Inflation is the rising price of goods and services. The increased cost of living essentially means you will need to spend more money when purchasing everyday items such as bread, milk, apples, petrol etc.
Generally speaking cash would be the worst asset class to hold in a high inflationary environment. However stocks would be a better choice. This is because a company’s revenue and earnings should grow at the same time as inflation. Companies usually pass rising costs to the consumer to maintain their profit margin.
Concerns in the US of rising inflation have recently surfaced as strong employment numbers have caused fears of wage growth. In January, the average hourly pay in the US jumped 2.9 percent in a year. This is the largest jump in 8 years. Companies may increase the prices they charge for goods and services to pay for these increased wages. This factor is causing concern for investors. Higher wages for some can contribute to a higher cost of living.
These are the top 6 sectors which benefit from high inflation.
Investors turn to safe haven investments such as gold stocks when they see high inflation in the economy. Gold traditionally is an investment commonly held when there is economic instability. High inflation would cause investors to want to safe guard their investments by buying gold stocks. Holding cash in bank accounts is of course a bad idea in a high inflation environment as the purchasing power of cash is eroded by the inflation.
There is a positive correlation between the price of oil and inflation. The consumer price index helps measure the inflation in the economy by tracking a basket of goods and services by households. Energy costs in households would be included in the consumer price index. As the oil prices increases, this directly affects the energy costs spent by consumers. This would lead to an increase in the CPI index and then inflation. Oil stocks should do well in high inflation environments.
When there is high inflation, companies will pass these costs onto the consumers. For instance, companies with higher energy cost from increased transportation cost or higher operating costs will pass these costs to the consumer. Therefore good and services will become more expensive. Consumers will become more selective when purchasing goods and services as they have less purchasing power. Consumer staples or basic goods will still be in demand in a high inflation environment as people will still buy bread and milk, even if the costs increase. Companies in consumer staples know that even if they increase the price, consumers will still need to buy it. Consumers will stay away from non-essential goods and services such as a new TV or a new car. They will only spend what is necessary if their budget is stretched. This means that investors should consider avoiding consumer discretionary stocks.
Utilities are defensive stocks as people will need utilities even in a high inflation environment. When operating costs rise for energy companies, they will pass these higher costs onto consumers and maintain their profit margin. Consumers will have no choice but to pay this inflated cost if they want to continue to receive the power. Demand in utility companies will still be strong even in high inflation periods.
Defensive stock such as healthcare are considered safer investments as people will always need healthcare even when consumer budgets are tight. Investors will sell out of high risk stocks and buy into low risk stocks in high inflationary periods as these are deemed safer. Just like groceries in a supermarket, people will always need medicine and medical treatment. Consumers will place priority in spending on healthcare as opposed to less crucial goods and services.
Inflation may also mean the economy is heating up and more goods are manufactured and sold. Companies can begin to sell more goods and services at increased prices. As demand increases, demand for raw materials also goes up which is a positive for material stocks.
Lauren Hua is a private client adviser at Fairmont Equities.
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