooned by two-thirds, to almost $7 trillion. To make matters worse, the Fed is mulling a more relaxed stance toward inflation, ready to abandon preemptive rate hikes — even though  consumer expectations have been  ticking up since May. 

As I’ve argued in a recent piece for Bloomberg Businessweek, bonds are no longer effective equity hedges in an ultra-low-rate world that faces inflationary pressure; gold can do a better job. But after a neck-breaking rally, it’s natural to ask if we’re already too late to the game. 

History can be our guide. After the collapse of Lehman Brothers in 2008, gold broke out and continued marching higher until September 2011, even as Tea Party belt-tighteners took control of the national narrative in the 2010 midterm election. A decade on, the Republican Party’s libertarian wing has all but disappeared, and is replaced by a cross-the-aisle nod to modern monetary theorists, who brush aside fiscal austerity. The Tea Party is no longer here to sour the gold rally. 

Meanwhile, since we’re at war, might it be smart to hedge against the possibility of losing? This cold war isn’t over a plot of land or sea, but domination over next-generation technology. 

The U.S. has the absolute advantage now, with chip and robotic designs far ahead of China’s, but that edge is slipping away. While Washington is wrangling over trillions of dollars of stimulus to fend off a recession caused by waves of coronavirus outbreaks, China, which has the pandemic relatively under control, is only strengthening its tech resolve. 

For Beijing, it’s killing two birds with one stone. The $1.4 trillion hard tech invesment is the nation’s new fiscal stimulus package. Instead of building more roads to nowhere, China is installing 5G base stations.

It’s high time to consider diversifying from U.S. stocks, anyhow. There have been nagging worries about the market being on a tear even with the economy in the dumps. Meanwhile, Big Tech has become too dominant, with the top five mega-cap names now accounting for more than 20% of the S&P 500 and its entire gain this year. This might help explain why mainland firms that recently went public in New York are outperforming their U.S. counterparts, despite the Trump administration’s attempt to delist China Inc. 

Now, I am not advocating that investors plow their money into China’s big tech companies, because they face the exact same problems that U.S. Big Tech has — overbought stocks and impossible expectations. This year’s passive flows only worsened the concentration risk of benchmark indexes. Alibaba Group Holding Ltd. and Tencent Holdings Ltd. account for a third of the MSCI China Index and about 14% of the MSCI Emerging Markets Index.  

Rather, investors should do their homework on smaller hard-tech companies. The truth is, once you identify a promising tech seedling, it doesn’t take a venture capitalist’s patience to watch it blossom. India’s Reliance Industries Ltd. joined the Century Club — stocks with over $100 billion market cap — in just three months. Tencent is another example of a melt-up.