Inflation-Proofing: The Art Of Shielding And Rebalancing Portfolios
Inflation is the villain in every investor’s story. But it can be tackled effectively once you wrap your head around how it influences the market.
Inflation has been above RBI’s target range of 6% for the last few months now. The ongoing geopolitical turmoil is escalating it further—the prices of most commodities have shot up by 30%-120% in the past year.
The Inflation Effect: What It Does To Companies
Inflationary pressure tends to dent profitability. Higher input cost facing a weak consumer demand puts pressure on the margins. Additionally, interest rates harden and add to the pressure on cash flows for corporates.
It’s important to understand that inflation doesn’t always spell bad news. An orderly increase in inflation, driven by strong consumer demand, is in fact, a healthy scenario. It boosts corporate earnings and has a positive fallout on equity markets.
But at present, the steep surge in input cost is likely to result in downgrades in earnings estimates across multiple sectors. Instead of earning upgrades observed in the past few quarters, the Q4 results season could witness a downgrade in consensus earnings growth of Nifty companies.
Fortifying Your Portfolio To Prep For Upcoming Quarters
On a top-down basis, I am expecting the impact of input cost inflation to be limited to IT services, private sector banks and select commodity companies. In addition, the tailwinds of the real estate sector would allow the scope for price hikes to pass on the cost pressure to homebuyers.
On a bottom-up basis, the focus needs to be on companies with a healthy balance sheet and pricing power. For example, there would be a limited impact of inflation on hospitals (Apollo Hospitals), along with telcos (Airtel) and media companies (PVR, Inox Leisure).
On the contrary, there could be a meaningful downgrade in the earnings of the following sectors:
- Auto OEMs (weaker demand & margin pressure)
- Cement manufacturers (margin pressure + little pricing power)
- Consumer staples (margin pressure + down trading)
- Construction & engineering companies (input cost pressure + high-interest outgo).
Also, as a pattern, NBFCs tend to underperform in a rising interest rate environment due to their dependence on the wholesale market as a source of funds.
Accordingly, you need to revamp your sector allocations. Personally, I feel it would be better to reduce exposure to broader markets as small companies would find it more difficult to manage profitability in tough business conditions.
The Big Picture
Though there seem to be some near-term challenges, I continue to believe that the equity markets would continue to thrive over the next few years, driven by growth in the economy and corporate profits. Hence, there is a need to re-adjust portfolios to factor in the changing macro environment but at the same time, we should not turn our backs on equity markets.
Manvendra Pratap Singh is the Founder and CEO of Trinkerr. He is an IIT Kanpur-IIM Lucknow alumnus and an investor with 15+ years of experience.