Has inflation reached its peak?

Here are 3 reasons why inflation may soon slow—even if oil prices stay high.

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Key takeaways

  • The recent surge in inflation may moderate in coming months, even if oil prices remain elevated.
  • Higher bond yields, a stronger dollar, and rising inventories may help slow inflation.
  • Inflation may level off below current levels but remain above 3%.
  • In that scenario, value stocks could shine.

A trip to the supermarket or your local restaurant brings home the reality of inflation. The consumer price index (CPI) has risen 8.5% over the last 12 months. Meanwhile, producer prices (PPI) have jumped by 11.2%. Those are the highest rates since the 1970s. And the forces driving prices up such as war, the pandemic, supply chain disruptions, and surging demand from consumers and businesses don't look to be going away anytime soon.

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But the bad news about higher prices obscures signs that a slowdown in inflation may be nearer than it seems. Director of Quantitative Market Strategy Denise Chisholm points out that the focus on how high the CPI has risen overlooks the fact that its rate of increase has actually begun to slow. "The latest core CPI came in slightly below expectations," she says. Chisholm studies market history and believes that history suggests this slowdown may represent the start of a shift in direction for prices. "My analysis shows that the runaway inflation of the 1970s was an exception, not the rule," she says. "High inflation historically tends to be self-limiting because it creates dynamics that can slow future inflation." Instead, she thinks inflation is likely to slow over upcoming months and present opportunities for investors, particularly in value stocks.

One of the most noticeable sources of inflation is high oil prices but Chisholm says that crude oil prices would have to rise further and then stay elevated for inflation to continue accelerating. She says, "I’m assuming that most of the other components in inflation still decelerate, so even a further rise in oil prices should be offset by lower inflation elsewhere. An overall deceleration in the Consumer Price Index is still the most likely path, though inflation is unlikely to fall below 3% this year.”

Chisholm says there are 3 powerful forces that are at work now that have the potential to help slow the pace of price increases and offset higher oil prices over the coming months.

1. Rising long-term bond yields

One sign that suggests that inflation may slow is the recent rise in long-term bond yields. The yield on the 10-year Treasury note has risen just over 100 basis points during the past 12 months, a jump on par with some of the biggest year-over-year increases of the past 2 decades. Increases in long bond yields push up rates on mortgages and other loans, which can curtail spending and take some of the air out of inflation.

2. A stronger dollar

The strong demand for goods that has driven up inflation in the US also has contributed to economic growth and interest rates that are higher than in other developed countries. The US dollar has leaped against other currencies as a result. The dollar could keep appreciating because US economic growth is likely to remain stronger than that of other developed markets and interest rates are expected to rise. The war in Ukraine has also helped strengthen the dollar as global investors have sought shelter in US assets. Since 1999, when the dollar has switched from depreciating to appreciating, inflation during the next 12 months has slowed 70% of the time. A stronger dollar would further reduce the cost of imported goods, which could help offset other inflationary pressures.

3. Increasing inventories

Inventories have climbed despite snarled supply chains. Companies typically try to capitalize on strong demand and inflation by adding to their inventories so they’ll have more products to sell at high prices. As inventories increase, they eventually catch up with demand which helps to moderate inflation. The past year has been no different, despite the supply-chain bottlenecks that have gotten so much attention. According to the Institute for Supply Management (ISM) Manufacturing Inventories Index, inventories recently expanded as quickly as they have at any time in at least 20 years.

What it may mean for stocks

While stocks overall have historically fared well when inflation was as high as 5% and have provided investors with hedges against inflation, some categories of stocks have performed better than others depending on how sharply the CPI was rising or falling. Says Chisholm, "Which stocks lead the market may depend on whether inflation falls to a relatively high or low rate. The answer has important investment implications."

Seeking value

Historically, when inflation has slowed but remained higher than average, value stocks—those that trade at lower prices than stocks of other companies with similar earnings—have been among the best performers. But while value, which includes energy company stocks, may be poised to outperform the broader market, discovering value can present challenges, even for experienced investors. Joel Tillinghast, veteran manager of Fidelity® Low-Priced Stock Fund, points to Amazon as an example of how important sophisticated research is for value investors.

"The challenge of finding undervalued stocks is that accountants don't know how to value intangibles such as brands, intellectual property, and good will with customers," he says. Tillinghast says he, like many others, didn't spot the opportunity to invest in Amazon before it emerged as a retail juggernaut and exemplary growth stock. "For many years, Amazon reported either losses or not very big profits. At the same time, it was building up an increasing number of loyal customers who kept purchasing more and more stuff from it. Those customer relationships turned out to be very valuable, even though they weren't visible on the company's income statement."

Tillinghast says experienced professional investment managers can look for growing sales to identify companies with value that the market doesn't perceive. "We look for growing free cash flow, which is cash from sales that's greater than the amount of capital that they're spending on operations," he says. "Amazon's free cash flows were better than you would have expected given their not-very­good profitability 10 years ago. That was a hint that their businesses were not very capital intensive. They were growing sales fast and they were producing cash that they could return to shareholders or invest in new businesses. Now their profits have been great."

Finding ideas

Value stocks now make up just 18% of the total value of US stocks, which means the large-blend or large-cap core mutual funds that are basic building blocks of many portfolios may be much more heavily weighted toward growth than they once were. “Over the last few years, growth stocks have outperformed value stocks,” says Naveen Malwal, institutional portfolio manager with Fidelity's Strategic Advisers LLC. “So some investors may be tempted to keep more exposure to growth stocks. But diversification across different types of stocks is a critical component of risk management. Our investment team believes that having exposure to both growth and value stocks may lead to smoother investment performance over the long run.” Investors interested in adding value stocks to help diversify their portfolios can find opportunities by running screens using the Mutual Fund Evaluator and ETF Screener on Fidelity.com. Here are the results of some illustrative mutual fund screens (which are not recommendations of Fidelity).

Fidelity mutual funds

  • Fidelity® Low-Priced Stock Fund (FLPSX)
  • Fidelity® Value Fund (FDVLX)
  • Fidelity® Value Strategy Fund (FSLSX)
  • Fidelity® Value Discovery Fund (FVDFX)

Non-Fidelity mutual funds

  • MFS Mid Cap Value Fund Class A (MVCAX)
  • American Century Mid Cap Value Fund Investor Class (ACMVX)
  • BlackRock Mid Cap Value Fund Investor A Shares (MDRFX)
  • Heartland Mid Cap Value Fund Investor Class (HRMDX)

Exchange-traded funds

  • Fidelity Value Factor ETF (FVAL)
  • Vanguard Value Index Fund ETF (VTV)
  • iShares Trust Russell ETF (IWD)
  • iShares S&P 500 Value ETF (IVE)

Separately managed accounts

  • Fidelity Equity Income SMA

The Fidelity screeners are research tools provided to help self-directed investors evaluate these types of securities. The criteria and inputs entered are at the sole discretion of the user, and all screens or strategies with preselected criteria (including expert ones) are solely for the convenience of the user. Expert screeners are provided by independent companies not affiliated with Fidelity. Information supplied or obtained from these screeners is for informational purposes only and should not be considered investment advice or guidance, an offer of or a solicitation of an offer to buy or sell securities, or a recommendation or endorsement by Fidelity of any security or investment strategy. Fidelity does not endorse or adopt any particular investment strategy or approach to screening or evaluating stocks, preferred securities, exchange­ traded products, or closed-end funds. Fidelity makes no guarantees that information supplied is accurate, complete, or timely, and does not provide any warranties regarding results obtained from its use. Determine which securities are right for you based on your investment objectives, risk tolerance, financial situation, and other individual factors, and reevaluate them on a periodic basis.

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