Portfolio Manager David Souccar explores the risks of hedging inflation with cyclicals and commodities and how quality companies can withstand inflationary pressures.
Companies with pricing power can defend against inflation. Business models like Mastercard take a percentage of revenues from customers. Thus, its revenues increase when prices increase. With mainly fixed costs and a low proportion of labor costs, Mastercard can help protect against inflation but also has operating leverage.
In the consumer staples and discretionary sectors, Nestle and LVMH are examples of brands that have pricing power. In industrials, Rentokil provides pest control, a necessary service where limited price increases go unnoticed
In a scenario where high inflation persists, cyclicals like banks and commodities, however, will not protect well against inflation. They have limited pricing power and commodity industries, being capital intensive, tend to struggle to protect operating margins.
Quality stocks can perform well in rising interest rate environments. If rates increase because of a healthy economy, there should be more demand, which is good for growth businesses. And if rates rise because of inflation, quality companies can maintain profitability and increase their relative strength vis-a-vis the overall market.
There are different shades of quality, which can lead to different levels of risk and return. Investors should be aware of the type of quality strategy there are invested in. We believe the best quality strategy offers a solid defense and low risk but can also outperform over a full market cycle.
In Europe, it is important to separate the economy and politics from investment opportunities. The continent is home to many world-leading businesses that are driven by secular trends. It is possible to find European businesses that are similar to those in the US but at better valuations
Technology that was not tested before the pandemic is working seamlessly, from remote working to vaccine development. In international markets, we believe there are great opportunities in technology that can introduce new ways of approaching older industries.
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