Inflation Jump Means Company Pricing Power Is Back – So, Buy Growth Stocks, Sell Long-Term Bonds And Take Gold Profits

We’ve entered the period Fed Chair Powell told us about: A “temporary” inflation rise above 2%. He’s not worrying, and neither should we. Temporary or not, it’s the sign that the U.S. economy has reached a new growth stage.

Why? Because inflation has been slogging along for twelve months as companies were wont to throw price rises onto Covid-troubled consumers. Instead, business efforts focused on maintaining brand status and generating adequate revenues and cash flow.

So, why now? Because the economy and business activity have reached a tipping point of sorts. Companies and consumers now feel they’ve waited and postponed long enough. Call it pent-up demand – for stuff and fun (consumers) and for increased revenues and profits (businesses). And that means a willingness to pay up and price higher. (Procter & Gamble’s
announcement of across-the-board price hikes coming in September is a perfect example.)

An inflation rate rise isn’t as bad as being made out

Yes, 4.2% “headline” CPI (includes everything) and 3% “core” CPI (excludes food and energy) look high after twelve months of under 2%. However, there are two issues that make those numbers bearable and even desirable.

First, inflation is catching up to its previous ~2% price rise before Covid-19 stepped in. This graph’s dashed green line shows the core CPI trend that was interrupted. The recent inflation jump is a move towards that trend.

Second, energy cannot be fully excluded from core CPI because it is a cost component in many non-energy products. Below are two graphs to show the effect: (1) A comparison of headline and core CPI numbers and (2) a comparison of the two with the price of oil. (Note: the annual change in the price of oil is on the left axis because the percentage gains and losses far outweigh the CPI changes.) The important point is that both CPIs are influenced by what’s going on with oil. And oil is now in a strong uptrend, with demand steadily increasing.

Why growth stocks?

Yes, value stocks offer a good story, and the DJIA is (was?) leading the way. However, in a growing economy supported by ample (actually, super-ample) money supply, demand will increase, causing increases in the production of goods and services. Contained in the production costs will be the price rises in the increased resources needed, hence the need for final price rises.

In that environment, the real winners will be the companies that can innovate and improve, not just ride the rising tide. Investors will gravitate to (and pay up for) this growth. Importantly, it will be company-focused – not theme-based. As a result, do not expect a pick-the-hot-index-ETF strategy to outperform. Index ETFs are simply a mixed bag of similar companies with no thought given or analysis undertaken to separate the gems from the rocks.

Growth investment managers (and that includes those actively managing mutual funds) will be the winners.

The bottom line: Accept higher inflation and invest to take advantage of it (and avoid being burned by it)

There are countless books about inflation and the damage it can cause. However, we are far from those days of woe. Instead, inflation’s appeal and “good” side will become apparent first. That will create a blissful acceptance of it. Inflation is usually a companion of a growth economy, and it produces “beneficial” effects in the form of pay raises, higher interest income and higher ownership values (e.g., homes, stocks, antiques and other collectibles).

Yes, gold and other precious metals will track along. However, since they offer no added value beyond inflation protection, returns will be higher elsewhere.

The one, sure death spiral will be in long-term bonds, particularly from today’s extreme, abnormally low yields. If yields were determined by the capital markets now, instead of by the Fed, they would be much higher. So, bond prices face a large decline made even worse by higher inflation.

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