SAN FRANCISCO — You don’t have to go far to see higher prices in the United States: Just stop at the gas station or the grocery store.
And while the government’s core inflation figure released Thursday is tame, up just 1 percent in the 12 months through January, the fact that Americans are doling out considerably more for basic energy and food disturbs many stock investors.
Their concern is understandable. Inflation destroys consumers’ buying power and depresses corporate earnings. In that hostile climate, the U.S. dollar loses clout and so-called hard assets gain favor — especially gold, the ultimate inflation hedge.
Yet stocks can be a strong inflation-fighter, too. So it was noteworthy when Richard Russell, editor of the widely watched investment newsletter Dow Theory Letters and a confirmed gold bug and stock bear, told subscribers in late January that they should buy U.S. stocks.
Not all U.S. stocks; Russell wasn’t about to do a complete reversal, even after missing the now almost two-year-long rally.
The veteran market observer simply recommended that investors own the 30 high-quality, large-cap stocks in the Dow Jones Industrial Average — mainstays of the global economy including International Business Machines, Caterpillar Inc. and Chevron Corp. — to hedge against inflation and the ravages of what he says is a slowly but steadily weaker U.S. dollar.
“When extreme currency devaluation occurs, stocks (the bluest of dividend-paying blue chips) can become inflation hedges,” Russell noted. “That’s exactly what I think we’ve been seeing in the stock market as the Dow pushes higher.”
Russell’s acerbic views may not be mainstream, but in fact he is echoing a vocal chorus of Wall Street strategists who are convinced this is the year that large-cap stocks finally take market leadership from small-cap and midcap rivals.
“The Great Rotation” is what Bank of America Merrill Lynch analysts have dubbed this major shift. In an early February report, the firm noted that investors globally have been trading out of gold, bonds, emerging market stocks and other 2010 winners. Buyers instead are beginning to favor developed-market large-cap stocks that are benefitting, the analysts noted, from “a normalization of economic growth, interest rates and asset allocation.”
Focusing on companies within the Dow that can best withstand inflationary pressures could be a wiser strategy.
Industrials, technology and oil & gas (energy) are the top three contributors to the Dow’s strong gain so far this year, with industrials taking the lead. These cyclical businesses not coincidentally boast low levels of long-term debt and high demand for their products, which allows them formidable pricing power.
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