Try the “productivity portfolio” to win the inflation debate

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The chip business could be a good bet in the productivity portfolio. Here, a new type of Bosch chip

Jens Schlueter / AFP via Getty Images

Whether inflation is transient or something more, there is a way for investors to benefit in either environment: bet on productivity.

Stocks tend to outperform bonds during times of rising inflation, as bond investors are forced to collect interest from fixed income securities while stock investors may receive dividends which tend to rise with increasing interest. time, because selling prices drive up profits, says Yardeni’s Ed Yardeni. Research.

To establish the relative outperformance of stocks, Yardeni released monthly data for the S&P 500 stock index, with and without reinvested dividends, from December 1935 to May 2021. “The data shows that over the long term, stock prices exceed indeed inflation, ”Yardeni explains.

After also cutting profits and dividends dating back to 1935, Yardeni says his analysis of the history of the stock market and inflation shows that over the long term, the S&P 500 has provided around 7% nominal return and 3 % real return (adjusted for inflation) per year, on average. The total return of the S&P 500, including dividends, provided nominal rates of 10% and comparable rates of 7%.

Of course, this long-term outperformance assumes that companies can pass higher prices on to their customers, find ways to reduce productivity to compensate for higher input prices, or both.

But one challenge that an inflationary environment presents for equity investors is that not all companies are able to benefit, or benefit equally, from rising prices. The trick, says Yardeni, is to find companies with unit growth, pricing power, and the ability to increase productivity, and avoid companies that do not have such means to amortize the cost. effect of rising costs.

Yet that still leaves investors with the big question of how to position themselves in the face of inflation that could really be fleeting, as the Federal Reserve maintains. Yardeni says his conclusion is that the best investment strategy for “all seasons”, ie transient inflation or persistent inflation, is what he calls “the productivity portfolio.”

It doesn’t matter what consumer prices (as measured by the consumer price index) and producer prices (as measured by the producer price index) do over the next few months and beyond that, “we are certain that labor will remain scarce and that labor costs will rise higher at a faster rate,” says Yardeni. Moreover, he notes, the situation is not expected to improve quickly, as demographic profiles become increasingly geriatric around the world and growth rates of working-age populations decline almost everywhere.

Thus, businesses in the United States and around the world have no choice but to increase their productivity to compensate for labor shortages and rising labor costs. Yardeni predicts that annual productivity growth will rise to 4% by the middle of the decade, from around 2% currently.

With that in mind, Yardeni says the productivity portfolio should include companies that produce workforce augmentation technologies, including semiconductors, robots, 5G communications, 3D manufacturing, and computing. cloud and quantum.

Investors should also look for non-tech companies that invest in the technology. Yardeni says this is especially happening in the consumer discretionary, financials, industrials and healthcare sectors.

Much depends on the increase in productivity. It is one of the main shock absorbers to help cushion the impact of price inflation that sets in and eventually sets off a wage-price spiral. Productivity since the start of the pandemic has increased better than in past recoveries, economists say, as companies incorporated new technology and other efficiency gains in order to survive during the pandemic.

From a macroeconomic perspective, sufficient productivity could make the difference between transient and persistent inflation. At a micro level of stock picking, this is one way for investors to position themselves for one outcome or the other.

Write to Lisa Beilfuss at lisa.beilfuss@barrons.com


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