Inflation has just hit the stock market again. What can investors do?

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On Friday morning, investors watched the latest Consumer Price Index (CPI) report closely as they hoped to see signs that inflation might finally start to peak. Unfortunately, that didn’t happen, as a 1% rise in the CPI in May took the index’s year-over-year increase to 8.6%, the highest ever. 40 years old. Stock market investors did not appreciate this unpleasant surprise and the futures markets fell sharply after the announcement. As of 9:15 a.m. ET, futures on the Dow Jones Industrial Average (^ DJI -2.25%) had fallen 412 points to 31,851. S&P500 (^GSPC -2.43%) futures had fallen 57 points to 3,959, and Nasdaq Compound (^IXIC -2.92%) futures were down 204 points to 12,071.

These moves may not seem that big, but they came even after jittery investors had already driven stock prices down significantly on Thursday. Since the bond market has also reacted negatively to inflationary pressures, many investors feel there is nothing they can do to protect themselves. However, there are some things to consider in your investment portfolio that can provide a viable long-term strategy.

The details of the inflationary peak

The latest report from the Bureau of Labor Statistics revealed many culprits behind the price hike. Most obvious to most consumers was energy, with gasoline prices rising 4.1% in the month. Food prices were also significantly higher, increasing by 1.2% between April and May.

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Food and energy prices are notoriously volatile, so while this is unrealistic from a household budget perspective, some economists prefer to focus on other prices. But even the core inflation figure that excludes these items rose 0.6% in May, with sizable gains in housing costs, air fares and new and used vehicles.

Some of the price increases have been really devastating to consumers. Fuel oil prices have more than doubled over the past 12 months and gasoline is up almost 50%. Food costs have also increased by a double digit percentage year over year.

Perhaps more troubling is that every component that goes into the CPI calculation has shown gains above the Federal Reserve’s target inflation rate. Even medical care costs, which remained largely contained during the inflationary surge, rose between 0.3% and 0.4% over the month. The danger that inflation could become an entrenched feature of the economy seems to be growing.

What is the right investment strategy for this market?

It has been difficult to find winning investments in today’s market. Most investors seek to have a balance of stocks and bonds in their portfolios, believing that the two markets have often moved in opposite directions during past downturns. However, the combination of macro stress and higher prices is unusual and has resulted in heavy losses for bond investors as well as the stock market.

In the short term, there are clear winners from high inflation. Energy companies are posting windfall profits due to high prices at the pump, with the energy sector the only sector to see strong gains in 2022. Utilities have also been resilient, as they are largely able to pass through higher costs to consumers directly through the regulatory bodies that oversee them.

However, the best thing for investors to do is think about which investments are being hit hard right now and which are best positioned for a rebound in a range of possible future scenarios. If the Fed succeeds in reducing inflation over the next two years, for example, hard-hit growth stocks will eventually see some relief. However, if the economy falls into recession, it could prolong the period of declining equity prices in many growth areas. This could make stocks that are currently at low valuations based on traditional metrics even more attractive.

Long-term investors whose strategies are adapted to the ups and downs of the economic cycle do not necessarily have to make changes. For them, short-term losses are simply part of the price you pay to reap longer-term profits over periods of years and decades. It’s not an easy philosophy to have, but it’s a philosophy that has worked for a very, very long time.

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