The Key to Investing During Inflationary Periods

With the latest inflation figures coming in higher than expected this week, the RBA has warned that it does not foresee any rate cuts until the end of 2025. This is unwelcome news for Australians struggling with the rising cost of living. With no immediate relief from the RBA in sight, it might be time for Australians to shift their mindset and explore ways to benefit from the inflationary environment.

Which sectors or stocks should you consider when interest rates rise?

Conventional wisdom suggests that you should invest in stocks in the financial, materials, or energy sectors during inflationary periods. However, while these sectors have historically performed well during times of inflation, both the energy and materials sectors experienced significant declines in 2011 and 2014, which were the previous two times that CPI was at or above the 3 per cent threshold. Financials also saw a decline in 2011 but improved in 2014.

Given that the traditional sectors might not be the best investment during inflation, where should you look? The key is to identify companies that directly benefit from rising interest rates.

One such company is Computershare, which holds around $25 billion in cash on behalf of clients. This means that every 1 per cent increase in the interest rate translates to an additional $250 million in earnings for Computershare. Historically, each time the RBA has begun to raise rates, as it did in 2009, CPU's share price found a long-term low and then rose strongly. With the potential for rates to increase, CPU is a company worth serious consideration to combat inflation.

Another company to consider is EML Payments. EML holds $2 billion in customer funds, so every 1 per cent rise in interest rates generates an additional $20 million in earnings. Like CPU, EML's share price has increased with interest rate changes. For example, EML’s share price reached its all-time low just before interest rates started to rise in 2009, with the stock soaring over 33,000 per cent to its all-time high in 2021. Since peaking, the share price has fallen by over 90 per cent, coinciding with a period of falling interest rates.

However, the share price has been rising again since October 2022, which is intriguing because the RBA started raising rates in June 2022 after years of consistent rate cuts. So, if the RBA continues to raise rates, EML could present a rare opportunity to pick up a stock with huge upside potential at its current price level.

What were the best and worst-performing sectors last week?

The best-performing sectors included Consumer Staples, up 1.02 per cent, followed by Consumer Discretionary, up 0.83 per cent, and Communication Services, up 0.59 per cent. The worst-performing sectors included Utilities, down 2.73 per cent, followed by Materials, down 1.35 per cent, and Energy, down 0.60 per cent.

The best-performing stocks in the ASX top 100 included NIB Holdings, up 5.38 per cent, followed by Whitehaven Coal, up 5.08 per cent and Domino’s Pizza up 5.05 per cent. The worst-performing stocks included Fortescue Metals Group, down 7.58 per cent, followed by Liontown Resources, down 5.11 per cent and IGO Limited, down 5.03 per cent.

What's next for the Australian stock market?

Sellers took control early last week, with the All-Ordinaries index dropping over one per cent by Thursday, but Friday saw a return of the buyers, with the market ending the week down under half a per cent. Interestingly, the market is now back at the crucial 7,900-point level. This level has proven to be a strong support level on three separate occasions this year, where the buyers have stepped in to prevent further declines leading to a gain of around 3 per cent each time the market dipped.

What's exciting is that with prices at the 7,900-point level, we are at an inflection point in the market with a clear scenario ahead. If buyers remain consistent, we should soon see prices rise from this level, potentially pushing the market back up to test the previous all-time high of 8,167 points.

However, if the 7,900 support level fails, it will introduce a new dynamic we haven't seen this year, offering insight into what may happen in June. In my previous report, I mentioned the possibility of the market hitting a mid-year low in June. This week has increased that likelihood, especially since June is historically a down month for the All Ordinaries Index. For the market to confirm a mid-year low in June, it would need to break below the April low of 7,743 points.

A decline in June would also offer traders and investors, who thought they had missed the mid-year buying opportunity, a renewed chance to enter the market. This is exciting news, as this opportunity seemed unlikely two weeks ago, and the outlook is now clearer than it has been for some weeks. Therefore, I encourage investors to be prepared to act at the first sign of confirmation.

For now, good luck and good trading.

Dale Gillham is the Chief Analyst at Wealth Within and the international bestselling author of How to Beat the Managed Funds by 20%. He is also the author of the bestselling and award-winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good bookstores and online.