With inflation at a 40-year high and showing no signs of slowing despite a surprisingly strong jobs report on Friday, advisors and their clients are still looking at ways to mitigate the impact of rising prices.
The June consumer price index reflected a 9.1% year-over-year increase, rising above May’s 8.6% reading. The Federal Reserve has aggressively hiked interest rates four consecutive times in 2022, with the current federal funds rate range at 2.25% to 2.5%, after July’s 75 basis point increase.
Brett Manning, senior market analyst at Briefing.com, says the Fed’s main concern is not necessarily what prices are now, but whether investors’ behavior changes to reflect an expectation that inflation will be out of control. That’s helped to spur recession talk and has weighed on prices for commodities such as gasoline and copper.
Chuck Self, chief investment strategist at Tandem Wealth, believes the economy is in a recession, so that makes investing to offset inflation tricky, saying some of the traditional inflation-fighting picks such as owning gold doesn’t work as well in recessionary times.
One sector both Self and Manning believe will perform well in the current environment is traditional energy, even as the sector retreats from its highs posted earlier this year. Demand is outstripping supply for crude oil and natural gas after years of disinvestment by oil companies and investors. Oil companies posted record profits as they released second-quarter earnings, spurred by strong prices and reticence to raise output.
“Supply and demand are going to take a long time to get into balance,” Self noted. “And the oil companies are being very slow as far as putting back supply on online.”
To invest in energy, Self is using the Vanguard Energy ETF (VDE). “Energy is the only sector where earnings’ estimates for future quarters into next year are actually going up,” he noted. “And it has the lowest price-to-earnings ratio of all the sectors, so valuation wise, it’s still attractive.”
Manning said investors who believe production capacity will be slow to come online could express that view through the S&P Oil & Gas Exploration & Production ETF (XOP). Meanwhile, clients who believe oil companies will expand production may be interested in the VanEck Oil Services ETF (OIH), which is made up of the services companies to help oil majors increase capacity.
For clients who would rather invest in materials to expand electrical infrastructure in the transition to carbon-free energy, Manning recommends exposure to copper through the Barclays iPath Series B Bloomberg Copper Subindex Total Return ETN (JJC), an exchange-traded note. Like oil, copper supplies are in a deficit versus projections for copper demand if electric vehicles become more prevalent.
Manning suggests another hard assets play, investing in real estate as a way to preserve pricing power, particularly important if inflation continues to surge. There are several inexpensive options to choose from, he explained, such as the Real Estate Select Sector SPDR (XLRE), the Charles Schwab U.S. REIT ETF (SCHH) and the Vanguard Real Estate Index Fund ETF (VNQ).
Self says health care is another sector that could benefit investors if inflation continues to rise and the economy slows, noting he uses the Health Care Select Sector SPDR Fund (XLV). Health care benefits from a secular tailwind because of an aging U.S. economy and globally as consumers in emerging markets grow richer and demand better health care.
He highlighted the Vanguard High Dividend Yield ETF (VYM), an index made up of companies that pay high dividends. He said the index methodology chooses high quality companies with strong dividends, rather than companies with just the highest dividends. That difference matters, as he wants to hold high quality companies going into a recession.
“Both health care and high-dividend-paying companies have pricing power to deal with inflation as these companies can pass along costs to consumers,” Self explained.