Inflation: Who Benefits?

By The Lerner Group on November 8, 2021

In October, markets recorded the best month of 2021, driven by positive consumer data. As we enter the second half of earnings season, we have seen how inflation and supply chain constraints have sorted companies into two general categories; those who have benefited from this environment and those who have not. In addition to earnings reports, the Federal Reserve formally announced their tapering plan signaling confidence in the economy. With the Fed reducing monthly asset purchases, we expect to see interest rates begin to rise. As economic data is released, we will gauge the impact of the Federal Reserve’s actions and adjust our models for opportunities ahead.

Despite high levels of inflation, the US consumer is in a strong financial position. Consumer confidence increased in October after falling each of the three previous months[1]. Overall financial strength is improving as employees see increases in income as employers compete to attract and retain workers. Retirees will benefit from the Social Security Administration’s 5.9% increase in benefits starting in 2022,[2] further fueling consumer spending. Additionally, more people are going back to work as unemployment continues to decline[3]. As income and personal net worth increase, we believe consumers can continue to thrive.

Increased inflation has benefited companies with pricing power and hampered those with already thin margins.  Commodity and energy producers prospered due to margin expansion. The costs of producing the raw materials stayed roughly the same, but the increase in prices flowed straight to the bottom line. Companies that don’t have pricing power, such as those in consumer staples, have suffered. Due to the nature of competition, these companies are absorbing their increased costs to maintain market share. As we see inflation levels remaining elevated for longer, we are adjusting portfolios to benefit from the trend while keeping cash available to take advantage of opportunities when the dynamics shift.

The Federal Reserve will officially begin tapering its asset purchases later this month, with the target of concluding by mid-2022. During this process, interest rates may increase as demand for bonds is reduced by $15B per month. If rates increase, savers will benefit from increased bond yields. We are also seeing estimates of two potential rate hikes by the Fed next year. As interest rates rise, we also would expect to see growth equities impacted as valuations decrease. The markets reacted positively to the Fed’s comments and believe they are addressing inflation concerns.

We believe that value-oriented companies, those with lower P/E ratios and above-average cash distributions, are in a position to outperform. Examples of these companies are in the financial, commodity, and energy sectors. Recently, they have found creative and efficient ways to distribute profits to shareholders and strengthen their financial position. We have seen companies announce floating dividends, with a fixed and floating component based on cash flows. These companies have also taken advantage of excess cash to reduce debt. Investing in these types of companies helps protect the downside of portfolios if we see any signs of economic slowdown.

If you have any questions on how these changes in the market impact your portfolio, please let us know, and we can review your portfolio and overall financial plan. We wish you a happy and safe Thanksgiving and hope for nothing but the best for all of you as the year starts to come to a close.

[1] https://www.wsj.com/articles/u-s-consumer-confidence-rose-as-delta-covid-19-wave-eased-11635263487

[2] https://blog.ssa.gov/social-security-benefits-increase-in-2022/

[3] Bloomberg Data