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General Category => Strategies => Topic started by: IanBezek on February 05, 2019, 04:23:25 PM

Title: Best stocks/sectors for higher inflation
Post by: IanBezek on February 05, 2019, 04:23:25 PM
I've been thinking a lot about how to protect my portfolio for more inflation in coming years. Obviously the great inflation that Fed critics expected after 2008 never happened. That said, political developments now - particularly mainstream political acceptance of MMT makes it seem more likely that the Fed/treasury will monetize some debt in the future. I don't care whether or not MMT is sound policy or ethical for the sake of this conversation, let's just consider the possibility that the government decides that, say, a 5 or 7% inflation rate is more correct and amps up money creation - taking seigniorage along the way - to get it.

I know the popular thinking on inflation is to buy gold, resource stocks, oil, etc. but historically these seem to be pretty awful investments outside of inflationary periods making them, on the whole, rather lousy investments. If inflation remains low, I don't want to own garbage merely as a portfolio hedge.

As such, what equities can we own in attractive businesses that hedge against higher inflation? My preliminary thinking is:

Highly levered companies - their debt obligation shrinks quickly in real dollars.
Companies that need very little capex - I'm thinking consumer staples plays like Hershey, McCormick. Diageo that can raise prices in line with higher inflation and their brands appreciate in value to keep up with inflation.
Some types of REITs
SAAS companies and other tech plays with free cash flow.
Emerging market levered-growth companies that should enjoy a boom as easy dollars float around the world

Your thoughts?
Title: Re: Best stocks/sectors for higher inflation
Post by: Spekulatius on February 05, 2019, 07:04:34 PM
Real estate and highly leveraged companies might have trouble, if interest rates rise with inflation. I would imagine that this means that cap rate would go up and real estate might get cheaper.

The best business will be those they donít need to reinvest much, but have pricing power. Food /consumer staples used to be they way, but I am not sure any more - they have lost a lot of pricing power in three last few years. It also depends on where the inflation pressure comes from - commodities, energy, wages?  I would think they tech/growth companies would do Ok, or perhaps something like Dunkin Donuts, Starbucks etc.
Title: Re: Best stocks/sectors for higher inflation
Post by: scorpioncapital on February 06, 2019, 04:07:20 AM
i've seen a paper showing real estate does better than straight up commodities or gold during an inflation. However it was pretty darn close to run of the mill bonds at the then-to-be interest rate. What was not in the paper was that quality well picked stocks should in theory do better if they have low capital intensity and growth rates (like tech). But high inflation also changes the discount rate, so high growth tech companies that haven't made money in a while, I'm not sure what the market would make of this...

Capital intense businesses can work if you made a huge investment now or last few years, before the unexpected inflation hits and then you're sort of in a run-off intensity scenario. It seems to be a dynamic process. If such a capital intensive business can get 10 years out of their investment and the inflation spikes, peaks, then drops after 10 years, well that may not be so bad.

I am weary of debt ladden companies. Yes their debt becomes smaller in relative terms but their costs go up, cutting into their profits. If they were a poor business that needed the low cost leverage, then it will cut into cash flow and valuations. Insurance companies I think could be alright if run well as their cost of funding/float could be much lower than the cost of borrowing. It's all about the tipping point. Another chart shows that moderately higher inflation and rates could increase market valuations from here but past a certain point it goes the other direction.

People think the fed controls interest rates...but what happens if buyers of treasury bonds disappear? how will the fed control the spike in rates to sell 1 trillion a year of debt, and refinance over 20 trillion of existing debt?

Title: Re: Best stocks/sectors for higher inflation
Post by: SHDL on February 06, 2019, 01:55:50 PM
Like Spekulatius noted, interest rates tend to go up in inflationary environments so high debt is not necessarily a good thing.  Basically, old debt can get inflated away, which is good, but at the same time the cost of new debt usually goes up with interest rates, which is bad.  So for example youíre in pretty good shape if youíve already borrowed all the money youíll ever need to borrow by selling a bunch of 50 year bonds, but you will not do as well if your debt mostly consists of adjustable rate loans or you need to borrow more or refinance your existing debt in a few years.  If you can get yourself something like a 30 year fixed rate mortgage (before interest rates go up, of course), that can be a very nice way to benefit from this.

In terms of sectors/stocks, I would also check out the major credit card networks (like V and MA) and cable cos (like CHTR and others).  Those guys can basically keep milking something theyíve already built and are unlikely to have much difficulty raising prices with inflation.  DIS is probably worth looking into as well, partly because itís an IP-based company with similar characteristics but also because (as I understand) ESPNís contracts with sports leagues are set in nominal terms and can therefore be inflated away.
Title: Re: Best stocks/sectors for higher inflation
Post by: bizaro86 on February 06, 2019, 04:05:06 PM
I think DIS is potentially a great inflation hedge. They'll have a decent debt load (after FOX closes) that could be inflated away, and it's much higher if you consider future fixed payments to sports leagues as debt.

They also have significant capital assets with very long lives (theme parks) that have huge pricing power. If inflation went to 10% per year I think the cost of Disney park tickets goes up 14% per year and the capital base used to build the park starts becoming inconsequential compared to the revenue stream in nominal dollars.

Their non-fixed assets (back catalogue, IP) probably also inflate and don't really require maintenance capex.
Title: Re: Best stocks/sectors for higher inflation
Post by: Gregmal on February 06, 2019, 04:41:15 PM
MSG

Ticket prices always go up. Yes even during the GFC.
Title: Re: Best stocks/sectors for higher inflation
Post by: KJP on February 06, 2019, 05:50:10 PM
MSG

Ticket prices always go up. Yes even during the GFC.

You know you have a good business when you can put out a garbage product like the typical Knicks roster over the last decade and still raise prices every year.  But even Knicks fans apparently have limits.  Their attendance is finally down to 16th in the league this year.  I have no doubt it would be top-five again with a decent team.
Title: Re: Best stocks/sectors for higher inflation
Post by: Gregmal on February 06, 2019, 06:02:20 PM
MSG

Ticket prices always go up. Yes even during the GFC.

You know you have a good business when you can put out a garbage product like the typical Knicks roster over the last decade and still raise prices every year.  But even Knicks fans apparently have limits.  Their attendance is finally down to 16th in the league this year.  I have no doubt it would be top-five again with a decent team.

Yea I'm a lifelong NJ Devils fan. So I've noticed what goes on across the Hudson and at the same time been envious of their obvious advantages. What I've also seen is that even with what they tend to report as "poor attendance", they still sold all of their tickets for the event. Something the Devils, as well as most other teams can only dream of. The corporate sponsorship/subsidization as I refer to it, is insane, and keeps prices high.
Title: Re: Best stocks/sectors for higher inflation
Post by: NewbieD on February 08, 2019, 04:12:29 AM
Pricing power, float and negative duration gap would be things to look for.

Betting companies that have float in form of customer deposits and addictive properties that gives relatively stable demand. Tobacco companies that have little debt or at least long debt. Agree with McDonalds, Starbucks above. Disney sounds interesting, thanks for the idea.

What you don't want to hold is permanent debt like preferred shares. But if you can find something that is financed using callable preferreds that should be good since you can buy them back cheaply during an interest rate surge.

Insurance companies that have a short duration investment portfolio and long liabilities that are fixed in nominal terms would do well since the liabilities are more heavily discounted. E.g. Storebrand.
Title: Re: Best stocks/sectors for higher inflation
Post by: scorpioncapital on February 09, 2019, 01:58:08 AM

Insurance companies that have a short duration investment portfolio and long liabilities that are fixed in nominal terms would do well since the liabilities are more heavily discounted. E.g. Storebrand.

what would you consider short duration? i've seen some companies hold 1 year, 2-3 year, and 5 year. I'm thinking 5 year is on the edge, although given the last 5 years and currently it seems a potential sweet spot.
Title: Re: Best stocks/sectors for higher inflation
Post by: NewbieD on February 11, 2019, 12:20:07 AM
I would say <2 years on interest bearing is a short duration. But it would depend on the other parts of the portfolio. I.e. if there is less than 10% equities, property and alternatives than 3 is pretty short.

And if the liabilities are very long the duration gap can still be at least a bit negative with investments of duration 5.
Title: Re: Best stocks/sectors for higher inflation
Post by: james22 on April 03, 2019, 08:03:09 PM
I'm thinking to allocate 5% to the financials index for just this reason.

How to Defend Yourself from Inflation

The most obvious way to defend yourself against the prospects of any future significant dollar weakness is to devote a portion of your portfolio toward this well ahead of time.

This implies to me a need to include physical gold as a store of family wealth. And from an equity perspective, look to areas that might grow as fast as inflation itself (or at least benefit from inelastic demand).

...

But for me, I like banks as a place to hide out.


https://realmoney.thestreet.com/articles/02/12/2018/why-i-bank-america-and-goldman-sachs-inflation-hedges-market-recon%2Bbank+stocks+inflation+hedge&client=safari&rls=en&hl=en&ct=clnk

Get into Bank Stocks Soon Because Inflation Is on the Way

https://investorplace.com/2018/08/get-into-bank-stocks-soon-because-inflation-is-on-the-way/%2Bbank+stocks+inflation&client=safari&rls=en&hl=en&ct=clnk

Helps that Buffett likes banks too.
Title: Re: Best stocks/sectors for higher inflation
Post by: sarganaga on April 04, 2019, 11:35:45 AM
If you're concerned about inflation, why not allocate a small percentage of your portfolio to gold coins? This also gives you some assets outside of the financial system in case things really go sideways.
Title: Re: Best stocks/sectors for higher inflation
Post by: SHDL on April 04, 2019, 12:46:12 PM
Also donít forget about TIPS.  Itís normally a boring, ultra conservative instrument, but if we do get a crazy regime change in the way monetary policy is conducted it could end up outperforming almost any other asset class.
Title: Re: Best stocks/sectors for higher inflation
Post by: Nell-e on April 04, 2019, 01:32:23 PM
Stocks in high speed broadband because of the companies' pricing power.
Title: Re: Best stocks/sectors for higher inflation
Post by: Spekulatius on April 05, 2019, 04:54:20 PM
I believe they banks don’t do well with high inflation rates. I think part of the reason is that they capital (which is partly held in liquid assets) gets eroded by inflation. At least that my observation from looking at several Emerging Market banks when inflation turns up. The sharply rising interest rates are also often correlated with economic distress.

Cable stocks have too much debt to be good in a high interest rate environment.
Title: Re: Best stocks/sectors for higher inflation
Post by: scorpioncapital on April 06, 2019, 03:31:03 AM
I feel that if your pricing power is enough to raise your prices faster than the cost of your debt then debt is fine. If it just matches the increase , the debt is netural, doesn't really confer a benefit other than having money you need. If it exceeds the inflation rate then the debt has a real benefit.

As for banks fixed income asset side of the balance sheet I'm just wondering if they can reinvest this at higher rates and therefore increase earnings. It can charge customers more for the debt. I know one card I have is charging me 8% when rates are 2%. Banks can set much higher rates than the fed rate.
Title: Re: Best stocks/sectors for higher inflation
Post by: Spekulatius on April 06, 2019, 05:30:24 PM
ďMarketplacesĒ, which take a cut out of a transaction should be good stocks in an inflationary environment.. the cost of goods trades might go up, but that is not a problem for a marketplace, which just takes a cut from the transaction. A dealer wholesale/ distributor has probably the same characteristics, but might have an issue where the inflationary inventory eats up more and more working capital.

Google, FB, eBay etc are marketplaces.
Title: Re: Best stocks/sectors for higher inflation
Post by: SharperDingaan on April 07, 2019, 08:28:55 AM
I believe they banks donít do well with high inflation rates. I think part of the reason is that they capital (which is partly held in liquid assets) gets eroded by inflation. At least that my observation from looking at several Emerging Market banks when inflation turns up. The sharply rising interest rates are also often correlated with economic distress.

Cable stocks have too much debt to be good in a high interest rate environment.

Normally, banks benefit from inflation as it increases the size of their loans.
If the thing you want to buy costs 10% more, and you borrow to buy it (ie: Visa, MC), the loan amount automatically increases 10%. If ability to pay hasn't really changed, larger balances 'float' over the 'due date'; and the bank earns both more interest, and at a typically higher spread.

But if the bank is coming off a long period of ultra-low interest rates?
Debtors have already used that ultra-low floating rate to maximize the amount they could borrow. Higher interest rates from inflation, trigger default losses that overwhelm the additional interest spread, lowering net income. Net income might TEMPORARILY increase until existing loan loss provisions are burnt through, but it's wide open to manipulation.

And a good banker, WILL manipulate  ;)
Hence, you're reeally betting on the relative 'skill' of the banker.
And 'quality' takes on a whole new meaning.

SD




Title: Re: Best stocks/sectors for higher inflation
Post by: Schwab711 on April 07, 2019, 08:56:18 AM
Visa/Mastercard
MCO/SPGI

All earn a percentage of a nominal amount, in non-competitive industries. If nominal growth is higher, earnings will be higher.
Title: Re: Best stocks/sectors for higher inflation
Post by: DTEJD1997 on April 07, 2019, 10:23:01 AM
Hey all:

One very important factor is how MUCH inflation, and how fast it comes about.

If we go from 2% inflation to 6% inflation in say a 3 year period, the banks may not do well at all.

If I recall correctly, banks and thrifts did not do well at all in the late 70's early 80's.

They had duration mismatch.  That is, they had 20-30 loans on houses made for 5% or 6% that they funded with MMA and short duration CD's.  It got to the point where they had a NEGATIVE credit spread.  They were borrowing money at rates HIGHER than what they lent out.  That was largely due to an unanticipated spike in the rate of inflation.

If inflation is relatively small and comes about slowly, then banks will probably be OK...but not if it is sudden & large.
Title: Re: Best stocks/sectors for higher inflation
Post by: scorpioncapital on April 07, 2019, 12:05:09 PM
Regarding this, insurance companies follow the same dynamic. If inflation comes on strong, they can have duration mismatch with their liabilities, but if it comes slowly they can re-invest bonds running off at higher rates. There was a study paper on insurance companies where it was shown that under deflation, no-flation, or inflation insurance companies do ok, but only under 'unexpected' large changes in inflation they can be caught by the inability to move fast enough. Probably similar situation with banks as mentioned. However I'm not quite sure why insurance companies can't just stuff the entirety of their fixed income portfolio with TIPS which would adjust with inflation.
Title: Re: Best stocks/sectors for higher inflation
Post by: SharperDingaan on April 07, 2019, 03:47:52 PM
Look at the vehicle leasing companies.
To make money in the business you must deliberatly miss-match the asset profile, and fund the bulk of the leases with rolling short-term debt; a portion of which must be refinanced every month. For the most part in any given month; lease run-off + insurance receipts (vehicles crashed) will fund the current month additions - but the debt roll-over is entirely exposed.

The wise lessors know how to handle this, the not so wise - not so much.
And that wise lessor typicallly also knows how to use it to bleed a competitor white, prior to making an offer they cannot refuse  ;D

SD
 
Title: Re: Best stocks/sectors for higher inflation
Post by: elliott on July 13, 2019, 03:58:25 PM
Yes, for banks it actually depends on the maturities they have in both sides of the balance sheet.
I do not know of US banks, but I have read bankd reports where maturies are specified, and even better the sensitivity to interest rates (what happens if rates go up, what happens if they go down).