Warning: Inflation Could Dent Your Portfolio

Inflation could be on the horizon, so stocks like West Fraser Timber (TSX:WFT) may serve as a buffer.

You Should Know This

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

If you feel the cost of living has jumped recently, you’re not alone. Corporations and governments across the world are also bracing for higher inflation in the second half of 2021. The economic reopening coupled with pent-up demand and relentless stimulus have already pushed the cost of raw materials to record highs. 

Here’s what a bout of inflation could do to your portfolio and how you should prepare. 

Inflation signals

This week, Bank of Canada Governor Tiff Macklem reiterated his team’s target of 2% inflation. However, it’s worth noting that this is average inflation. That means if inflation was below 2% in recent years, the central bank is okay with the rate being higher than 2% for a while

According to the BoC, average inflation in 2020 was just 0.72% — which means the Macklem team is okay with much higher inflation this year. That seems to be happening already. 

The price of lumber, oil, corn, soybeans, copper and several other commodities have spiked in recent months. Demand for travel and housing could push fuel costs and rents higher as the economy recovers. All this means ordinary Canadians should brace for higher living costs by next year. 

It also means that investors need to reassess their positions. 

Stocks that could be dented

Higher inflation should theoretically lead to higher interest rates. The BoC has already said that rates could rise in 2022. That’s sooner than expected. Higher interest rates may have a noticeable impact on the valuation of growth stocks that are unprofitable. 

Tech stocks like Shopify are a good example. The stock trades at a price-to-earnings ratio of 488, which implies an earnings yield of 0.002%. Of course, investors expect tremendous growth in the years ahead, which is why they overlook the earnings yield. However, if interest rates climb the present value of future earnings declines. 

In other words, the incentive to wait for growth is lower when you can get a higher risk-free return right away. Shopify stock, along with several other overvalued tech stocks, could correct sharply if inflation and interest rates rise in 2021. 

Sectors that outperform

Not all sectors and stocks underperform when inflation rises. Some companies can pass the higher costs onto consumers and save themselves. Nuvei, for instance, should see growth in gross transactions if the costs of everything rises. The payments platform transmits inflation, which renders it better positioned. 

Another way to position yourself for higher inflation is to bet on commodity stocks like West Fraser Timber. The stock is up 175% over the past year and 20% year to date as the cost of lumber has spiked. If the raw material remains valuable, WFT stock should see further upside in 2021. Deploying some capital in these stocks could buffer your portfolio if inflation climbs. 

Bottom line

Canadian households and investors should brace for higher inflation. That could be detrimental for overvalued tech stocks but good news for commodity and inflation-protected companies.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Vishesh Raisinghani has no position in any of the stocks mentioned. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Shopify and Shopify.

More on Investing

A solar cell panel generates power in a country mountain landscape.
Top TSX Stocks

3 TSX Stocks You Can Hold for the Next 3 Decades

While the market faces significant headwinds, it's crucial to ensure that you can commit to the TSX stocks you're holding…

Read more »

energy oil gas
Dividend Stocks

2 High-Yield Energy Stocks to Buy as Recession Approaches

Energy stocks such as TC Energy and Canadian Natural Resources allow investors to generate income even in recessionary times.

Read more »

green power renewable energy
Dividend Stocks

3 Top Dividend Stocks to Drive Your Passive Income

These three high-yielding, safe dividend stocks could boost your passive income.

Read more »

Dial moving from 4G to 5G
Tech Stocks

TFSA Investors: 2 Canadian Stocks With Unbelievable Staying Power 

Amid economic uncertainty, investors look for stocks that can thrive in any crisis and grow long term. Here are two…

Read more »

protect, safe, trust
Dividend Stocks

TFSA Wealth: How to Earn $363 in Monthly Passive Income for Life

Canadian investors can harness the power of the TFSA to generate steady tax-free passive income for decades.

Read more »

Canadian Dollars
Dividend Stocks

TFSA Millionaire: How to Turn $40,000 Into $1.2 Million for Retirement

Here's how TFSA investors are using the power of compounding to buy top Canadian dividend stocks to build retirement wealth.

Read more »

potted green plant grows up in arrow shape
Stocks for Beginners

3 Superb Income and Growth Stocks for Every Portfolio

The market is full of superb income and growth stocks, but not all belong in your portfolio. Here are three…

Read more »

stock market
Stocks for Beginners

Worried About Stagflation? 2 Canadian Stocks for All Market Cycles 

Stagflation delays economic recovery. You can keep your portfolio stagflation ready with these Canadian stocks that are suitable for all…

Read more »