How to Rationalize the Impact of Inflation on Your Portfolio

If you’re worried about how record-high inflation could continue to impact your portfolio and the stock market as a whole in the months ahead, you’re definitely not alone. But, just because inflation is soaring doesn’t mean investors should be running for the hills. In this segment of Backstage Pass, recorded on Jan. 12, Fool contributors Rachel Warren and Jamie Louko discuss.

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Rachel Warren: Are you growing concerned about inflation? Do you think that this is something that investors and consumers should expect to contend with for the foreseeable future? Then on that note, as this record-high inflation is clearly carrying into the new year, are there any areas in your portfolio that you plan to add to or trim to deal with the impact this is having on the broader market? Jamie, why don’t you take this one first.

Jamie Louko: One of the most important things that I noticed in this report was that expectations were also 7% and they were for 7% inflation, which is exactly what the CPI reported.

If there’s one thing I learned in my college economics class, it is the major difference is expected versus unexpected when it comes to inflation. Why do I say that? If everybody is expecting 7% inflation, you, me, Rachel, Trevor, if we had salary jobs, were going to ask for 7% raises because that’s inflation. We’re going to budget 7% more for our groceries.

We’re going to budget 7% more for our gas or anything else that we need.

Similarly, Wall Street is going to budget for 7% inflation in their DCFs. In their discounted cash flow models. And so that really mitigates, at least to me.

A really important point is I tend to focus on unexpected inflation because that is where businesses can get hit if we’re expecting 7% inflation and we see 9% then there’s 2% that nobody is expecting.

That is going to surprise a lot of people, especially when it comes to investing in earnings reports, etc. I don’t know. I’m just really focused on what comes as unexpected as opposed to expected. The one thing that I took from this was that all of this inflation that we saw in the CPI was expected. Everybody was expecting it.

That really makes me less worried about it going forward. In terms of my portfolio investing, buying, selling. I’m not really going to be changing anything. The only thing I am going to be doing, however, is focusing on some more consumer goods and focusing on that side of my portfolio.

Specifically, I want to focus on the consumer goods companies that I own that have pricing power. What I’m going to be really looking for is, if companies can raise their prices with inflation. That shows to me that they do have pricing power. We’ve seen some of these already. Chipotle (NYSE: CMG) being a prominent example last year, they raised their prices because they were expecting inflation.

If there are consumer goods companies in my portfolio that aren’t able to raise the prices with inflation, that shows me that they don’t have a lot of pricing power, which means their brand isn’t really that strong. I like to buy consumer goods companies that have really strong brands.

If they can’t raise their prices, then they will have to as a business, eat those higher costs of goods sold. If that happens, I would really want to force myself to take another look to see how strong those brands really are for these businesses that I own.

Warren: Yeah. I think that’s a great point. Looking at companies that are meeting those essential needs that consumers are looking for year-round. Whether that’s everyday goods that you are buying or not. A lot of the companies that we talk about regularly on the show, like Apple (NASDAQ: AAPL) for example.

Maybe you don’t actually need that new MacBook Pro. But this is a company that has such tremendous brand authority.

As such, the go-to for so many consumers, everyday tech needs that it can just raise those prices and adjust where needed. Consumers are still going to go to Apple. They’re not going to scale back those purchases.

Jamie Louko owns Apple and Chipotle Mexican Grill. Rachel Warren owns Apple. The Motley Fool owns and recommends Apple and Chipotle Mexican Grill. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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