Message from Companies: Growth with Inflation Is Coming

Friday, December 4, 2009

338064_ml_t4Leading companies necessarily need to look out many years into the future. Planning and implementing research & development projects, capital investments and corporate strategies cannot be done quickly. So, when a new trend begins, we need to take notice. A broad-based corporate activity now is vertical integration – the expansion of firms down (e.g., into raw materials) and up (e.g., into distribution)…

The Wall Street Journal has an excellent article, “Companies More Prone to Go ‘Vertical’” (December 1, page A-16), in which it describes the moves being made by many leading companies in a variety of industries.

(By the way, don’t let the fact that the article was on A-16 mean it is less important. This placement is a common characteristic of leading edge articles: a single mention not on the front page. This is why looking only at the front page headlines can miss key investment information.)

I won’t repeat what is covered in the article. Rather, I want to get into is what we, as investors, can deduce from these activities.

First, corporations see growth coming. They have decided that control over the whole process will enhance their growth potential and profitability. Naturally, this means they believe their common stocks are great investments.

Second, corporations want inflation protection. High inflation with a non-integrated process is problematic, with each company fighting the others to ensure its profitability by controlling costs and raising prices (the late 1970s and early 1980s was just such an environment). A vertically-integrated process changes this growth/survival activity to a simple accounting task to measure each division’s profitability. Vertical integration also lessens high inflation’s added risks, such as price controls and rationing. Company managements are acting now to ensure they can continue to focus on the business and overall profitability in case high inflation returns.

So, there are two important investment actions to consider:

  1. We should be looking at stocks, particularly where management is moving to vertical integration, for both growth and inflation protection.
  2. We should be wary of bonds, where inflation-caused losses mean a double whammy: prices down as interest rates rise to compensate for inflation AND purchasing power down as inflation decreases real income.

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