By Michael Brush, MarketWatch
Reason 4: The dollar is going to weaken
Many investors think higher U.S. interest rates, as the Federal Reserve raises its benchmark rate, will attract foreign investment and push the dollar higher. But what if rate cutting and other stimulus in Europe, China and emerging markets works, sparking growth in those regions? That’s going to attract investment money there, and drive up those currencies against the dollar, pushing the dollar lower.
The upshot will be inflation, since a lower dollar often drives up the prices of commodities and oil.
Reason 5: The markets are telling you inflation is on the way
Sectors that do well when there’s inflation — such as transportation and materials — have all been doing well recently. So have emerging market stocks, which benefit from inflation because of their exposure to commodities and manufacturing. Gold has been going up, and so are Treasury yields.
Groups to own and avoid: The 30,000-foot view
If surprise inflation is on the way, you want to own sectors and things that benefit. This includes: commodities, real estate, hard assets, materials companies, and industrial and transportation companies, which benefit from higher selling prices. Also consider small-cap companies. They’re leaner than large-cap companies, so higher prices bring superior earnings leverage. And foreign companies, because they have greater exposure to the industrial sector and commodities. You want to avoid bonds (unless you plan to hold to maturity from the outset), and bond-like stocks, meaning dividend payers.
I checked in with a few money managers, and here are some individual stocks they say would benefit from rising prices.
These will do better because they own a lot of hard assets, which go up in value when there’s inflation, says Eric Marshall, a portfolio manager and director of research at Hodges Capital Management. The higher prices also make it costlier for competitors to come in.
“It creates a barrier to entry,” he says.
He likes Martin Marietta Materials Inc. /zigman2/quotes/208827848/composite MLM -2.33% , Vulcan Materials Co. /zigman2/quotes/203479463/composite VMC -2.09% and Eagle Materials Inc. /zigman2/quotes/207732987/composite EXP -2.63% . They’ll benefit from inflation, even if Marshall doesn’t actually buy my inflation thesis. He likes these because they will benefit from the $305 billion, five-year highway bill signed into law in December. It’s the first long-term highway bill in a decade. So long-term projects held back by the uncertainty of past, temporary bills will get bid out.
Agricultural commodities will rise in price with inflation, pushed along by a weakening dollar. This will help producers and farm-equipment companies. A weaker dollar will also make it easier for U.S. farm-equipment companies to export, points out Marshall. He favors Deere & Co. /zigman2/quotes/207941296/composite DE -3.44% , AGCO Corp. /zigman2/quotes/203686311/composite AGCO -3.88% and Archer Daniels Midland Co. /zigman2/quotes/203479136/composite ADM -5.14% .
Higher inflation will drive up long-term bond yields, steepening the yield curve. It will also force the Federal Reserve to raise interest rates faster, which would drive up yields, too. All of this will help banks, because they tend to lend at the longer end of the yield curve, and borrow (take deposits) at the short end. This will improve the difference between the two, called net interest margin (NIM).
“The spread between short and long rates has been very narrow. The whole sector has been under NIM compression,” says Brian Smoluch a co-portfolio manager at Hood River Small Cap Growth Fund /zigman2/quotes/205436709/realtime HRSRX -2.64% .
His fund gets a five-star rating from Morningstar, and it beats competing funds by over 3 percentage points, annualized, over the past five years.
“So if the Fed raises rates, banks can price their loans higher, and there is a lag effect on them taking up their deposit costs. So their NIM will rise.”
Smoluch favors Bank of the Ozarks Inc. , where commercial real estate lending strengths have helped loan growth surpass 40%. He also likes Webster Financial Corp. /zigman2/quotes/207965570/composite WBS -1.94% , which has a low-cost funding base because it collects a lot of deposits via health-savings accounts; and First Interstate Bancsystem Inc. /zigman2/quotes/208790106/composite FIBK -2.67% in part because it has room to cut costs and improve fee income.
Land is the ultimate inflation hedge. Since it can be tough to buy land outright as an investment, consider shares of Texas Pacific Land Trust /zigman2/quotes/203839070/composite TPL -7.84% , says Marshall, at Hodges Capital Management. It owns about 900,000 acres in Texas. It collects oil and gas royalties from the property, so it should benefit from higher energy prices, too.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested ACGO in his stock newsletter Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.