The broad stock market has not done well when inflation was higher than 5%. Some companies, however, thrive under high inflation conditions; companies with “pricing power”. These companies raise their prices as their labor and material costs increase. They are, therefore, able to maintain or even increase their margins.
Because consumers are unwilling to delay these purchases, companies that produce consumer staples such as food, toilet paper, shampoo, toothpaste, and pain relievers are generally able to raise their prices with inflation. The stocks of consumer staples companies tend to outperform the market because their profit margins are relatively secure and their earnings and dividends go up along with the general inflationary trend - or even faster.
Many firms are unable to raise prices without triggering a significant fall in demand for their products; the broad stock market, consequently, lags behind the consumer staples companies. Automobiles, home appliances, restaurants, home electronics, and books are examples of products consumers are willing to delay buying when the price goes up. Companies producing these “discretionary” items are squeezed. If they raise prices, volume goes down. If they don’t raise prices margins go down.
Many firms experience the volume-margin squeeze. That’s why most mutual funds, including index funds, generally do poorly in an inflationary environment.
Today some ETF’s (Exchange Traded Funds) specialize in consumer staples companies. I’ve never bought them because I don’t trust their stock picking. If a company makes consumer staples it’s included in the fund regardless of the soundness of the underlying business.
I prefer to buy shares of individual consumer staples companies with a track record of paying and increasing dividends. My favorite consumer staples stocks are Proctor & Gambol (PG), Johnson & Johnson (JNJ), and 3M (MMM). I own shares in all three companies.
The common shares of good quality consumer staples companies can be expected to keep pace with inflation whereas the broad market indexes do poorly when inflation is high.
Links to the Inflation Protection Special Report
Part 1 - The Need
Part 2 - Gold
Part 3 - Oil
Part 4 -TIPS
Part 5 - Consumer Staples
Part 6 - Commodities
Part 7 - Summary