Which Equities Should Perform Better in Times of Higher Inflation and Why Should I Care?

One aspect of rising interest rates is the fight to control inflation.  As history demonstrates, loose monetary policy leads to too many dollars chasing too few goods, creating upward pressure on inflation.  In the previous piece, Atlanta Federal Reserve Bank’s Mr. Dennis Lockhart stated that a prominent risk of low interest rates is an uptick in inflation.   As the chart at the end shows, interest rates are set to rise in 2015 and continue into 2016, but if the Feds are already behind the curve and if rates do not rise sufficiently to curb inflation, it will once again creep back into our everyday lexicon.

There are sectors of the economy that historically do better with a touch of inflation and positive real interest rates.  While the list is not meant to be exhaustive, we hope to touch on a few sectors and which stocks in our universe may be poised to benefit from this environment.

Commodities and basic materials usually react favorable with a touch of inflation and usually rise with it over time.  Glencore (GLNCF) is a trader and miner of industrial chemicals.  BHP Billiton (BHP) is a global miner of industrial commodities as well. Southern Copper (SCCO) is a major global miner of copper.  

Financial firms with fixed income investments, especially international finance and insurance, should experience an uptick in investment income as rates improve.  Berkshire Hathaway (BRK-B) has less of its investment portfolio invested in bond than its peers do.  Buffet prefers equities and entire businesses than purchased a portfolio of fixed income investment.  While this has worked to its favor as equity markets have outpaced the bond markets over time, other insurance companies may see a bigger boast in their investment income.  Power Corp of Canada (POW.TO, PWCDF) owns a majority percent of Power Financial/Sun Life of Canada.  Although a substantial chunk of fixed assets held by AFLAC (AFL) are in Japanese and European fixed income markets, higher income from its US bond portfolio should boost earnings.   Lincoln National (LNC) should benefit as well.

Real Estate usually increases with rising inflation. Both rents and home/commercial prices trend higher with the inflation rate.   Many REITs should perform adequately, however rising interest rates may pressure competitive yield offered by REITs.  Established triple-net REITs, such as National Retail Properties (NNN) or Reality Income (O), are structured to pass along increases in operating costs to their tenants. 

Gold is usually mentioned as benefiting from inflation.  The S&P Gold ETF (GLD) and various gold miners should rise as gold’s price tracks inflation numbers.  Gold mining mutual fund Tocqueville Gold (TGLDX) should benefit from inflation.   Gold mining and energy income fund Gabelli Global Natural Resources (GGN) offers a 10% distribution (mainly categorized as return of capital) and should benefit as well.     

Oil and natural gas prices will move higher along with inflation.  Suncor (SU), Dorchester Minerals (DMLP), and Total (TOT) should respond favorably.

Floating rate bank loan mutual funds will increase their income as higher interest rates and inflation take hold.   Fidelity Floating Rate High Yield Income (FFRHX) and Oppenheimer Senior Floating Rate (OOSYX) are two examples of funds that hold variable rate bank loans. 

Investors should care because inflation will become a headline event not too far into the future, and when it happens, it could be too late to move into these inflation-sensitive investments. Do not be like the Feds and become behind the inflation-curve. 

First appeared in the Sept 2014 issue Guiding Mast Investments newsletter.  Thanks for reading and your interest,  George Fisher