Here’s how I’d protect my FTSE 100 portfolio from an inflation shock

The FTSE 100 index started the day weakly and is currently at muted 6,900 levels. Fears of rising inflation are reportedly responsible for this. Here’s why.

US reports ugly inflation numbers

Yesterday, the US reported a 4.2% annual consumer price inflation rate for April. This is an ugly number for at least four reasons. 

One, it is the highest since September, 2008. 

Two, it is well ahead of economists’ expectations of 3.6%. 

Three, it is a sharp increase compared to the 2.6% year-on-year inflation seen in March, 2021. 

And importantly, four, it is well above the federal reserve’s 2% target.  

An inflation rise was always expected. I mean, we need to look no further than the oil price increases through 2021. And we have a rise in industrial metals’ prices since last year.

Also, updates from company after company that I have covered in recent weeks have flagged inflation as a growing concern. 

The shock comes from the extent and the speed with which it has happened, bringing the bears back out.

What does it mean for FTSE 100 stocks

For FTSE 100 companies — or any others for that matter — rising inflation translates into cost pressures. They can react in one of two ways. Either they absorb the costs, which results in lower profits. Or they pass the cost increase to end customers, which further fuels inflation. Also, depending on the nature of their customers, this may affect demand levels. 

More broadly, at an economy-wide level, rising inflation means that with the same amount of money in their hands, consumers can buy less. In other words, a sharp inflation increase runs the risk that the economy will slump as less can be bought. 

What happens next

And right now, of all times, that is too big a risk. This means that monetary policy can kick in soon, if these inflation rates are sustained.

But that is only if high inflation is sustained. So far the Fed has adopted a wait-and-watch approach, while the economic recovery takes root. If the recovery does not turn out to be as immediate as expected, inflation numbers could subside. 

How I’d prepare for high inflation

But I think as investors, we need to ensure that our portfolios are protected from inflation in any case, since the threat has come up. 

In recent days, I have talked of multiple stocks that can be good hedges. Oil stocks, industrial miners and stocks of high brand value companies are some examples. Even banks can be considered, for now. Admittedly debatable, but cryptocurrency miners, have also been talked of as an inflation hedge recently. 

Another way to protect a portfolio is to closely assess the prospects of those stocks that can be affected by inflation. This includes consumer discretionary segments like non-essential retailers, supermarkets, pubs and restaurants, food delivery and travel stocks. If they are likely to be impacted significantly, I would think twice before buying them.