Inflation and Market Performance

With inflation heating up, many investors are wondering how their investments might perform during a period of inflation. Prior to the recent uptick, we had experienced decades of historically low inflation.

Consumers are seeing the impact of inflation on  items they buy everyday including groceries, gasoline, dining out and a host of other products they use on a regular basis. Inflation has caused a large increase in the price of new cars as well.

How the market typically performs

Data from the Federal Reserve Bank of St. Louis indicates stocks tend to perform the best when the CPI (Consumer Price Index) ranges from 1.1% to 4.0% over a 12-month period. This data is from 1979 through 2021.

During periods of inflation at the higher end of this range, the data suggests that mid cap stocks and value stocks tend to hold up well. Companies with higher operating leverage often tend to perform well at the upper end of the inflation range. Many companies in the value and mid-cap stock categories tend to have more operating leverage than growth stocks.

While equities can be impacted in the short term by inflation, over time they are a solid hedge against inflation. That said, different stocks will be impacted in different ways depending upon their ability to increase prices at a pace that lets them stay ahead of cost inflation.

Equity categories that have historically provided a good hedge against inflation include:

  • Real estate
  • Energy
  • Industrials
  • Commodity based equites including those related to gold

Current inflation

For the one year period ending June 30, 2022, inflation in the United States was 9.1% (CPI). This is the highest rate of inflation since November 1981.

The largest components of this latest CPI increase were energy including fuels of various types, gas for autos and utilities.

The best performing S&P sector to date has been energy, up over 33% year-to-date through July 25. Communications services, consumer discretionary and information technology are the lowest performers, all off between 20% and 30% year-to-date.

The Federal Reserve has pledged to combat inflation by raising the overnight funds rate and have increased it by 2.25% so far this year. The Fed appears committed, but the task could be daunting. Housing costs are a large part of inflation the calculation and might prove hard to budge.  Labor can also be sticky. With increases in jobs, we saw productivity go down significantly in first quarter 2022 (-7.3%) and we may see similar results for the second quarter when announced August 9th (more workers and less output for first half of the year is fairly inflationary).  Planning for some inflation to remain in the economy seems prudent.

What should investors do now?

Any market downturn or change in the economic landscape can be cause for investors to review their portfolio and perhaps their investing strategy. In reviewing your portfolio, this is a good time to be sure that your portfolio has been rebalanced back to its target asset allocation to be sure that the allocation reflects your risk tolerance and investing time horizon.

While reviewing your holdings to ensure they are still a good fit for your portfolio, it is a good idea to make sure components of your portfolio will still serve their purpose in economic conditions like higher inflation.

It can make sense to tweak your portfolio a bit to add some holdings that you feel might outperform in this environment, and perhaps reduce exposure to securities that might not be a good fit. This can be done in the course of rebalancing your portfolio. This might even lead to opportunities to do some tax-loss harvesting.

Your best option is to discuss your portfolio with your Wedbush financial advisor. They can offer their expertise and objective advice to help you position your portfolio in line with your financial goals and objectives.


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