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What to buy during rising inflation?

During the early-to-mid 1970s and into the early-to-mid 1980s, the Consumer Price Index (CPI) exploded to the upside, sustaining for a decade. Rising inflation and stagnant economic growth led to a stagflation cycle and a structural sideways trading range stock market.

Although no two markets are the same, a review of past inflation periods may offer insights into investment opportunities that can excel during this challenging economic environment.

Investors need to increase exposure to physical or hard assets in an inflationary environment. Real estate is a classic hard asset. Physical assets include commodities, such as gold, silver, crude oil, copper, and others.

As inflation surges, hard assets tend to excel as they keep up with rising prices. However, physical assets such as real estate are illiquid and not readily accessible to all investors. Also, the high transaction costs (i.e., commissions) associated with buying and selling real estate make it prohibitive to trade.

For most investors, the most effective way to take part in this environment is to buy industries, sectors, and stocks that perform well during periods of rising inflation.

Buying real estate investment trusts (REITs) or real estate companies in the real estate industry is an indirect way to take part in hard assets.

Energy and materials may be a better way, as both sectors dramatically outperform their peers during inflationary periods, specifically from 1973-1975, 1978-1980, and Feb 2021 to the present. Interestingly, during these three timeframes, the Consumer Price Index (CPI) doubled in value in less than two years.

Select financials and industrials are also relative outperformers during periods of high inflation.

Underperformers are defensive sectors such as healthcare, consumer staples, and utilities.

Economically sensitive areas such as consumer discretionary and technology also fared poorly.

It is reasonable to expect healthcare, consumer discretionary, and technology to underperform because of the higher interest rates. However, the underperformance in consumer staples and utilities came as a surprise since they are safe-haven sectors that excel during market turmoil.

In a rising interest rate environment coupled with rising inflation, select financials that can pass on the cost to the customers can still outperform their financial peers. Select industrial companies that take part in commodities can also benefit during an inflationary period.

Investors may need to reposition their portfolios if they believe inflation is sustainable for the longer term. An overweighting of their investment portfolios in commodities, energy, and materials can minimize the effects of rising inflation.

Enclosed are year-to-date performances of the eleven S&P sectors and the energy and materials sub-industries.

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

Source: Courtesy of

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