Industries that will be helped – and hurt – by inflation

Inflation will help commodity and real estate industries, hurt industries with high inventories, and put most other sectors in limbo. The worst impact of inflation will not come directly from the rise in prices, but indirectly from the reaction of the Federal Reserve.

Inflation is not cooked in the cake at this point, in mid-2021, but it is highly likely to accelerate. Not only in the coming months, but also in the years to come, will inflation increase as I wrote recently. Even business leaders who share the Fed’s view that inflation will be temporary will benefit from understanding the risks at the industry level.

Commodity prices rise disproportionately with headline inflation. Look for profit increases for mining companies. For example, expect a copper mining company to make higher profits. But processors and manufacturers will be tortured, paying higher costs, then collecting higher prices, then faced with another round of cost increases and another round of increases in their own prices. On average, their margins won’t change much, but the timing of cost and income changes can make their finances less predictable.

Commodity processors should also plan to use more working capital. A copper pipe dispenser, for example, can move as many pieces of pipe as it did before inflation. But if each part sells for twice as much as last year, the business needs twice as much working capital for inventory and accounts receivable.

Real estate companies generally also benefit from inflation. Mortgage costs are most often fixed, while rents will rise with headline inflation, which will help homeowners.

While many business leaders complain about rising costs, the prices they charge will also rise, leaving gross margins little changed. The biggest problem is with companies with large inventories. A store’s profit, for example, usually reflects the difference between retail and wholesale prices. In an inflationary environment, profit is both the gap between retail and wholesale as well as increasing prices while maintaining inventory. And this higher profit is taxable. But taxable inflation gains are not real. The company will replace recently sold goods with more expensive products.

The challenge for all businesses will be to manage uncertain economic cycles. Higher average inflation usually means a less stable real economy. For example, from 2010 to 2019, US GDP grew in a very narrow range, with a low of 1.6% growth and a high of 2.9%. During this period, inflation averaged 2%. But back in the 1973-1982 period, when inflation averaged 8.8 percent, GDP ranged from -2.7 percent to 4.6 percent. We have experienced three recessions during this period of high inflation.

The correlation between higher inflation and greater economic volatility has been found in international studies covering many different countries over many different time periods. If, in fact, US inflation rises and remains high for a decade, companies in all industries will experience more booms and more recessions.

Greater variation in the economy will disproportionately harm industries that tend to be more volatile. These include construction, business capital goods and durable consumer goods. At the other end of the range are relatively stable industries, such as healthcare, which will not be too affected by fluctuations in the economy.

Perhaps the hardest part of dealing with higher inflation and more economic fluctuations will be the change in attitude of leaders. The economy was exceptionally stable before and after the Great Recession, far more stable than most of our economic history. Business leaders certainly understand the risks they took during the Great Recession, but it was different living year after year with greater volatility in prices and unit sales. But get ready for it.