Meme stocks were getting all the attention a couple of years ago. Then it was cryptocurrencies and the potential for blockchain and web3 technology to change the world. More recently, artificial intelligence is capturing everyone's minds.
But perhaps no other topic has been more pressing than inflation. This really wasn't much of a concern for the past few decades, so most people probably have no idea what it is or how to deal with it. But there's one crucial thing to keep in mind: You can't control inflation, but you can definitely control what you do about it.
Let's dive deeper into the topic of inflation and what it means for investors.
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An overview of inflation
Inflation simply means that over time, the prices for goods and services across the economy rise. Generally, this is a sign that the economy is growing, which is obviously what we want to see. But it's worth mentioning that low inflation, like the 2% annual rate that the Federal Reserve targets, is stable. People can live with that.
What's alarming is the high level of inflation the U.S. has been experiencing for about two years now. This substantially lowers consumers' purchasing power, and it completely changes the economic backdrop. The Fed has aggressively hiked interest rates since March of last year to curb soaring prices, and it has pressured stock valuations, resulted in slow growth for businesses, and has everyone worried about the threat of a recession.
It can be argued that the inflation that started in 2021 was caused by a combination of factors. Companies were dealing with pandemic-related supply chain bottlenecks that made it more difficult to source the inputs needed to produce enough goods.
Major central banks across the world were pumping trillions of dollars into the economy to spur growth and help keep people and businesses afloat during the health crisis. And demand from consumers was strong in 2021 following the worst of the pandemic when spending might have been tempered a bit.
This explanation for what caused the decades-high inflation in recent years makes sense in theory, but don't take it as gospel. Even economists disagree about the root causes of the inflation surge we've been seeing. This is the case with anything macro-related. There are just way too many variables working simultaneously that can have an effect.
Positioning your portfolio
For the average investor, trying to decipher the topic of inflation is not a good use of time. Sure, having a general understanding of it is important. But the best course of action is to focus on what you can control, which is how you invest.
For starters, holding cash in your portfolio during times of high inflation is not the best thing to do. That's because your purchasing power is declining more than usual. I think it's better to remain fully invested and add cash to your portfolio as well.
The best businesses to own are those that have pricing power, Warren Buffett's favorite qualitative characteristic. Investors can't control nor predict inflation, so why not own companies that can raise their prices with really no impact on demand? This way, they are more than able to offset elevated expenses.
Chipotle Mexican Grill, the incredibly popular Tex-Mex fast-casual chain, has raised its menu prices multiple times in recent years to fight the rising costs of key inputs, especially labor. Yet revenue was up 14.4% in 2022. And in the latest quarter, growth accelerated to 17.2% compared to the year-ago period. The company's amazing value proposition is something customers would pay even more for.
Investors might also look at luxury auto retailer Ferrari. Known for selling some of the most expensive cars in the world, this company has a customer base that is extremely affluent. And its newer automobiles often come with long waiting lists. The management team has done an excellent job to maintain the brand's exclusivity, which only makes people desire the cars even more. Sales were up about 20% in 2021 and 2022.
Inflation is something that can't be avoided. The best way to deal with this reality is to properly position your portfolio.
