Persistently low inflation in the face of continuing economic expansion has been a head-scratcher for many. The unlikely culprit: technology.
Disruptive technologies are propelling low cost alternatives, creating pockets of deflation and promoting a better quality of life. When you consider the varied uses of a smartphone, for instance - as a phone and camera, to surf the internet, compute, listen to music and play videos–even a $1,000 iPhone can seem like a bargain when you think about how many devices would be needed at higher cost 20 years ago to achieve similar functionality.
Today, many digital businesses have low incremental costs, allowing them to produce massive quantities of products inexpensively, to the benefit of consumers. It once took decades for successful corporations to establish global scale, requiring large investments in physical capital and ultimately leading to higher prices for consumers. Today, successful digital companies like Airbnb and Uber have achieved scale in just a few years with minimal investments in physical capital leading to competitive prices for consumers. E-commerce has also contributed to the deflationary trend, promoting price transparency, and making it more difficult for traditional retailers to sell high-margin items based on information asymmetry.
So far, deflationary technologies have kept inflation in check, bolstering growth and fostering low interest rates, and a continuation of this theme would be positive for global markets. That said, the network effects of having pockets of deflation across different countries and industries has the potential to lead to broader, more pronounced deflation, which hasn’t occurred since the 1930s. This can be deeply unsettling for the economy and have an adverse impact on investments.
To this end, NEPC recommends including assets in your portfolio that provide liquidity across different economic environments. Safe-haven fixed-income securities, such as government bonds, should add value in both benign and extreme deflation.
Within equities, we believe deflationary technology helps make a case for active management. In the face of continued technological disruption and deflation, there are going to be winners and losers within sectors and among companies, and avoiding who gets left behind may be just as vital as identifying the victor. We also think it is worthwhile to consider private over public equity on the margin; since many companies are going public only once they have achieved massive growth, small-cap exposure through private markets may benefit investors with longer-term horizons.