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Transitory Inflation May be Good for U.S. Economy: 6 Picks

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Nalak Das
·6 min read
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U.S. economy is on a recovery path in 2021 after suffering the largest yearly decline in 2020 since World War II owing to the coronavirus pandemic. However, the possibility of a faster-than-expected recovery, buoyed by a ramp up in COVID-19 vaccinations and a massive $1.9 trillion fiscal stimulus, have triggered expectations of higher inflation this year.

On Mar 17, the Fed in its FOMC minutes also stated the possibility but reaffirmed that it will keep the benchmark interest rate and bond-buying program steady through 2023. Meanwhile, a transient inflation, as described by the Fed, may turn good for the U.S. economy. Let's discuss briefly.

Higher Utilization of Resources

On Mar 17, Fed chairman Jerome Powell said the central bank expects the core PCE index — Fed's favorite gauge of inflation — to stay at 2.3%, higher than its 2% target rate. However, this inflation will be transitory in nature as the expectation of long-run inflation is 2%. Meanwhile, higher inflation means higher aggregate demand, which will enable businesses to deploy higher capital spending and recruit more manpower.

The U.S. economy is operating at a sub-optimal level since March 2020 owing to either full or partial lockdowns. The labor market, which was the best-performing segment of the economy before the pandemic, is still far below it pre-pandemic level. Higher recruitment by businesses will help the struggling labor market to stabilize faster.

Moreover, businesses can generate higher profit despite raising the wage rate. The spread between higher inflation and higher wage will increase their profit and in turn induce them to increase the scale of operation and lead to higher job creation.

Positive Effect on Business and Federal Debts

Theoretically, inflation is generally helpful for debtors as their repayment of loan will be less valuable in real term (after adjusting inflation) than their borrowed money. The Fed reported that U.S. business debt jumped 9.1% year over year in 2020 to $17.7 trillion. Moreover, the Federal debt soared 24% to a staggering $23.6 trillion last year.

Moreover, yields on long-term treasury notes are climbing on expectations of a faster economic recovery as investors are shifting to risky equities from safe-haven bonds. On Mar 18, the yield on 10-year U.S. Treasury Note surged to a 14-month high of 1.75%.

Consequently, higher market interest rate will compel financial institutions to lend more while a mild inflation will enable businesses to borrow more. This will lead to higher economic activities, more employment and higher GDP.

Possible Impact on U.S. Dollar

The ICE U.S. Dollar Index (DXY), a gauge of the greenback against a basket of six major currencies, surged nearly 2.5% year to date. In macroeconomic theory, higher inflation generally results in depreciation of a country's currency value in international market.

First, the purchasing power parity between two countries deviates as the purchasing power of currency of the country with higher inflation decreases, depreciating the value of its currency.

Second, Fed's decision to keep the benchmark interest rate as low as 0-0.25% and higher money supply through quantitative easing program (buying $120 billion of bonds per month) will depreciate the value of U.S. dollar making the country’s products more attractive internationally.

Our Top Picks

At this stage, it will be prudent to invest in cyclical stocks as high-flying growth/momentum stocks are likely to lose value with higher risk-free return. However, cyclical stocks will gain as U.S. and global economies reopen steadily.

We have narrowed down our search to six U.S. corporate behemoths (market capital > $100 billion) as these companies have a well-established business model and powerful brand value. These stocks have strong upside potential for 2021 and witnessed robust earnings estimate revisions in the last 7 to 30 days.

Moreover, all these stocks have strong long-term (3-5) growth prospects and are regular dividend payers providing an important income stream during a market downturn. Finally, each of our picks carries either a Zacks Rank #1 (Strong Buy) or 2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows the price performance of our six picks year to date.

Exxon Mobil Corp. XOM has an expected earnings growth rate of more than 100% for the current year. The company has a long-term growth rate of 9.5%. The Zacks Consensus Estimate for the current year has improved 12.2% over the last 7 days. This Zacks Rank #1 company has a current dividend yield of 5.86%.

Chevron Corp. CVX has an expected earnings growth rate of more than 100% for the current year. The company has a long-term growth rate of 5%. The Zacks Consensus Estimate for the current year has improved 25.3% over the last 7 days. This Zacks Rank #1 company has a current dividend yield of 4.78%.

Deere & Co. DE has an expected earnings growth rate of 82.5% for the current year (ending October 2021). The company has a long-term growth rate of 18.5%. The Zacks Consensus Estimate for the current year has improved 20.5% over the last 30 days. This Zacks Rank #2 company has a current dividend yield of 0.80%.

Caterpillar Inc. CAT has an expected earnings growth rate of 21.8% for the current year. The company has a long-term growth rate of 12%. The Zacks Consensus Estimate for the current year has improved 0.4% over the last 30 days. This Zacks Rank #2 company has a current dividend yield of 1.76%.

The Goldman Sachs Group Inc. GS has an expected earnings growth rate of 22% for the current year. The company has a long-term growth rate of 19.2%. The Zacks Consensus Estimate for the current year has improved 2.9% over the last 30 days. This Zacks Rank #2 company has a current dividend yield of 1.45%.

NIKE Corp. NKE has an expected earnings growth rate of 85.63% for the current year (ending May 2021). The company has a long-term growth rate of 19.3%. The Zacks Consensus Estimate for the current year has improved 0.3% over the last 7 days. This Zacks Rank #2 company has a current dividend yield of 0.76%.

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