Whether you are watching the news these days or have felt the pain of your gas and grocery bills rising, you know inflation is on the way up. Beyond general concern for how expensive things are becoming, investors care about this because inflation usually pushes up interest rates.
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If interest rates rise faster than economic growth, then it will drag on the stock market. This is why the market dropped last Thursday and Friday. The Bureau of Labor Statistics reported the monthly Consumer Price Index (CPI) which was 0.6% on a month-over-month basis – or about 7.5% annualized.
That inflation rate is faster than growth and investors used it as an excuse to drive stocks lower on Thursday and Friday.
While it is true that inflation is high right now, we don’t know how long it will stay elevated. Higher prices have been more persistent than we would have expected, so it makes sense to be careful over the next few weeks while we see what the next few rounds of data say.
On the bright side, although inflation was higher than investors had hoped, the rate of inflation hasn’t moved much. So, although we are concerned about inflation, at least the trend isn’t getting worse.
For now, we are maintaining our bullish outlook with a small shift in focus towards those sectors that tend to do better during inflationary periods.
On Our Watchlist
Within the financial sector there are some interesting opportunities. We have been very bullish on stocks like Bank of America (NYSE:BAC) for a while and have made a lot of money over the last few months in that stock.
Here’s a snapshot of the gains our Strategic Trader readers have had the chance to grab on BAC over the last year.
However, brokers are likely to be a better trade in the short term…
What most investors don’t know is how much brokers benefit from higher rates. Like a bank, a broker pays little or no interest on the assets you have deposited with them. However, they charge very high rates from clients who are borrowing cash to short stocks or buy on margin.
In fact, if you have an account with margin (most of you probably do), then the broker may “borrow” stock you own and then lend it to a trader who wants to short those shares. They pay you nothing for that, but they charge the short seller interest on the loan. For example, short sellers pay Charles Schwab (NYSE:SCHW) an effective rate of 8.33% right now to borrow stocks or funds from the broker.
Don’t worry; just because the broker has borrowed your shares, if you decide to sell there are market clearing mechanisms in place to make sure you can get out of your stock if you want.
Here’s the point: If rates rise, that basically goes directly to the broker’s bottom line because it is very unlikely they would raise the rate they pay account holders on their cash balances. We estimate that a full percentage point increase would add an additional 15% to Schwab’s profit margin without anything else having to change.
Bottom Line for This Week
Earnings will continue to trickle in this week with an important one from Walmart (NYSE:WMT) on Thursday morning. Is WMT planning to raise prices further? Do they see inflation as a constraint on growth? These are critical questions that we will hear about when WMT reports.
The Federal Reserve will also be releasing an announcement on Thursday afternoon. This is important because the Fed is tasked with controlling inflation — and the way they do that is by raising interest rates. What they say on Thursday could trigger another round of back-and-forth trading, so be vigilant.
Quick reminder: Tonight at 7:00 p.m. ET, we’ll be going live with our next YouTube stream.
This week, we’re talking about how inflation fears sent stocks crashing last Friday, begging the question if investors should be worried or not. Let’s look at the current price target for the S&P 500 and find out which stocks to buy this month once the major indexes have found a bottom.
Click here to set a reminder for tonight’s livestream.
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