Stock markets are one of the best places to be in to earn good money on your investments so long as you stay in the discipline. But non-discipline may come from the other side. From inflation.
Inflation is a “secrecy” warning to investors because it cuts away at real savings and investment returns. Most investors aim to increase their long-term purchasing power.
Inflation puts this goal at risk because investment returns must first keep up with the rate of inflation in order to increase real purchasing power.
For example, an investment that delivers 3% before inflation in an atmosphere of 4% inflation will truly provide a negative return (−1%) when modified for inflation.
Particularly, if investors don’t protect their portfolios, inflation can be dangerous to fixed income returns. Various investors buy fixed income securities because they need a solid income. That comes in the sort of interest, or coupon, payments.
Nevertheless, because the rate of interest on most fixed income securities persists the same until maturity, the buying power of the interest payments decreases as inflation increases.
Though, over shorter time intervals, stocks often had a negative relationship with inflation. So they can be particularly disturbed by sudden inflation. When inflation increases quickly or suddenly, it can increase the risk of the economy. That will lead to lower earnings for companies and lower equity values.
To combat the negative impact of inflation, returns on some types of stocks are linked to changes in inflation.
So, what can you do, where to invest, which stock to buy in the period of inflations?
1. Oil Stocks
There is a positive connection between the price of oil and inflation. The consumer price index helps measure inflation in the economy by tracking a basket of goods and services by households. Energy costs in households are part of the consumer price index. When the oil prices increase, it directly affects the energy costs spent by consumers. This leads to an increase in the CPI index and then inflation. Oil stocks always do well in high inflation environments.
Utilities are defensive stocks. Everyone will need utilities even in a high inflation situation. When operating costs rise for energy companies, in the final instance the consumers will pay them. So, the companies will maintain their profit margin. Consumers will have no choice. They have to pay for the newly inflated cost if they want to receive electricity, for example.
Demand in utility businesses will still be effective even in high inflation times.
Healthcare is also a defensive stock. They are considered safer investments as people will always need healthcare. Even when consumer budgets are poor. During the inflationary period, investors will sell out high-risk stocks. They will prefer to buy into low-risk stocks because these are considered safer. People will always need medicine and medical treatment. They will give priority in spending on healthcare as opposed to less crucial goods and services.
4. Gold Stocks
When investors notice high inflation in the economy they want to turn to safe-haven investments such as gold stocks. Gold traditionally is an investment held during the economic instability. High inflation causes investors to want to safeguard their investments by buying gold stocks. Of course, holding cash in bank accounts is a bad idea in a high inflation environment.
Because the purchasing power of cash is eroded by inflation.
5. Basic goods/consumer staples
For instance, companies with higher energy cost from increased transportation cost or higher operating costs will pass these costs to the consumer. Goods and services will become more expensive. Consumers will become more selectable when purchasing goods and services because they have less buying power.
But, basic goods or consumer staples will still be in demand in a high inflation environment. Even if the costs increase, people will still buy bread and milk. Even if such companies increase the price of their goods, consumers will need to buy it. Consumers will not buy non-essential goods and services such as a new car or furniture. They will only spend what is necessary. That kind of companies is a good opportunity.
During the period of inflation never invest in discretionary stocks.
6. Material Stocks
Basic materials companies are involved in the exploration, development, and processing of raw materials. Hence, many times target specific resources, such as gold, silver and crude oil. This area also covers businesses that run refineries and plants to develop refined materials. The dividend yields in this sector are higher than average relating to the broader market.
If you’re looking to invest in dividend-paying basic materials stocks, you may also be interested in dividend-paying basic materials exchange-traded funds (ETFs). These funds submit a diversified dividend payment based on a basket of basic materials stock holdings.
What we want to show is that there is no solution to inflation, but there’s the reason for hope. And for profits and returns of course.
Most years, financial markets are a mixed bag. A bad year for risky investments, like stocks, might be a great one for safe bets like government bonds.
Or, if you are worried that inflation is going to cut bond investments, commodities like gold will probably do well.
But last year something different happened.
For the first time in decades, every major type of investment has fared poorly. Stocks around the world were getting pummeled, while commodities and bonds are tumbling. All of which has left investors with few places to put their money.
Pessimism arising from the stock market could force buyers to be scared to spend. The collapse in crude oil prices discouraged new investment and hiring in the oil patch. In that mind, the markets are both a measure of what investors anticipate to happen in the economy and a potential impetus for their choices. On Sept. 20, last year, stock investors in the United States were sitting on a nearly 10 percent gain for the year. Benchmark American crude oil prices were up more than 20 percent. The tech-heavy Nasdaq composite index was up more than 15 percent.
But those profits are gone.
Since October, an index of commodities that includes oil and copper has swung from gains of 20 percent to losses for the year. A similar move took place in risky corporate bonds. After another steep drop, the S&P 500-stock index is down about 2.8 percent to the end of the year.
In every year, at least one of these categories generated a return of 5% or more. A separate study by JPMorgan Chase analysts found that “2018 has delivered losses on almost every asset class and investing style.”
The experience of 2015 could be a useful road map for investors. Stocks, bonds, and commodities all dropped, but Treasury bonds performed well and went out a minuscule gain.
In the center of the market turbulence, the Federal Reserve reduced the pace of its interest rate increases. And the pause from the central bank reinvigorated risk-taking among investors, with the S&P 500 rising 9.5 percent the next year, and the economy continuing to grow.
Investors can be quick to jump to conclusions. But they can also be wrong.