A proposed heirarchy of stock performance in an inflationary environment
First and foremost, this blog is going to be directly on-topic. But in keeping with my general blogging habits, I must start a bit off topic. lol. I want to give a shout out to Doug Kass. He twits and blogs many times a day (dozens?) and many of those posts have links to older posts of his, sometimes years older, which has long led me to believe that he can remember somehow all of his old posts. It took me 20 minutes and eventually I turned to google to find this old post, which is related to todays topic:
So, Mr. Kass, a shout out for that apparently supreme memory. Also, in browsing through the titles of my blogs over the last couple of years, I was struck by how many times I have gotten things wrong. I mean holy crap have I beaten the market and all the pros in real life, I must be some genius who played this market like a fiddle, right? Boy, oh boy, is that not the case. I have been wrong about so many things... and just gotten a few really big things right. Which will lead me to a blog in a day or two about how little old nobodies like us - no inside information, really no information at all (my biggest resource is still yahoo finance) - can beat all those well dressed pontificating overpaid pros, and beat them big. Why its really us, not them, that have the upper hand. But first, back to the point here:
In that post I offered some thoughts on different categories of stocks. I had resource, productive, and financial stocks... categorized like this:
resource stocks get stuff out of the ground or something similar. drillers, oil, miners, farmers, growers, whatever.
productive stocks make stuff, usually from the products of resource stocks. chemical companies and steel companies and stuff on one level, and manufacturers on another.
financial stocks are companies that don't make spit and just sit and play around with money. banks, insurers, BDCs, and so forth.
Its well documented that in the fullness of time stocks catch up to inflation and beat it, and I proposed, and will propose anew, that in significant inflation, the order in which these stocks will perform well is basically:
first: resource stocks, second: tier one productive stocks (chemical companies etc), third: tier two productive stocks (manufacturers) and last financial stocks (because they are holding generally debt, which doesn't do well in inflation at all. eventually they will catch up as premiums written go up in price, each loan for a home goes up in value, etc., but they are definitely last on the agenda). That is one of the best blogs I have ever written, IMO, and I've never seen a commentary like it in my web browsing.
So I propose, and open for discussion, a more detailed heirarchy of what stocks perform best in inflation, MY HOPE IS THAT SOME FOLKS WILL CHIP IN AND HELP ME IMPROVE THIS LIST, AS MY DEEP THINKING ON IT IS LIMITED TO THOSE ORIGINAL 3 1/2 CATEGORIES, I consider this list only semi-complete and maybe we can complete it:
In order of first-to-respond:
Resource stocks: Miners, farmers, drillers, and so forth. These are the stocks that will do the best in inflationary times. TCK, CENX, ATPG, coal stocks, oil stocks, gold and silver miners, FCX, etc.
Resource support stocks: Companies who thrive when the resource companies are thriving. Fertilizer companies who sell larger amounts to farmers excited about high grain prices, oil service companies, and stuff like that.
Productive stocks, tier 1: Chemical companies and steel mills and things that are first in line to pass higher commodity prices on to their customers. DOW, DD, and so forth.
Productive stocks, tier 2: manufacturers. They are lower on the totem pole because they get stuck with higher prices from the tier 1 guys, but can't instantly pass on. Some of them, like F or GM, almost literally have to wait for the inflation to make its way all the way to wages before they can pass things on, some like ASH can pass them on sooner.
Necessity retail stocks: grocery stores and other stores selling necessary things can and must raise prices as their input costs go up, so their sales go up, so at their generally small margins their profits go up. I have low conviction about putting this one here as I haven't thought about it that much.
Discretionary retail stocks: restaurants, clothes, etc. In some of these cases, to be honest, input costs don't really matter that much. You really think the cost of cotton means that much to Polo Ralph Lauren? I don't know the answer, but I suspect its pretty low. Similarly for say Kraft. A box of oreos has what? 10 cents worth of wheat in it? 20 cents worth of sugar? tops? Its just advertising you are paying for there. Another low conviction pick here.
Pure service stocks: ad stocks, tv, cable, they can't really pass on prices (monopolies aside) until the inflation makes its way to companies bottom lines and to consumers top lines. another low conviction pick here.
Financial stocks: These guys are last in line, no comment to add to my original blogs comments.
And... maybe we see now why financial stocks remain the cheapest stocks on the market. In a deflationary environment nobody wants them because their collateral tanks and loans default and so forth. In an inflationary environment their assets are about the worst ones you can be holding. So its really a "normalish" outcome in which they would finally march towards reasonable valuations, maybe. In my view insurers remain the cheapest stocks on the market, as they have been for 2 years. But the market doesn't want to un-cheapen them, and maybe this is why.
Anyway, I am open to, and requesting, corrections, additions, and suggestions. But this kind of cost-pass-through heirarchy probably has some real value if we do see a period of sustained inflation.