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Higher Inflation: Which Sectors Benefit?

January 24, 2017 | Global/Emerging Markets


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In a series of recent posts, my colleague Olga Bitel and I have provided broader context around the recent drivers of the global economy and capital markets, and discuss what we see as the themes moving forward.

We note that while we have not had inflation in several years, it is not unexpected given our late-stage cyclical economic expansion—but nevertheless, as it has become more apparent, it has taken both equity and fixed-income markets by surprise.

It is taking only a small move in inflation and bond yields to create significant ripples throughout the capital markets. We believe this expansionary element will persist for some time. But what does it mean for financial markets?

In my opinion, we are in an environment in which industrials, financials (both banking and insurance), and commodities could perform much better.

In my opinion, we are in an environment in which industrials, financials (both banking and insurance), and commodities could perform much better, as they have the ability to take advantage of a steeper yield curve.

What does it mean from a valuation perspective? Valuation sensitivity has increased across geographies and sectors. Looking at the traditional discounted cash flow framework, the three main elements are suddenly working against investors with long-life assets.

The terminal multiple (the final multiple projected for a period, used in a discounted cash flow analysis and valuation) is probably coming down a little. The cost of capital seems to be heading up a little. Free cash flows are under pressure from taxes and protectionism.

Our preference remains for high-quality growth, but we believe the available opportunity set has expanded, and some of those companies are in cheaper areas of the market.

In this environment, we have been adding to high-quality companies with a focus on lower valuations. Our preference remains for high-quality growth, but we believe the available opportunity set has expanded, and some of those companies are in cheaper areas of the market.