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5 stocks not afraid of inflation's bite
The Fed's recipe to fight rising prices -- higher interest rates -- is bad news for the market. But a select few companies in the technology, energy and service sectors will thrive.
By Jim Jubak
Suddenly inflation is back -- and that's not good for most stocks. Especially in markets like this one, where higher inflation will certainly bring higher interest rates from the Federal Reserve.
But in this column I've got five picks that should thrive with higher inflation. The last two are conventional hard-asset and commodity picks: These kinds of stocks are traditional safe havens for investors in times like these. The first three, which I made in my regular weekly appearance on CNBC's "Morning Call," are a bit outside the box. Because every bout of inflation is different, I think in this market investors will see gains, despite inflation, from energy, technology, and service sector stocks.
Last week the Department of Commerce announced that inflation at the consumer level --measured by the Consumer Price Index -- had climbed at a 4.7% annual rate in September. The 1.2% monthly jump was the steepest in 15 years. Even if you take out the huge increase in energy prices, inflation is still moving up. The core CPI, which excludes energy and food, was up at a 2% rate. That's a big increase from the 40-year low that the core rate hit at 1.1% back in January 2004. And history tells us that the core CPI lags the overall CPI by about a year.
This week, the Department of Commerce announced wholesale prices, as measured by the Producer Price Index, came in at a whopping 6.9% annual rate of increase. Even the core PPI, without energy and food, showed a 2.6% annual increase.
Inflation hurts most companies in more ways than one
Why is this so bad for stocks? Three reasons.
First, higher inflation, especially higher energy prices, is taking a bite out of company earnings. On Oct. 17, for example, Mattel (MAT, news, msgs) reported that net income dropped 12% in the third quarter of 2005. Part of that was Barbie's fault: Worldwide Barbie sales slumped 19% in the quarter. But a big part of the decrease in net income was due to higher energy costs. The company just hadn't planned for $60-a-barrel oil sending the price of plastics soaring. Gross profit margins for the quarter dropped by 2.1 percentage points. The stock dropped 4.5% on the day's news.
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Second, companies are having trouble passing along all of their higher costs to consumers -- and that cuts into profit margins. When inflation at the producer level -- the PPI -- is increasing faster than at the consumer level -- the CPI -- as it is now, that's a sign that companies aren't passing along all their increased costs to their customers. They're afraid that recouping all the higher costs they see by charging higher prices to consumers would result in lower sales. So Mattel raised prices just 2% to 4% earlier this year, and while that pushed up inflation at the consumer price level, it wasn't enough to keep Mattel's own higher costs from cutting into margins.
And third, higher inflation means higher interest rates from the U.S. Federal Reserve as Alan Greenspan & Co. try to stop inflation by slowing economic growth and cutting demand for goods and services. Higher interest rates never help the stock market as a whole. Higher rates increase the cost that companies have to pay to borrow the money they need to run their businesses and pushes up the yields of bonds and other income vehicles making them more attractive alternatives to stocks.
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