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.
Cash would not be the best asset class to hold in a high inflationary environment because inflation is rising faster than the interest that you earn on your cash. Stocks would be a better choice. For many companies, their revenue and earnings should grow at the same time as inflation. Soe companies are able to pass rising costs to the consumer to maintain their profit margin.
Below is a list of sectors which benefit from high inflation.
Oil Stocks – There is a positive correlation between the price of oil and inflation. The consumer price index (CPI) 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.
Consumer Staples – 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, all goods and services will become more expensive. Consumers will become more selective when purchasing discretionary goods and services because they have less purchasing power. However, consumer staples, or basic goods will still be in demand in a high inflation environment. This is because people will still buy bread and milk, even if the costs increase. Companies in consumer staples know that even if they increase the price of a good, 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 – 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 utilities. Demand in utility companies will still be strong even in high inflation periods.
Healthcare – 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.
Lauren Hua is a private client adviser at Fairmont Equities.
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