3Q 2021 US Equity Outlook: Hedging Inflation with Quality

Hedging Inflation with Quality

CIO Matthew Benkendorf discusses business models with pricing power that can defend against inflation.

• While investors fear rising inflation, it generally indicates a healthier economic environment. Investors should be more concerned with an overreaction by the Fed, which could have an immediate effect on sentiment and spending.
• Companies with the right business models can withstand inflationary pressures. For example, certain strong consumer goods companies such as Nike have powerful brands that command high prices, and also have high margins. Good pricing power can outpace growth in the markets in an inflationary environment. Pricing power also comes through in business models focused on maintenance, services and subscriptions that are less economically sensitive, or where there is recurring demand for products that consumers’ need, desire or have a regulatory requirement to consume.
• Investors tend to flock to commodities, such as energy companies, as a hedge against inflation. While energy companies may benefit in the short-term as the price of oil rises to keep up with inflation, energy is a capital intensive industry. Eventually, companies will have to re-invest in the business, at least to maintain production, depreciation will increase and margins will normalize.
• From a political standpoint, the Biden administration has generally delivered on issues as forecasted. Vaccination programs, transfer payments to consumers, the ongoing move towards infrastructure, the US’s geopolitical stance on global relationships, and heightened regulatory scrutiny in certain areas have minimized uncertainty in the markets. As we end 2021 and enter 2022, we expect to see a rise in volatility. The political landscape will naturally become more contentious as the important mid-term election serves as a barometer of the public’s satisfaction with the Biden administration.
• We do expect some continued equity market volatility this year as economic data fluctuates from quarter to quarter. But given interest rate policy will remain fairly accommodative over the next 18 months and the threat of Covid-19 is dissipating, the landscape is positive for active stock pickers to find good investment opportunities.

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