ASX shares, it would seem, weren't overly worried about the sharp spike in inflation reported by the United States Labor Department on Thursday.
In Friday's trade, the All Ordinaries Index (ASX: XAO) closed up 0.24%. The All Ords is now up 8.97% so far in 2021.
Biggest US inflation leap in 13 years
ASX shares were up on average despite the world's largest economy reporting a 0.6% rise in the consumer price index (CPI) in May. Year-on-year that brings the US inflation rate to 5%. That's the biggest 1-year inflation leap in the US since 2008.
On the surface that may sound rather alarming. But dig a little deeper and you'll find some rather unique reasons for the year-on-year price spike that could well mean it's a short-term issue.
eToro market analyst Josh Gilbert told the Motley Fool he expects the spike in most prices to be transient.
According to Gilbert:
Many of the drivers are one-offs, such as US inflation being at 0.1% in May 2020. Or supply disruptions, such as semiconductor chips or shipping rates due to the blocking of the Suez Canal.
We're also seeing dramatic year-over-year swings in oil, which went from near zero to US$72 a barrel, as well as broader commodity prices rises. Many of these will work themselves out in the coming months as economies and supply chains normalise. In the case of commodities, they're too small to have a large impact, as economies and inflation baskets have become a lot less commodity-dependent.
eToro is expecting US headline CPI to come in at a little over 3% in 2021 and fall back to around 2.5% next year.
Which ASX shares will struggle with higher inflation?
Gilbert points out that the news flow around inflation is leading to higher volatility in US markets. As the ASX tends to take its lead from US markets, we won't be immune here in Australia.
"Investors should expect periods of volatility over the next few months as uncertainty sweeps through the market," Gilbert told us. "Global markets see US inflation pressure as a view that rates will rise across the world sooner than expected."
So which ASX shares will face strong headwinds in a higher inflation environment?
According to Gilbert:
Growth and tech stocks are most at risk from inflation. These sectors have been the stocks in focus for the last few years. With bond yields low, we see that investors are willing to pay a premium for these stocks, as they look to capitalise on returns over several years rather than settling for lower rates with bonds.
When bond yields rise, as we are currently seeing, investors rotate into cyclical sectors and expect much faster returns from these growth stocks. The environment we are in highlights more than ever that investors should have a diversified portfolio. Big tech is currently being supported by clean balance sheets and strong earnings that support high valuations.
Which ASX shares could benefit with higher inflation?
The underlying concerns about inflation aren't so much that prices may rise a bit above the 2–3% annual target rate set by the Reserve Bank of Australia. It's that commercial banks will lift lending rates to at least match the pace of inflation.
If the cost of money goes up, ASX shares that have been in favour for their potential to deliver large gains down the road, even though they're unprofitable today, could find investors turning to shares that are already turning smaller profits.
Gilbert told the Motley Fool:
The focus across the broader market would be to continue to look at value stocks. Areas such as consumer discretionary, financials and energy will lead the market performance through 2021. They have more room for earnings growth, cheaper valuations and provide upside to the re-opening of economies.
