Inflation won’t normalize anytime soon, so look for stocks with ‘pricing power’, strategist says

Although coming down from imminent peaks, inflation is unlikely to normalize in the near future, according to Francesco Curto, head of research at asset management firm DWS, as he advised investors to seek companies with strong pricing power.

US inflation stood at 7% in December on an annual basis, new figures showed on Wednesday, its highest level since 1982. Meanwhile, rising consumer prices in the UK, Europe and elsewhere has also hit multi-decade highs in recent months, prompting most central banks to begin guiding the market toward monetary policy tightening, with the exception of the European Central Bank.

US Federal Reserve Chairman Jerome Powell told a congressional hearing on Tuesday that interest rate hikes and a smaller balance sheet, what he described as a “normalization” of policy, would be needed to contain inflation.

However, Curto told CNBC on Wednesday that the rising carbon and energy prices needed to meet governments’ emissions reduction targets would prevent the kind of “normalization” that would drive inflation back toward central bank targets. .

Lower prices, he argued, would be key to bringing consumers back to spend in light of the pandemic, even if the lifting of Covid-era restrictions frees up more supply.

“People are going to be very upset if all of a sudden after the pandemic they start to see higher inflation eating away at their purchasing power. That’s an obvious risk from a sustainability perspective,” he said. declared.

Much of the investment narrative over the past year has focused on a rotation from popular growth stocks, such as “Big Tech” (referring to companies such as Apple and Alphabet), towards value stocks. The latter refers to companies that are trading at a discount to their financial fundamentals, such as banks and energy, which have both performed well in 2021 on higher interest rate expectations.

However, Big Tech’s various sell-offs were short-lived, including the one last week, calling into question the expected inverse relationship between value and growth. Curto echoed other commentators in noting a divergence between speculative tech stocks and those with proven pricing power.

“We’ve seen over the last 12 months now a significant negative price adjustment on some of the speculative assets that were just driven by fast money, by quantitative easing, and there were questions about where this business is ultimately going. provide a real level of profitability,” he said, adding that investors were right to be cautious in this segment of the market.

“More nuanced approach” in 2022

The tech-heavy Nasdaq 100 suffered a strong sell-off in the first week of the new trading year, but has since rebounded, with the shift from growth to value appearing to fade in recent sessions.

“I think the way to navigate an inflation market is to look at companies that have strong pricing power. It’s as simple as that,” Curto explained, noting that some value stocks lack price. this pricing power, as evidenced by various UK energy suppliers. be driven out of business in 2021 by rising energy prices.

“Some of the tech companies have strong pricing power, it’s just that the valuations of some of them have been unreasonable. It’s unreasonable to believe that these companies will continue to grow forever.”

Frankfurt-based DWS, which has 880 billion euros ($1 trillion) in assets under management as of June 2021, seeks structurally sound companies with strong profitability and reasonable valuations, rather than trying to play sector or thematic rotations, explained Curto. He recommended investors take a more “nuanced” approach in 2022 than buying stocks that align with the economic recovery.

“If you invest in this part of the market, you can resist inflation without any problem, because companies, because of their pricing power, will be able to pass on the increase in input prices to the consumer.”

This means that the overall growth momentum will not necessarily die out, as some of the major players in this basket of stocks, such as US tech giants, still have strong pricing power, suggested. Curto, while most speculative stocks that have yet to shore up strong and sustainable cash flow, can be difficult.

In the area of ​​market value, Curto noted that banks are likely to benefit from higher inflation and interest rates, while some energy companies could benefit from reduced capital expenditures they will face. because it will improve underlying profitability, provided that governments do not raise taxes on them.

However, not everyone shares this view. In research notes on Wednesday, Goldman Sachs and BCA Research reiterated their core assumptions for the pursuit of broad growth-to-value rotation, with the latter advocating sectors and themes that typically outperform in an interest rate environment. rising.