Stocks that are effective in protecting portfolios against inflation share certain characteristics. These characteristics include a durable competitive advantage, pricing power and capable management. These companies in the consumer space have the ability to raise prices without it negatively affecting revenues due to their leadership in the market and strong brand awareness. Companies in pharmaceuticals also have pricing power and monopolies when drugs first come on the market.

Inflation

Inflation leads to lower real returns. Over time, this can be a serious drag on performance and hamper the ability of investors to meet retirement and other financial goals. Therefore, it is prudent for investors to prepare for this possibility. In many ways, financial advisers and investors have been conditioned to not take inflation very seriously; inflation and interest rates have steadily trended lower from 1981.

Investors and funds that aggressively bet on inflation were disappointed during this time frame, as long-term inflation has been consistently tepid. The market has very modest expectations for inflation going forward. This is evident in the yields of various durations of U.S. debt. For example, as of July 2015, the 30-year Treasury note (T-note) was yielding 2.96%.

The long-term average of inflation is 3%. Therefore, the real return is negative assuming normal levels of inflation. Clearly, the market does not fear inflation in the next 30 years based on the yield received from Treasurys. Only time will tell whether the market's forecast will be correct. However, it does provide an opportunity for investors who are wary about inflation to pick up protection.

Moderate levels of inflation can be healthy for the economy, as it supports of increased spending. In response to the increased spending, businesses expand operations, increase production and boost hiring, which feeds back into increased spending. As this phase continues, upward pressures on prices may emerge as tightness develops in labor markets. Interest rates also rise in conjunction with rising prices and the growing economy. However, at some point, high interest rates and inflation begin to deter growth leading to decreased spending.

The Clorox Company

At this point, may companies struggle and are unable to adapt to the changing environment. Consumer staples and pharmaceuticals are well positioned to survive in these environments as spending on these products is not tied to economic growth. Rather, they sell products that are necessary for human life, such as medicine, cleaning supplies or household items. This also gives them the ability to regularly raise prices.

The bulk of Clorox's (NYSE: CLX) sales comes from selling products such as laundry detergent, charcoal cat litter, and household and industrial cleaning supplies. This makes Clorox ideally suited to protect portfolios from inflation, as the company is able to raise prices due to customers' constant demand for these products. Due to exceptional management, Clorox has exceeded this bar by lowering costs in addition to raising prices. The company has raised dividends nearly every year since 1987. As of July 2015, Clorox's annual dividend payout is $3.08. Investors in Clorox can count on its dividend to continue growing faster than inflation.

Gilead Sciences Inc.

Gilead Sciences (Nasdaq: GILD) is one of the fastest-growing companies in history due to its success in developing blockbuster drugs. The company works through different channels, such as partnerships with other companies, research and development, and acquisitions to continue innovating. With most spending on pharmaceutical coming from Medicaid and Medicare, this is also immunity to economic weakness. Inflation in the drug sector is more than double the inflation in the broad economy. Gilead is one of the biggest beneficiaries of this discrepancy.

Johnson & Johnson

Johnson & Johnson's (NYSE: JNJ) major sources of revenue are in consumer staples and pharmaceuticals. Like Clorox, the company has a consistent record of raising dividends, tangible evidence of its ability to protect against inflation. The company offers growth in terms of revenues while paying yields that are above Treasury yields. This combination makes Johnson & Johnson a good choice for an inflation hedge.

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