How Equity Investors Can Profit From Surging U.S. Inflation
U.S. inflation figures for the month of June accelerated to the fastest pace since 2008, as the economic recovery following the Covid-19 related lockdowns continues to gather pace. Per the Labor Department, the consumer-price index rose 5.4% from a year ago, while the core price index, which excludes food and energy, rose by 4.5% versus last year. The price increases have been driven by surging demand for goods and services which have outpaced the ability of companies to keep up. Although supply-side bottlenecks should be ironed out in the coming quarters, factors such as significant stimulus funding, a surge in the U.S. personal savings rate and a continuation of the low-interest rate environment over the next two years could mean inflation is likely to remain at elevated levels in the near future.
So how should equity investors play the current inflationary environment? Our theme on Stocks To Play Rising Inflation includes companies from the banking, insurance, consumer staples, and energy sector that could remain stable or potentially even gain from high inflation. The theme has returned about 16% year-to-date, roughly in line with the S&P 500. However, it has underperformed since the end of 2019, remaining roughly flat, compared to the S&P 500 which is up by about 35%. Oil and gas major Exxon Mobil (XOM) has been the strongest performer in our theme, rising by about 43% year-to-date. On the other side, Procter & Gamble (PG) has underperformed, with its stock remaining roughly flat.
[6/17/2021] Stocks To Play Rising Inflation
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U.S. inflation has been trending higher, as abundant liquidity, soaring demand following Covid-19 lockdowns, and supply-side constraints are putting pressure on prices. On Wednesday, the Federal Reserve considerably raised its expectations for inflation for 2021, projecting that prices for personal consumption expenditures – its preferred inflation measure – could rise 3.4% this year, a full percentage point ahead of its March projection of 2.4%. The central bank didn’t make any changes to its aggressive bond-buying program and also indicated that interest rates will continue to remain near 0%, although it signaled two rate hikes in 2023.
So how should equity investors play the current inflationary environment and the prospect of higher interest rates? Our theme on Stocks To Play Rising Inflation includes stocks from the banking, insurance, consumer staples, and energy sector that could remain stable or potentially even gain from higher inflation rates. The theme has outperformed, returning about 17% year-to-date, compared to a return of just about 13% on the S&P 500. However, it has underperformed since the end of 2019, remaining roughly flat, compared to the S&P 500 which is up by about 31%. Oil and gas major Exxon Mobil (XOM) has been the strongest performer in our theme, rising by about 56% year-to-date. On the other side, Procter & Gamble (PG) has underperformed significantly, with its stock down by about 5% this year.
[5/27/2021] Rising Inflation Theme
Inflation has been trending higher, driven by expansionary monetary policy by central banks, pent-up demand for commodities following the Coivd-19 lockdowns, moves by companies to replenish or build up inventory, and also due to significant supply-side constraints. Now inflation appears to be here to stay, with the 10-Year Breakeven Inflation rate, which captures expected inflation rates over the next ten years standing at around 2.4%, around the highest levels it has been since 2013. 
So how should equity investors play the current inflationary environment? Our theme on Stocks To Play Rising Inflation includes stocks that could remain stable or potentially even gain from higher inflation rates. The theme has outperformed, returning about 18% year-to-date, compared to a return of just about 12% on the S&P 500. However, it has underperformed since the end of 2019, returning just about 1% Since versus 30% for S&P 500. The theme is predominantly comprised of stocks from the banking, insurance, consumer staples, and energy sector, which stand to benefit from higher inflation in the longer run. We have excluded sectors such as metals, building materials, and semiconductor manufacturing which have fared exceedingly well through the initial reopening but look poised to peak. Here is a bit more about the stocks and sectors in our theme.
Banking Stocks: Banks make money off the net interest spread, which is essentially the difference between interest rates on deposits and interest rates the bank receives from loans it makes. Now higher inflation typically results in rising interest rates and this, in turn, can help banks boost their net interest income and earnings. Separately, banks also stand to benefit from increased credit card spending by consumers. Banks in our theme include Citigroup (C) and U.S. Bank (USB): – which have a higher exposure to the retail banking space. Citi stock is up by 26% year-to-date, while U.S. Bancorp is up 28%.
Insurance stocks: Insurance companies typically invest excess capital from underwriting to generate interest income. Now higher inflation, which leads to higher interest rates, can also help boost their profitability. Companies such as The Travelers Companies (TRV) and Chubb (CB), which are more reliant on investment income compared to peers in the insurance space, should stand to benefit. Travelers stock is up by about 12% this year, while Chubb is up 8%.
Consumer staples: Consumer stocks should also hold up well in the face of higher inflation. Demand for these companies remains stable as they deal with essential products., and these companies can also pass on higher costs to customers. Our theme includes Tobacco giant Altria Group, (MO) which is up 21% this year, food, and beverage major PepsiCo (PEP) which is roughly flat, and consumer products player Procter & Gamble (PG), which is down about 1%.
Oil and Gas: Energy stocks have a nice track record of performance during periods of rising consumer prices. While expanding economies should bode well for oil demand and pricing, big oil companies also have high operating leverage which helps them deliver higher profit as revenue grows. Picks in our theme include oil and gas bellwether Exxon Mobil (XOM), which has gained a whopping 43% this year, and Chevron (CVX), which is up by about 23%.
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- 10-Year Breakeven Inflation Rate, St. Louis Fed [↩]