Inflation has been a relatively minor concern for U.S. investors since the late 1970s and early 1980s, when the Federal Reserve Board reined it in with a spike in interest rates that sparked a deep recession. Now inflation is emerging as an increasingly big threat in 2019. Economists at JPMorgan Chase believe that inflation is trending higher than the target zone set by the Federal Reserve Board, which is committed to keep it in check by hiking interest rates, The Wall Street Journal reports. Higher interest rates, in turn, will crimp the profits of non-financial companies, reduce stock valuations, and cause a general slowdown in the economy.

Significance For Investors

The consumer price index (CPI) was unchanged in November compared to October, but up by 2.2% from a year ago. Core inflation, which excludes food and energy prices, which tend to be volatile, was up by 0.2% from the prior month and by 2.2% from a year ago. Using a slightly different measure, the Fed is targeting 2% annual inflation, and JPMorgan Chase sees several forces that will raise it to 2.4% by the second quarter of 2019, which they believe is the upper end of the Fed's "comfort zone," as the WSJ puts it.

With the unemployment rate at 3.7% and trending downward, wage increases are an important contributor to the overall inflation rate. Goldman Sachs sees unemployment falling to 3.1% in 2021, per a previous Investopedia article. While rising wages are increasing consumers' incomes, they also are cutting into their spending power by raising the costs of services, as well as domestically-produced goods with high labor inputs. Additionally, new tariffs are raising the prices of imported finished goods and components, also contributing to inflationary pressures.

Meanwhile, renowned investor Warren Buffett once called inflation, per CNBC, "a gigantic corporate tapeworm" that consumes investment dollars by making a given volume of business increasingly costlier to produce. Other remarks of his over the years about inflation, per the same source, include: "high rates of inflation create a tax on capital that makes much corporate investment unwise," and "inflation is a far more devastating tax than anything that has been enacted by our legislatures."

According to Buffett, there is an "investor's misery index" that equals the rate of inflation plus the tax rates on dividends and capital gains. "When this index exceeds the rate of return earned on equity in the business, the investor's purchasing power (real capital) shrinks even though he consumes nothing at all," he elaborated.

One way for investors to protect themselves against inflation is to look for stocks that normally benefit from rising prices and robust economic growth. Since the prices of oil and metals tend to increase in such an environment, energy and mining stocks usually perform well, per TheStreet. Carrizo Oil & Gas Inc. (CRZO), down 29% from its 52-week high, and mining firm BHP Billiton Ltd. (BHP), down 12%, are suggested in that article. Noting that inflation tends to raise interest rates and widen profit margins for banks, the article also mentioned Wells Fargo & Co. (WFC), down by 30% from its high.

Looking back at history, the annual rate of increase in the CPI peaked at 13.5% in 1980, per the Federal Reserve Bank of Minneapolis. The Fed responded with massive interest rate hikes that sent the U.S. economy into its deepest economic downturn, up to that point, since the Great Depression of the 1930s. The fed funds rate exceeded 22% at several points in the first half of 1981, per Macrotrends,

Looking Ahead

Noting that his preferred acquisitions are "businesses that produce cash, not those that consume it," Buffett has stated, per CNBC, that companies with rich cash flows are those best-positioned to thrive "as inflation intensifies." In an inflationary environment, he also has observed that the best performers will be businesses with:

"(1) an ability increase prices rather easily (even when product demand is flat and capacity is not fully utilized) without fear of significant loss of either market share or unit volume."

"(2) an ability to accommodate large dollar volume increases in business (often produced more by inflation that by real growth) with only minor additional investment of capital."