Prices are rising fast.
In the United States, they are rising at the fastest rate in forty years.
In January 2022, prices were 7.5% higher than they had been a year ago.
This is significant, and the market was surprised by this number. It expected inflation of about 7%.
What’s worse, inflation is here to stay for a while. It’s no longer thought of as something “transitory.”
In a moment, we will tell you why inflation is here to stay… and what options investors may consider as a way of handling it.
We’ve been here before… here’s what you need to know in 2022.
Why Is Inflation Here to Stay?
First, let us clarify something. We do not think that high inflation will last for many years.
It’s likely to stay elevated in 2022 and then will gradually go back to its below-5% levels.
Why? Because most of the reasons why inflation is high are medium-term.
First, the labor shortages that contribute to high labor costs (and inflation) will not persist forever. The market still has not found the level of salaries that would be attractive enough for some people to return to work—but it will. That’s how the market works.
For now, though, we’re looking at a period of rising labor costs, which contribute to inflation.
Second, the price of oil is swinging wildly. So far this year, crude oil is up 25%. This, too, contributes to inflation.
And this problem will not resolve itself overnight. Prices could continue climbing due to supply-demand problems and strategic inconsistency on the part of OPEC, an organization of oil-exporting countries.
The political problems in Europe aren’t helping.
But the oil market is not a free one. OPEC pretty much controls it, in our view. So it will correct any supply-demand imbalances over the coming months.
Third, even though the omicron wave of the Covid-19 pandemic has peaked in the rich world, globally, it has yet to do so. Which means that countries will continue introducing measures like lockdowns or port closures.
This will make the supply chain problems that have been plaguing global trade continue.
And supply chain shortages lead to higher prices as well. It’s another supply-demand problem. Customers want more goods than manufacturers can deliver them. As a result, prices are up.
Again, we’re not saying that inflation is here to stay for decades.
But we could be looking at a year or more of high prices.
How can investors deal with this?
Consider Companies with Pricing Power
Investors have a variety of ways to deal with inflation. No need to be alarmed.
Considering shares of companies with pricing power is one option.
As a reminder, pricing power is the company’s ability to raise prices without harming its sales. So, when its costs go up due to inflation, it can charge its customers more. By doing that, it passes some of the costs to the consumers. And its profitability doesn’t suffer as much or not at all.
For example, airline companies use fuel. If fuel costs go up, some airlines can increase ticket prices. As a result, they don’t have to absorb higher costs by themselves. They “pass them along” to consumers.
Not all airlines could do that, of course. Do your due diligence and understand if this or that airline, or any other company, managed to charge its customers more and keep its sales mostly intact.
As a rule, for a company to be able to do this, it needs to have little competition. Or high barriers to entry, which means that it would take a lot of capital and expertise for a new entrant to compete with it.
Companies like Adobe, for example, make software for professionals who, once trained, will likely continue using these products for a long time. They become “captive.” So when another software company comes in and wants to compete with Adobe, its customers will need to re-learn how to use the competitor’s products from scratch.
For many, it’s too much to ask. They would rather pay more for the familiar products than change their whole workflow.
Or Netflix, which has a unique catalog of proprietary media. Netflix has been rising prices steadily, and its customer base didn’t vanish in response. What keeps people paying ever-increasing monthly fees is—you got it—the fact that there are shows on Netflix that aren’t available anywhere else.
This is why content companies invest billions of dollars into new productions. It’s a great way to make their audiences “captive” and extract more value from them. That is also a sign of pricing power.
As inflation continues ravaging consumers’ budgets, smart investors put themselves on the other side of this “trade.” Considering companies with the power to extract more value from their customers is a good way to benefit from rising prices.
Thank you for your loyal readership,
The Financial Star team