by Thomas Alonso.
In our 2021Q3 earnings review piece (here) we noted the strong uptick in the numbers of companies mentioning inflation on their earnings calls in the quarter (See Exhibit 1 below).
Exhibit 1: S&P 500 Companies Mentioning Inflation on Earnings Call by Quarter
With CPI continuing to climb and having reached its highest YoY change in almost 40 years (Exhibit 2) and the Fed now looking to raise rates in 2022 (Exhibit 3), we decided to look at sector performance relative to rising inflation.
Exhibit 2: CPI – All Urban Sample: All Items – Annual Inflation Rate
Exhibit 3: Fed Dot Plot December and September 2021
To try to gauge the impact of inflation on S&P 500 sectors, we looked at performance for the year leading up to and after prior peaks in inflation. We limited our analysis to peaks that were greater than a 4% YoY increase. This gives us three time periods to analyze where sector level data is available: October 1990, September 2005, and July 2008. We also looked at performance for the past year leading up to the most recent inflation reading, in case November’s 6.8% proves to be the peak for this cycle.
In the charts below, we show sector performance for the two-year period around the inflation peak, rebased to 100 at the time of the peak. For the 1990 peak, (Exhibit 4) the healthcare sector had the best performance (+10.9%) followed by the energy sector (+9.0) and consumer staples (+6.4%), while the financials and the consumer discretionary sectors saw the weakest performance, down 40.8% and 28.5% respectively.
Exhibit 4: S&P500 Sector Performance Around 1990 Inflation Peak
Moving past the peak, the financials showed the best performance, up 58.5% one year after inflation peaked, followed by health care (+46.0%) and consumer discretionary (+42.0%). Communication services was the weakest performer in the year after the peak, up only 2.2% and no sector was down one year after the peak in inflation.
Looking at the September 2005 peak (Exhibit 5), energy (+51.2%) was the best performing sector in the year leading up to the peak, followed by utilities (+33.3%) and real estate (+22.6%). A quick note, real estate sector data only goes back to 2001, so this is the first inflationary period where data was available. On the flip side, communication services was the weakest sector leading into the peak, down 0.3%, followed by financials (+3.2%) and materials (+3.9%)
Exhibit 5: S&P500 Sector Performance Around 2005 Inflation Peak
For the year after the 2005 peak, the real estate sector showed the best performance, up 21.2% followed by communication services (+21.0%) and financials (+17.3%). Utilities was the weakest performer in the year after the peak, up only 1.9%, and like the 1990 peak, no sector was down one year after the peak in inflation.
For the July 2008 peak (Exhibit 6), energy (+10.5%) again led the way, followed by utilities (+0.9%) and consumer staples (+0.2%), although overall performance was much weaker during this period due to the overlap with the global financial crisis. Not surprisingly given the GFC backdrop, financials (-52.2%) were the weakest sector, followed by consumer discretionary (-32.1%) and real estate (-23.9%).
Exhibit 6: S&P500 Sector Performance Around 2008 Inflation Peak
For the year after the 2008 peak, the consumer discretionary sector had the best performance, down 5.5% followed by information technology (-8.9%%) and consumer staples (-9.4%). Real estate was the weakest performer in the year after the peak, down 42.2%, followed by energy (-33.4%), with all 11 sectors down one year after the peak in inflation given the impact of the GFC.
Assuming November’s CPI reading is the peak for this cycle, we can look back to see which sectors have performed best over the past year (Exhibit 7). For the current cycle, the energy sector is again the best performer (+102.1%), followed by financials (+68.3%) and information technology (+50.5%). Given the strong rebound from 2020’s COVID-impacted sell-off, it’s not surprising to see all sectors positive over the past year.
Exhibit 7: S&P500 Sector Performance Around Potential 2021 Inflation Peak
Using the average sector performance (Exhibit 8) from the above periods, we see that the energy sector has historically been the best performing sector leading up to a peak in inflation, while financials has been the weakest. For the year after the peak, the performance essentially flips, with financials the best performing sector on average while real estate is the weakest, followed by energy.
Exhibit 8: Average S&P500 Sector Performance Around Prior Inflation Peaks
While it’s still too early to say if the recent bout of inflation will prove transitory and if we’ve already put in a peak for this cycle, it’s safe to say that investors will remain focused on inflation and the Fed’s reaction to it, as we move into and through 2022. With that in mind, we’d also point to the work done by our colleague Tim Gaumer, found here looking at performance of Refinitiv StarMine models in prior periods of Fed rate increases.