The Federal Reserve decided to aggressively raise interest rates starting in March 2022 to combat what at the time were inflation levels not seen in four decades. While the stock market tanked last year, it has bounced back in 2023. And there are signs the Consumer Price Index, a key measure of inflation, has been cooling in the past several months.
Even though inflation does impact portfolio performance, investors have no influence over it. But they can control what they do about it. Let’s take a closer look to obtain a better understanding of this phenomenon.
A confusing topic
Inflation is the rising price of goods and services across an economy. This can happen because of higher production costs (think labor and materials), as well as greater demand from buyers. The central bank targets a 2% annual inflation rate, which they view as indicative of a healthy economy. This level incentivizes consumers to spend.
On the other hand, too much inflation is bad, as it leads to a rapid devaluation of a currency. Some countries have experienced hyperinflation, which causes chaos for everyday people and a loss of trust in government and financial institutions.
But even the most well-educated economists have trouble pinpointing exactly what causes inflation, particularly the surge in prices seen following the worst days of the pandemic. Some point to supply chain issues, while others blame massive government stimulus programs or tight labor markets. This just goes to show that inflation is truly a complex topic to wrap one’s head around.
Inflation can’t be controlled, but that doesn’t mean investors should ignore it completely. Your best bet is to find ways to shield your portfolio as necessary.
On way investors can do that in periods of high inflation is to identify businesses that have enduring pricing power. If these companies can periodically raise the prices their customers pay without negative impacts to demand, then they are in a prime position to do well if inflation rises quickly.
Chipotle Mexican Grill is a great example as the popular Tex-Mex restaurant chain has consistently raised menu prices over the past couple years to offset rising input costs for things like dairy, beef, avocados, paper products, and labor. But in 2022, the business still grew revenue 14% to $8.6 billion with comparable sales up 8%. And through the first six months of 2023, sales and net income were up 15% and 51%, respectively. This means consumer demand has remained strong, and profitability actually improved throughout the inflationary environment.
Another wonderful example of a company that has long had pricing power is Apple. Thanks to its incredibly popular hardware products and services, the tech giant is able to charge a premium for its various offerings, and customers are willing to pay up. The company’s gross margin with its products is 35%, while its services carry a gross margin of 71%. Higher prices for the iPhone, Apple’s flagship product, continue to be met with strong demand.
Another way to insulate your portfolio from the threat of inflation is to seek out companies that benefit from the rising cost of goods and services, such as Visa and Mastercard. The two giant card networks, which processed $5.3 trillion in total payment volume during the three-month period that ended June 30, are essentially inflation hedges. As consumers are forced to pay higher prices, the card companies see their revenues climb because they collect a percentage of every transaction anytime one of their cards is used.
By having a better understanding of inflation, investors can adjust their portfolio holdings as necessary.
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Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, Chipotle Mexican Grill, Mastercard, and Visa. The Motley Fool recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy.