Investors who look in the right places can take advantage of rising inflation, according to Rohan Reddy, an analyst with Global X, a provider of exchange-traded funds based in New York City with $25 billion in managed assets.
Factors are right for a moderate increase in inflation, Reddy said in a recent interview.
“The market’s inflation expectation is now at 2.2%, its highest rate since mid-2018,” Reddy said. “Inflation was already on an upward trajectory prior to the pandemic, when it hit 2.5% in January 2020, so there could be some momentum carried from that point. Household wealth in the U.S. also grew by $5 trillion through the pandemic from the last quarter of 2019 through the third quarter of 2020.”
Inflation is expected to rise for a few reasons. Congress may pass an infrastructure bill, which will pump more money into the economy, he said, while business reopenings will add consumer money to the mix.
There are sectors investors should concentrate on to prepare for rising prices, Reddy said.
Small caps value stocks are primed for a rebound after a long slump because of their cyclical ties to the economy, he said, adding that reopening the economy is positive for sectors like energy and financials, which benefit from inflation. “Oil prices typically rise during inflationary periods, and financial stocks like banks do well from stronger economic conditions and higher interest rates on loan portfolios,” Reddy said.
Commodities also are rallying. “Copper and oil are directly correlated to the state of the economy, so we like those two as our top commodity picks in this environment. A weak dollar, which most commodities are denominated in, is also driving demand internationally and from emerging market nations,” he added.
On the other hand, defensive stocks not tied to economic cycles and growth stocks, which have been doing well, may be set for a pullback, he said. “We would stay away from utilities and consumer staples, which are defensive and rate sensitive. The yield spreads may not look as attractive with rates rising, and these sectors don’t benefit as much from rising economic activity,” Reddy said.
Many analysts are pushing technology and health care as sectors with opportunities, but Reddy warned investors to be particular about what they choose.
“These sectors could be due for an unwind with bond yields rising and profit-taking occurring after the strong performance runs. The stay-at-home economy gains, vaccine euphoria, and political effects have mostly been priced in at this point,” he said.
Some sectors will not be affected by an inflation, such as real estate and energy, because the cost can be passed on to consumers, and they benefit from rising economic activity. Financials and materials also will benefit from more economic activity, he said.
The Federal Reserve Board is well prepared to combat excessive inflation, but the board should have no problem letting inflation get above 2% in a tepid economic period like this one, he said.
“A lack of inflation has been a key issue for central banks globally for the last decade plus, so allowing inflation to return, especially out of the pandemic period, means the economy is functioning properly,” Reddy said.