Preparing for inflation, whether it’s temporary or not

As the debate rages over whether inflation is only a temporary symptom of the pandemic recovery, investors should at least be thinking about which sectors will benefit and which could struggle in an inflationary environment.

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“Part of the difficulty in predicting the impacts of inflation is really the fact that we haven’t seen meaningful inflation in some time,” said Natalie Taylor, a portfolio manager with CIBC Asset Management.

Economic data reflecting higher prices in recent months have some investors fearing that inflation is back, while central bankers remain convinced that inflation will be temporary. Taylor is leaning toward the second camp.

She pointed to slack in employment that would need to drop before there’s significant wage inflation, and a shift in consumer spending back to services as economies reopen, which should remove some pressure on consumer goods prices.

And the longer-term deflationary trends that existed before the pandemic — an aging population and increased technology adoption — are still relevant.

“I think it’s more likely that the inflation we’re seeing is more transitory in nature, but we’ll be watching the data carefully over the next few months to determine the outcome of this debate,” she said.

In the meantime, investors should be considering how inflation could affect their portfolios. In many cases this needs to be evaluated on a company-by-company basis, she said, but there are some general sector themes.

“Inflation would typically benefit raw materials initially, and we’ve seen very significant moves in energy prices, copper, corn, iron ore [and] other base metals and commodities,” said Taylor, who manages the CIBC Dividend Income Fund.

“While materials companies benefit from those higher prices, the higher margins are difficult to sustain over the longer term, as typically supply and demand will balance out.”

Copper may be an exception and the boom may last longer because of a larger trend toward decarbonization, she said. Copper projects, which can face lengthy regulatory approvals, have lacked investment, which could further contribute to higher prices for the commodity.

Banks should also benefit from inflation as higher interest rates boost their margins. However, if inflation overheats to the point of affecting the economy, Taylor cautioned, that would be negative for banks.

Highly levered utilities would likely struggle the most in an inflationary environment, she said, as their returns are regulated and there’s a lag as they adjust to higher prices.

Consumer product companies can often pass on higher prices to customers, she said, while industrials may have a more difficult time.

“In other sectors the impact is less clear cut, and it really comes down to the business model, pricing power and the degree of input cost inflation that [a] company is seeing,” Taylor said.

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