Inflation hurts, but some sectors weather the pain

Possible US tax cuts, tariff increases and an expanding budget deficit have led to concern about a fresh surge of inflation in coming years. That leaves investors wondering what sectors of the stock market might benefit from sharply rising prices.

They could be a boon for energy and real estate companies, but could bring challenges for banks, utilities and tech companies alike.

Looking at the market as a whole (MSCI USA Index) over the last 50 years, when consumer price inflation was less than 3% and rising, equity returns beat inflation in 90% of rolling 12-month periods, according to a report from Hartford Funds. 

But when inflation surpassed 3% and was rising, stocks trumped inflation only 48% of the time. Inflation now stands at 2.6%, and the worry is now that it could go much higher. 

As for stock sectors that benefit in times of high and rising inflation, they include energy and equity real estate investments trusts (REITs).

The energy sector topped inflation 74% of the time during high and rising periods of inflation, producing an average annual real return of 12.9% per year. 

“This is a fairly intuitive result,” the Hartford report notes. “The revenues of energy stocks are naturally tied to energy prices, a key component of inflation indices. So by definition, they generally have performed well when inflation rises.”

Inflation’s impact on REITs, utilities and tech

Equity REITs bested inflation 66% of the time in periods of high and rising inflation, clocking an average real annual return of 4.6%. 

“This makes sense too,” the Hartford report says. Equity REITs own real estate, which may provide a partial inflation hedge through rising rents and property prices.

You might think utility stocks would be winners in inflationary times, as everybody needs electricity, heat and gas, no matter what inflation is. But that’s not the case, says Hartford. Utility stocks offer a disappointing success rate of only slightly above 50% for beating inflation in inflationary periods, the report says. 

“As natural monopolies, they should be able to pass on cost increases to consumers to maintain profit margins. However, in practice, regulation often prevents them from fully doing so.” 

Also, with stable businesses and steady dividends, utility stocks are often traded as bond proxies. That means they might underperform other sectors, when soaring inflation depresses bond prices.

Technology stocks also don’t measure up in inflationary times. “The bulk of their cash flows are expected to arrive in the distant future, which may be worth far less in today’s money when inflation increases,” Hartford says. 

Mixed picture for bank stocks

Meanwhile, inflation is mixed for bank stocks. On the plus side, their cash flows tend to amass in the near term, Hartford notes. “But high inflation can still be harmful, because it erodes the present value of existing loans that will be paid back in the future.”

In terms of investing style, value, momentum and quality stocks scored well against the overall market in eight inflationary periods since 1940, according to Allianz Global Investors. Value and momentum outperformed in six of the periods, and quality in four of the six periods where data was available. 

Value stocks—like General Motors (NYSE: GM)—are those that score low on valuation metrics such as price to earnings or price to sales. Momentum stocks include those that have risen in the last year; Nvidia (NASDAQ: NVDA), for example. And quality stocks are those with sound fundamentals, such as strong free cash flow, like Berkshire Hathaway (NYSE: BRK.B).

Inflation isn’t pleasant, but you can mitigate its damage on your portfolio.