Inflation in the U.S. continues to rise, with the consumer price index (CPI) published by the Bureau of Labor Statistics last week coming in at a higher than expected 8.6% in May compared to a year ago. This marks the fastest annual increase since December 1981 and an increase from the 8.3% rate seen in April. Key factors driving inflation higher include soaring energy and food prices made worse by the Russian invasion of Ukraine and supply-side constraints following the Covid-19 reopening. Moreover, the labor market also remains unusually tight, leading to surging wages. The S&P 500 fell by almost 3% in Friday’s trading, after the data was released, with the Nasdaq-100 down by over 3.5%. The S&P 500 also remains down by about 19% year-to-date. However, our theme of Inflation stocks – which predominantly includes companies from the banking, insurance, consumer staples, and energy sectors – has risen by about 9% year-to-date, considerably outperforming the broader markets.
So will this outperformance continue? The U.S. Federal Reserve is getting much more serious about fighting inflation. It raised benchmark rates by a quarter percentage point in March and followed this up with a half-percentage point hike in early May. Fed Chair Jerome Powell has indicated that half-point hikes are likely in June and July as well, while leaving open a possibility of even larger hikes. The futures markets project that the Federal Reserve’s benchmark funds rate could hit 3% by the end of this year and close to 4% by mid-2023. Policymakers are hoping that higher rates and more limited money supply will put the brakes on demand growth and, in turn, cool down prices.
Although it remains to be seen just how effective the Fed’s moves will be in containing the price rise, we don’t think the theme of inflation stocks will outperform in the longer term. If inflation does indeed cool off, investors could start to look beyond the theme and consider growth names once again. On the other side, if inflation persists, it will continue to eat into household spending power, impacting the broader U.S. economic growth. There are already signs of this happening, with consumer confidence in the U.S. falling considerably. This could also indirectly impact the stocks in our theme.
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Within our theme, energy major Exxon Mobil stock (NYSE: XOM) has been the strongest performer rising by almost 58% year-to-date due to elevated oil and gas prices. Insurance players have also fared well with the insurance stocks in our theme remaining in the green, as they typically invest excess capital from underwriting to generate interest income and stand to benefit from rising rates. On the other side, banking major Citigroup (NYSE:C), is down 24% year-to-date, as the banking sector could face headwinds due to the prospect of slowing economic growth.
|S&P 500 Return||-3%||-16%||78%|
|Trefis Multi-Strategy Portfolio||-4%||-23%||204%|
 Month-to-date and year-to-date as of 6/13/2022
 Cumulative total returns since the end of 2016