In the past couple of years, there hasn't been a more popular topic than that of inflation. Rising prices following the worst of the pandemic and supply chain issues rattled the economy. And this kicked off the fastest pace of rising interest rates in U.S. history.
While the inflation rate, as measured by the widely followed Consumer Price Index, has been coming down over the past 12 months, it's certainly something that is still fully on investors' minds.
But it's important to understand that we have no control over what happens with inflation. All we can do is properly position our individual portfolios to do well over the long term. Let's take a closer look.
Breaking down inflation
At a high level, inflation just means that the prices for goods and services across the economy go up over time. The Federal Reserve believes that a 2% long-term target is a sign of a healthy economy. And the thinking is that there should always be a little bit of inflation baked in to incentivize consumers to spend their money.
However, the inflation that started hitting the U.S. economy in the second half of 2021, a pace of rising prices not seen in decades, could have come about from the combination of a number of factors, including tremendous amounts of pandemic-related government stimulus, supply chain bottlenecks that caused production issues, and renewed consumer demand following the health crisis. The tightening of the labor market could also deserve some blame.
Even the smartest financial analysts and economists disagree on what caused the recent surge in inflation. Moreover, they can't accurately predict what inflation rates will be in any given month. There are just too many factors at work across the economy to be able to do this. Luckily, investors don't need to predict anything.
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How to position your portfolio
Inflation is important, but it's not really predictable. But all hope isn't lost. I think the best course of action is to find companies that are better equipped to handle inflationary pressures than others.
Owning businesses that have pricing power is a smart way to deal with inflation. Chipotle Mexican Grill (CMG 2.41%) comes to mind. Even after numerous menu price hikes over the past couple of years, the popular Tex-Mex chain continues growing revenue at double-digit rates. And these higher prices are more than offsetting rising costs for food, paper products, and labor. The company's operating margin in 2022 of 13.4% was much better than the 2021 figure of 10.7%.
Visa (V -0.23%) and Mastercard (MA 0.07%), the massive card networks, are unique because they are natural inflation hedges. They both earn percentage-based fees anytime someone swipes one of their branded cards, which are accepted virtually everywhere. This means that if a consumer has to pay more for things in their daily lives, then the fees these financial giants collect automatically go up. It's truly a wonderful position to be in, no matter what the economy is doing.
Costco (COST 1.01%) also deserves some attention here. Its focus on selling quality merchandise at the lowest prices around is attractive for budget-conscious customers in all economic environments, whether inflation is running hot or at normal levels. But the company's membership has proven pricing power. Costco last raised annual membership dues in June 2017, with management signaling that another one might be on the horizon. With a worldwide membership renewal rate hovering around 90%, this means Costco is well positioned no matter what happens with inflation.
We can't control inflation, but we have full power over what companies we add to our portfolios. And if done right, this can end up being a huge benefit in the long term.
