Morgan Stanley admits to being on the wrong side and rapidly upgrades its rating for U.S. IT hardware stocks: "Chip inflation" is transforming from a demand killer into a catalyst for a buying frenzy, with storage stocks being the most favored.

Morgan Stanley has revised its previously cautious stance, upgrading the rating of the U.S. IT hardware industry. The reason cited is that the ongoing surge in memory chip prices, termed "chipflation," has not stifled demand as expected; instead, it has pushed companies to accelerate their procurement, resulting in a wave of stocking driven by a "fear of missing procurement." However, the firm also cautions that the current market conditions are primarily cyclical in nature and, once the earnings upgrade cycle peaks, a return to caution is likely. In a recent report, Morgan Stanley analyst Erik Woodring raised the outlook for the U.S. IT hardware industry from "cautious" to "in line with the market," candidly admitting that they had previously "taken the wrong side on enterprise hardware trades." The firm had once believed that the record inflation in component prices would quickly hinder the recovery in hardware spending, but the reality has turned out to be quite the opposite. With the industry rating upgrade, Morgan Stanley has made a series of individual stock rating adjustments: raising Hewlett Packard Enterprise Co. (HPE.US) and Everpure, Inc. (P.US) to "overweight," upgrading NetApp Inc. (NTAP.US) to "equal weight," while downgrading the rating for Teradata Corporation (TDC.US). The "fear of missing procurement" and the AI expansion driving the reversal Two main factors have driven this change in stance. First, Woodring noted that companies are viewing memory "chipflation" as "a long-term structural headwind." Unlike the traditional mindset of waiting for prices to drop before making purchases, Chief Information Officers are rapidly prioritizing the procurement of PCs, servers, and storage arrays to lock in favorable prices while avoiding future supply shortages. Woodring has referred to this dynamic as the "Fear of Missing Procurement" (FOMP). The second factor is Morgan Stanley's proprietary AlphaWise survey. The results show that upfront demand related to the expansion of artificial intelligence (AI) is driving the growth rate of servers and storage to "reach an all-time high in 2027." This long-term visibility allows the firm to believe that, despite hardware stocks having surged, there is still room for the current cycle to continue. In terms of sector preferences, Morgan Stanley has reordered its preferences, favoring storage, servers, and PCs, in that order. The firm has raised its earnings forecasts for the OEMs it covers, estimating earnings per share for 2026 and 2027 to be 9% to 12% higher than the general expectations on Wall Street. Why "chipflation" is persistent This shift in purchasing behavior is rooted in a historic surge in memory prices. Driven by AI demand, memory chip prices are increasing sharply. The electronic components and accessories segment of the U.S. Producer Price Index surged 27.6% year-over-year in June, marking the largest increase on record since 1966, easily surpassing price increases seen during the rise of personal computers in the 1980s and the chip shortages during the pandemic. Morgan Stanley introduced the term "chipflation" in a report in June, pointing out that memory prices have risen more than sixfold over the past year. This contrasts sharply with the trend of continuously decreasing computer memory prices over the past few decadesbetween 1957 and 2020, the price of dynamic random-access memory per GB decreased by about tenfold every five years. However, the firm emphasizes that "this trend no longer holds in the AI economy." The soaring prices are the result of a battle for supply. AI giants such as Meta (META.US), Microsoft Corporation (MSFT.US), and Alphabet (GOOGL.US) are securing memory supplies years in advance through long-term agreements, leaving traditional PC and smartphone manufacturers to vie for an increasingly shrinking supply pool. Reports indicate that Apple Inc. (AAPL.US) is currently testing products from Chinese memory chip maker ChangXin Memory Technologies to cope with rising costs, although such collaborations typically require approval from the White House. J.P. Morgan strategist Jay Kwon also weighed in on the memory chip sector this week. He believes that the chip shortage will take at least two more years to alleviate. In a report on Monday, Kwon wrote, "With dual drivers of price and shipment volume, the overall potential market for memory continues to expand, and the supply-demand gap will persist over the next two years. The trend of memory demand expanding from GPUs to CPUs seems to be underestimated by investorswhile conceptually well-known, the actual supply-demand impact has not been fully recognized. This remains a key variable for upward adjustments to demand expectations." David Goeckeler, CEO of memory chip maker SanDisk (SNDK.US), perhaps best summed up the current market dynamics during last week's earnings call. Goeckeler stated, "Over the past two to three quarters, we have spent considerable time deeply engaging with our core major customers regarding their demand commitments. Now we have visibility into business for over four years and feel confident about our business outlook." As the July Consumer Price Index (CPI) report is set to be released this Wednesday, Morgan Stanley anticipates that this "chipflation" will contribute approximately 0.10 percentage points to the overall Consumer Price Index, with an impact on the PCs and smartphones sub-index potentially reaching as high as 15 percentage points. Despite this optimistic outlook, Morgan Stanley remains cautious, characterizing the current wave of optimism as tactical rather than structural. The firm emphasizes that the current positive factors are "primarily cyclical." The hardware sector has already increased by more than 100% since the beginning of 2025, reaching historically high price levels. Woodring warns that the current cycle may begin to reverse from 2027, and the peak of momentum in earnings forecast adjustments will be a "clear signal for us to turn cautious again."