Inflation may make 2011 a stockpickers’ year

Stockpickers have been disappointed over the past year by the increasing correlation between stocks in the same sector. With inflation looming, that may be about to change.

Stocks with low margins and little bargaining power will be left squeezed by inflation. Stocks with high margins and strong bargaining power could do well.

If inflation increases, firms’ costs go up. However, if the economy is weak, and they cannot pass on costs to their consumers, firms may find themselves struggling with their profitability.

If a firm has a strong niche, either in the form of a brand or exclusive intellectual property, it may find it easier to charge more for its goods.

By contrast, if it has a more generic range of products, it may still defend its margins if it buys in bulk and can squeeze its suppliers. (article continues below)

With neither scale nor exclusivity, firms may struggle to retain their record profit margins, which have been boosted by ultra-low interest rates and a benign inflation in their costs – that is, in the unlikely scenario they didn’t slash them in the period 2008-2010.

As interest rates could rise this year to combat inflation, firms who haven’t refinanced may find themselves with lower pre-tax profits, or at least encounter greater restrictions as to how they can expand.

Companies who have retained some cash on their balance sheets may find this year more manageable than those with little.