June 1, 2022
Inflation in the U.S. has accelerated over the last 18 months to a high of 8.5% in March (8.3% in April), a level that was last observed in the early 1970s.1 In response to this surge, the U.S. Federal Reserve instituted a series of interest rate hikes (shown by the slight uptick in rates in the chart below) in an attempt to slow down inflation without further endangering the post-COVID 19 economic recovery.
And while inflation has been surging, the economic recovery has sputtered, with gross domestic product (GDP) contracting 1.4% (year-over-year) in the first quarter of 2022.2 On a historical basis, defensive sectors such as healthcare, consumer staples and energy have benefited the most in times of rising inflation. Information technology (IT) was the other sector with positive excess returns during periods of rising inflation and performed even better in falling-inflation environments.
However, when inflation and economic growth trends were combined, the outcome was slightly altered. On average, the defensive sectors that performed well in rising inflation environments (healthcare, consumer staples and energy), continued to benefit during periods of slowing growth, which was in line with their defensive bias. On the other hand, while IT typically did well in periods of rising inflation, it lagged in periods of rising inflation and lower growth. One sector outlier is utilities, which generally underperformed during periods of high inflation and rising growth but did well in lower-growth environments with high inflation due to its regulated nature and consistent dividends.
As shown in the chart below, energy, utilities and consumer staples have been the best-performing sectors year-to-date, with the recent energy-sector surge largely idiosyncratic and linked to a supply shock from the Russia-Ukraine war and associated international sanctions on Russia.
While research and historical analysis can help us understand U.S.-sector performance, evaluation has become increasingly difficult with soaring inflation that will continue to impact consumer spending and influence the Fed’s actions. Interest rate hikes by the Fed could influence the economic growth outlook and may lead to any number of economic regimes. The resulting regime, in turn, may impact the performance of equities, since economic growth, inflation and interest rates affect companies’ cash flows. The impact on cash flows will vary by sector, depending on their ability to adjust prices for inflation and how economic growth impacts the demand for that sector’s products and/or services.
USA Federal Reserve Effective Rates
Source: FRED, Federal Reserve Bank of St. Louis, as of April 2022
MSCI USA Sector Indexes Performance
Source: MSCI, monthly net returns in USD, as of April 2022
Chart 43 footnotes
1U.S. Bureau of Labor Statistics
2U.S. Bureau of Economic Analysis