March 19, 2019

Fundamentally: Picking Stocks to Keep Ahead of Inflation

IF investor behavior foreshadows what’s in store for the economy several months down the road, inflation could be a bigger threat than government figures now suggest.

The current numbers paint a rather benign picture, as core inflation in the United States has been growing at a modest annual rate of 1.1 percent. Even when volatile food and energy prices are factored in, overall consumer prices rose just 2.1 percent over the year through February, the most recent period for which data are available.

Yet the market appears to be looking past this information. Since the end of December, investors have been pulling money out of mutual funds that invest in assets that fare poorly when inflation kicks up, like intermediate-term bonds and cash, according to an analysis of fund flows by Bank of America Merrill Lynch Global Equity Research.

At the same time, they’ve been pouring money into funds that invest in traditional inflation plays. Those include Treasury inflation-protected securities, commodities and, of course, stocks. Equity funds alone have drawn $30 billion in net inflows since the end of December, according to the Investment Company Institute, the fund industry trade group.

Of course, there is still a debate over whether these shifts make sense. Worrisome levels of inflation may not materialize at all. Economists at IHS Global Insight, for example, are forecasting that consumer prices will grow at only around 2 percent a year from 2012 through 2014. They say they believe that wage growth will be muted in a sluggish job recovery.

But some strategists are bracing for an inflation jump. Jason Hsu, chief investment officer at Research Affiliates, a consulting firm in Newport Beach, Calif., said he expected the numbers to rise in a little more than a year from now. “We’re talking about inflation hovering in the 4 percent area,” he said, with a risk of it moving even higher. He pointed to the flood of stimulus that’s been pumped into the economy by governments throughout the world. Some central banks overseas have already reversed course and are raising rates to keep a lid on prices. The European Central Bank made such a move last week, citing worrisome levels of inflation in food and energy costs. Even if Mr. Hsu is right, though, there is still the question of how effective stocks will be in protecting portfolios amid rising consumer prices.

Historically, stocks have been regarded as a decent inflation hedge — at least relative to bonds and cash — because stock returns have outpaced inflation for most of the past century.

Yet it’s not always the case. Ned Davis Research, based in Venice, Fla., recently analyzed how the market performed in different inflationary environments over the past four decades. While the Standard Poor’s 500-stock index posted double-digit gains, on average, when inflation has been between 1 percent and 4 percent, stocks fell at an annualized rate of 1.4 percent when inflation jumped to between 4 percent and 9 percent.

What’s more, in periods when the inflation rate is accelerating, not all types of stocks perform the same way. Sam Stovall, chief investment strategist at Standard Poor’s Equity Research, looked at periods since 1970 when the year-over-year change in the Consumer Price Index was accelerating. He found eight such sustained periods, and saw that half of the 10 market sectors, on average, gained ground during those times; the others declined or were flat.

Which types of equities are likely to outperform if inflation starts to heat up this time?

Mr. Hsu says he thinks large, domestically based multinational companies would look attractive if inflation really took off and the dollar continued to weaken against other major currencies. Although a weaker dollar would effectively raise the cost of goods imported from overseas, it would lower prices for exports, thus benefiting the American multinationals.

Another promising area is dividend-paying stocks, said Kate Warne, investment strategist at Edward Jones in St. Louis. Since 1947, payouts issued by the S. P. 500 companies have grown at an annual rate of 5.6 percent, she said, outpacing the 3.7 percent inflation rate during the period.

BUT there is another reason to favor dividend payers, she said. Businesses that stand to thrive during inflationary periods are those that have the power to pass along price increases to their customers. And companies with growing dividends often have that ability. “When you think about it,” she said, “companies that have pricing power — and are thus able to maintain their profit margins — will be able to continue to raise their dividends.”

Brad Sorensen, director of market and sector analysis at Charles Schwab, said pricing power might be focused in certain sectors. Historically, “energy companies have proven they can raise prices pretty quickly at the pump if oil climbs,” he said. “On the other end of the spectrum, consumer companies have a hard time passing along price increases on things like clothes because there’s so much competition.”

If inflation spikes, energy has proved to be a good place to hide. But if the discussion moves from rising inflation to hyperinflation, other defensive areas of the market like health care and utilities would seem to make sense, Mr. Stovall said. After all, no matter how expensive things become, people still need to see the doctor and turn on the lights. 

Paul J. Lim is a senior editor at Money magazine. E-mail:

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Stocks & Bonds: Stocks on Wall Street Post Gains

The government said the economy grew at a 3.1 percent annual rate in the fourth quarter of 2010, slightly better than economists had expected and higher than the estimate made last month.

Technology shares rose after the business software giant Oracle reported a 78 percent increase in income late Thursday. The company, which makes database software, credited new software license sales and the benefit of three full months of revenue from Sun Microsystems, a company it acquired last year. The Dow rose 50.03 points, or 0.41 percent, to close at 12,220.59. It gained 362 points for the week, the most since a 512-point jump during the week ending July 9.

The Standard Poor’s 500-stock index rose 4.14 points, or 0.32 percent, to 1,313.80. The Nasdaq rose 6.64 points, or 0.24 percent, to 2,743.06.

All three stock indexes gained more than 2 percent for the week, helping them erase losses after the March 11 earthquake that hit Japan. The week started with a 178.01 point jump for the Dow after ATT agreed to buy T-Mobile USA for $39 billion, raising hopes for more buyouts. Better economic reports and stronger earnings followed, driving more gains.

Investors were able to set aside a long list of worries including high oil prices, problems with Japan’s nuclear reactors and fresh developments in Europe’s debt crisis. Portugal looked likely to need bailout funds from the European Union after lawmakers rejected a plan to cut the country’s debts and the government fell. Standard Poor’s lowered its credit rating on Portugal late Thursday.

Portugal’s debt troubles aren’t rattling stock investors in the United States because there’s an assumption that the European Union will come to the country’s aid, said Jack Ablin, chief investment officer of Harris Private Bank in Chicago. “There’s really this notion that governments stand ready in Europe or elsewhere to come to the rescue,” he said.

There’s also little incentive to shift money into the safest of investments, like bonds, Mr. Ablin said. The benchmark 10-year Treasury currently pays 3.4 percent a year. Even with a recent bout of turbulence, the Dow has gained 5.6 percent this year. “In the short term, taking risk pays.”

The VIX, a measure of volatility for American stocks, fell 27 percent over the week. That’s the biggest one-week drop since August 2007.

Accenture shares rose 4.5 percent, to $54.29. The consulting firm’s quarterly earnings rose 22 percent on stronger revenue. Both its income and revenue beat analysts’ expectations.

Research In Motion, the maker of the BlackBerry mobile device, fell 11 percent. Its profit jumped, but the company forecast earnings in the current quarter that were well below what analysts had expected.

The dollar rose and Treasury prices fell after Charles I. Plosser, president of the Federal Reserve’s Philadelphia branch, said the stronger United States economy required the central bank to begin planning ways to sell Treasury bonds and raise short-term interest rates in the “not-too-distant future.”

The Treasury’s benchmark 10-year note fell 10/32, to 101 17/32, and the yield rose to 3.44 percent, from 3.40 percent late Thursday.

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