By Numer de Guia, CFA With signs that inflationary pressures are building in the U.S. economy, how should equity investors respond? We've decided to spotlight a couple of different approaches in this column. Last time around, we looked at stocks with a history of rising profit margins -- suggesting that they maintain superior pricing power (see BW Online, 4/8/05, "Seeking Inflation-Resistant Stocks").
This week, we're taking a different tack. Instead of focusing on company fundamentals, we looked for stocks whose returns move in the same direction as the rate of consumer inflation. In other words, issues that have risen in price along with the rate of inflation, as measured by the urban consumer price index -- more commonly known as CPI -- the widely followed inflation indicator compiled by the Commerce Dept.
DECADE OF DATA. We searched the Standard & Poor's Super 1500 index (a gauge of the broader stock market comprising the S&P 500, S&P MidCap 400, and S&P 600 indexes) for stocks whose monthly returns are positively correlated with the monthly changes in urban CPI. We wanted to make sure we had a solid basis for the comparisons, so we used nearly a decade's worth of data for the calculations: monthly returns and inflation from December, 1994, to March, 2005. The CPI numbers were lagged one month to mitigate statistical "forward bias."
When we finished our search, these 19 stocks emerged. The positive correlations of the stocks on the list ranged from 0.15 to 0.23 (1.0 would represent a perfect correlation with the rate of inflation):
El Paso Electric
Watts Water Technologies
De Guia is an analyst for Standard & Poor's Portfolio Advisors