Do Financial Stocks Benefit from Inflation?

PUBLISHED Jun 1, 2024, 5:56:54 PM        SHARE

img
imgMuhammad Shoaib

Expertise provided by Kevin Matthews from buildingbread.com

Inflation plays a role, in the economy affecting market sectors in various ways. Financial stocks in particular are closely tied to inflation and interest rates influencing their performance significantly. This article explores how inflation impacts stocks. It discusses which finance sectors are more resilient to inflation. It also provides stock strategies for high inflation. It also examines the impact of inflation on fixed income investments.

Financial Stocks That Are Inflation-Resistant

Stocks show resilience during periods of high inflation. like Banks, credit card companies, and payment processors are included. These stocks are strong because of their business models. They benefit from rising interest rates. This is a response to inflation.

Banks:

Banks typically profit from the interest rate spread between what they pay on deposits and what they charge on loans. With rising inflation, the Federal Reserve often raises interest rates to combat it. Higher interest rates allow banks to charge more for loans boosting their profits.

Credit Card Companies:

Credit card companies also benefit from interest rates. They can charge more on balances, which leads to higher revenue. Moreover, when inflation is on the rise, individuals tend to turn to credit to manage the elevated expenses. In terms of payment processors, they do not profit from the surge in rates. But they usually see a boost in transactions as prices and transactions increase in inflation.

The Impact of Rising Inflation on Financial Stocks

There seems to be a connection between inflation, interest rates and financial stocks. To grasp this relationship, it's crucial to delve into the details;

Rising Inflation

Prices of goods and services rise due to inflation. It is influenced by factors like high demand, supply chain problems, or higher production costs.

Federal Reserve Action;

In response to inflation, the Federal Reserve usually raises interest rates. High interest rates cause borrowing. They can reduce economic activity and help curb inflation.

Impact on Financial Stocks

Banks:

With rising interest rates, banks can impose rates on loans. They can also impose them on existing adjustable-rate loans. This will boost their interest income.

Credit Card Companies:

Similarly, credit card companies can raise interest rates on balances. This increases their revenue from finance charges.

Payment Processors:

They are not directly impacted by interest rate changes. But, they will gain from more transactions as inflation raises prices.

Why Increasing Interest Rates are Advantageous for Financial Stocks

benefit of investing financial stocks

Rising interest rates help financial stocks. They are good for banks and credit card companies. Here's the reason why;

Boosted Profit Margins:

When interest rates go up, banks and credit card companies can raise their charges on loans and credit. This boosts their profit margins. For instance, if a bank was charging a 3% interest rate on a mortgage. If it raises to 7% due to increased rates, the bank's earnings from that loan notably grow.

Higher Interest Income:

As interest rates rise, the income generated from loans increases. This is a big help. It is especially good for banks with large portfolios of loans with variable rates.

Credit Card Revenues:

Credit card companies can charge higher interest rates on revolving credit. This increases their revenues from finance charges. However, this positive impact can be mitigated if a recession is anticipated. During downturns, loan demand could drop and defaults rise. This would hurt financial stocks.

The Role of Inflation in Fixed Income Investments

Inflation can have a detrimental effect on fixed income investments. Fixed income securities, such as bonds, offer a set interest payment over time. When inflation rises, these payments lose value. The interest received buys less. Here's how inflation impacts fixed income investments:

Eroding Value:

The fixed payments from bonds become less valuable in real terms as inflation rises. For example, a bond paying 3% interest may provide a decent return when inflation is at 1%. However, if inflation rises to 4%, the real return becomes negative.

Interest Rate Risk:

When inflation increases, interest rates typically rise. This causes the prices of existing bonds to fall. New bonds are issued at higher rates, which makes older bonds with lower rates less attractive.

Inflation-Protected Securities:

Some fixed income investments aim to fight inflation. An example is Treasury Inflation-Protected Securities (TIPS). The principal of TIPS increases with inflation. This provides a hedge against rising prices.

Investing in Financial Stocks During High Inflation

You need a strategy to invest in financial stocks during high inflation. Here are some strategies to consider:

Focus on Banks and Credit Card Companies:

When it comes to banks and credit card companies they typically do better when interest rates are, on the rise. These types of stocks tend to hold up during times of inflation.

Diversify Within the Financial Sector:

It's an idea to spread out your investments within the sector even if banks and credit card companies are doing well. Adding payment processors and insurance companies to your portfolio can help. This is especially true when inflation is a concern.

i. Monitor Economic Indicators:

Keep an eye on indicators like inflation rates, interest rates and GDP growth. Understanding these factors can help you make investment choices. They are based on the economy.

ii. Avoid Overleveraged Companies:

Debt-laden companies may struggle when interest rates rise. This is because their borrowing costs will increase. Look for companies with strong balance sheets to minimize risks.

iii. Consider Inflation-Protected Securities:

Are you worried about inflation hurting your fixed income investments? If so, consider adding TIPS to your mix. TIPS are designed to protect against inflation.

Historical Performance of Financial Stocks During Inflationary Periods

Looking back at data, financial stocks have generally done well during inflation. This was due to rising interest rates. But, this trend may not always hold true. This is especially true if a recession is expected.

1980s Inflation:

In the 1970s and early 1980s, inflation was high. Financial stocks, especially banks', did well due to the high interest rates. However, the financial sector faced a downturn during the recession, in the 1980s.

2000s Housing Bubble:

The housing bubble of the 2000s led to the 2008 crisis. It was fueled by low interest rates and excessive borrowing. The burst had an impact on stocks. It highlighted the risks of high leverage and downturns.

Recent Trends:

In recent years, financial stocks have done well when inflation was high. For example, in 2022, higher interest rates increased revenue. This helped banks and credit card companies. However concerns about a recession tempered investor optimism.

The Current Economic Climate and Its Impact on Financial Stocks

The current economic landscape plays a role in shaping the performance of stocks. Presently we are facing a situation where inflation's high while worries about a recession persist.

2022 Scenario:

In 2022 inflation rose sharply prompting the Federal Reserve to raise interest rates. This move should have helped stocks. But, fear of a recession made investors cautious. Many were concerned that higher interest rates could slow growth. This could lead to loan defaults and less borrowing demand.

Current Outlook:

Looking ahead, financial stocks will benefit more from interest rates. But, this will only happen if the economy avoids a recession. A slowdown in the economy may reduce the benefits of interest rates. This is because credit risk may rise and loan demand may decrease.

Weighing the Risks and Rewards of Financial Stocks During Inflation

Risks and Rewards of Financial Stocks During Inflation

Investing, in stocks amid periods of inflation presents a mix of opportunities and risks. On one side the surge in interest rates can enhance the profitability of banks and credit card companies. On the other hand, the likely downturn adds uncertainty. To maneuver through this scenario investors should;

• Concentrate on Sound Financially Companies:

Focus on investing in banks and credit card companies first. They have strong finances and careful lending.

• Diversify Investments:

Expand within the sector. This will diversify risk and seize opportunities.

• Stay Informed:

Stay informed about indicators. Also, learn central bank strategies. They help you foresee market shifts.

• Consider Inflation-Protected Securities:

To protect against inflation's impact on fixed income, consider adding TIPS to your investments. TIPS stands for Treasury Inflation Protected Securities.

Conclusion

Understanding inflation is key. It helps investors grasp interest rates and financial stocks. This understanding helps them make informed decisions. As historical records reveal, financial stocks can thrive in such times. But, thinking about the economy is crucial. It helps for navigating the complexities of the market.

For more information watch this video:

https://youtu.be/JDPOUCNEJVc



Sound investments
don't happen alone

Find your crew, build teams, compete in VS MODE, and identify investment trends in our evergrowing investment ecosystem. You aren't on an island anymore, and our community is here to help you make informed decisions in a complex world.

More Reads
What will the Metaverse be in five years?
Image

The metaverse is here to stay as the next iteration of the internet. While an older generation may not see why this is the next technology, a younger generation and their parents are seeing the transition.

Virtual Events in the Metaverse
Image

People are more than ever going to live events, but virtual events are seeing an uptick in 2024. With new ad revenue streams in works, virtual events could see a new resurgence.

Metaverse ETFs
Image

While the Metaverse megatrend is looking promising in 2024, the collapse in metaverse investments prices in 2021 and 2022 caused at least three metaverse themed ETFs to liquidate.

Microsoft and the Growth Explosion
Image

Microsoft is an amazing stock for new investors to try. The company has evolved, acquired, and developed a multifaceted set of businesses that are fundamentally driving growth. But for new investors, the barrier to entry is mindset.

AGCO Group - The Pure-Play Farming Stock May be too Hot!
Image

The stock’s intrinsic value clearly shows the cyclicality of the farming industry, independent of AGCO’s own analysis. Agco’s analysis also takes into account the farming industry cyclicality.

Littelfuse - Undervalued Opportunity to Hold for Years
Image

Littelfuse (LFUS) is a component manufacturer currently near a $6 Billion market capitalization. This makes it a small-cap stock, with the potential for further growth in its market segments or to be bought out by a competitor.

Dover Corporation - Great Dividend Stock but Possibly Overpriced
Image

Dover Corporation is a strong investment candidate thanks to its consistent dividend growth, its robust financial performance, and strong capital implementation plan. This stock fits into a strong dividend portfolio well that plans on holding onto stocks for multiple years.

Is BorgWarner a Buy?
Image

BorgWarner fell below $30 today, making it an interesting buy opportunity. The reasons are quite straightforward. The company’s book value per share is $25.36 a share. This means that as long as money continues to be made, BorgWarner becomes undervalued if it nears its book value per share.

Union Pacific is Going Nowhere
Image

Union Pacific is not a buy to start off 2024. Union Pacific is a fine business. There are issues but nothing that is significant enough to believe the company’s intrinsic value will shrink in the next decade.

Dividend Stock Watch List: Lanny’s February 2024 Edition
Image

Dividend investing happens, whether the stock market is up or down, whether the fed raises interest rates or lowers. Inflation or deflation. Banks are failing or being bailed out. Recession, no recession. It’s all about buying dividend income producing stocks – the best source of passive income source on your journey to financial freedom!

January 2024 Stock Considerations
Image

With a new trading year already in full swing it is time, once again, to highlight some of my potential stock purchases for the month.

5 Reasons Not to Use ChatGPT for Financial Advice
Image

It’s truly amazing how far AI has come in such a short period. Not only can it answer most questions, but it can also generate online posts, research papers, and even poetry. However, it still has its limitations.

The Zen Ten - My Top Picks for 2024
Image

I've managed to beat the market by an average of 3.7% per year over the past 10 years. Since I began using this list with clients in 2000, I’ve beaten the market by an average of 9.1% per year.

5 Key Benefits of Long Term Investing in Dividend Stocks
Image

Overall, long-term dividend investing in individual dividend stocks can be a reliable and potentially lucrative way to build wealth and generate passive income over the long term

You Can Be an Excellent DIY Investor
Image

First, save money to invest. That is: don’t spend everything that you make. Next, invest consistently in a reasonable way. That’s it! That’s all it takes to be an excellent DIY investor!

IBM Dividend Safety Analysis
Image

International Business Machines (IBM) is a stock investors love to hate. But after years of underperformance, the share price has recovered to levels last seen in early 2017.

Thermo Fisher Scientific Consistently Creates Shareholder Value
Image

Thermo Fisher’s share price can be volatile. Just before Christmas 2021, for example, TMO’s share traded above $660. At the beginning of March 2022, however, the share price had plummeted to ~$530.

Western Alliance Bank: A Golden Opportunity if we can just Stay Calm
Image

As Western Alliance has dropped from the headlines, the company’s stock has begun to rebound. The stock received a bump after each earnings announcement by reporting the “business as usual”. As we will see, if Western Alliance can continue business as usual, the bank may be a fantastic investment opportunity.

Is Southern Company a Buy?
Image

Southern Company’s price target is neutral at $70. Expect the utility’s price volatility to peak at plus or minus 20% from this price target but not improving too far past this price point for the next few years.

Is Atkore Inc (ATKR) a Buy?
Image

Atkore is an intriguing stock to analyze. It is well liked by institutional investors and value investors due to its high return on equity and consistent earnings growth.

Resources for Publishers
Resources for New Investors
Boosted with BossCoin
Financial Literacy Leaders
user_profile
Tom Hamilton
user_profile
Wise Intelligent
user_profile
Mark Robertson
user_profile
Kevin Matthews II
user_profile
Akeiva Ellis
user_profile
Brendan Dale
user_profile
Kenneth Chavis IV
user_profile
Sharita Humphrey