As an investor, I need to be alert to economic factors that influence the price of the FTSE 100 stocks in my portfolio. Sometimes, I might think that it’s only company-specific factors that moves the share price. For example, company earnings. This isn’t the case. In reality, elements such as employment, inflation or GDP figures impact the share price as well.
How inflation affects me
Earlier this week, the latest inflation numbers came out for May. It showed that inflation shot up to 2.1%, higher than the target level of 2% from the Bank of England. This has several implications for FTSE 100 stocks.
For example, the main way to control higher inflation is to raise interest rates. This creates less of an incentive to spend rather than save. In raising interest rates, it makes it more expensive for companies to refinance debt, or issue new debt. This becomes a negative for most companies that have high levels of debt.
Another implication of higher inflation is that it shows consumers are out spending more. In this way, rising inflation could be good for some FTSE 100 stocks, as they are the benefactors of the increased activity. This helps to boost revenues, and ultimately profits.
Finally, for myself, higher inflation erodes the value of the cash sitting in my bank. If prices are inflating by 2.1% per year and my interest rate is 0%, then I’m losing 2.1% in effective purchasing power. So any excess cash I have, I’d like to invest and put to work.
Protecting my FTSE 100 stocks
There are several ways I can be smart when it comes to rising inflation. Firstly, I want to check whether the stocks I own have high levels of debt. If they do, then I’d look to offset this by investing in some companies that have very little debt. In this way, it counterbalances the impact of any potential interest rate hike.
Secondly, I’d look to invest in companies that could actually benefit from an interest rate hike. The obvious sector here would be banks. Higher interest rates allow the banks to make a larger margin between lending and borrowing rates. Therefore, if inflation continues to rise and rates increase, the share price of FTSE 100 banking stocks should rise.
Thirdly, I would consider allocating some money to inflation-protected assets outside of stocks. These include assets like gold and inflation-linked bonds. These assets don’t lose purchasing power during periods of high inflation. To be clear, I’d still remain heavily invested in stocks, but just take a small position in these assets.
Finally, I’d consider buying FTSE 100 stocks that are likely to benefit from higher spending. In this case, I think retail and tourism stocks would be the area to buy.
As a well-rounded investor, being aware and preparing for higher inflation should allow me to avoid unnecessary losses with my FTSE 100 stocks portfolio.
Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.