Inflation is now forecast to peak at over 7% in April, which naturally has many people worried about how that will affect their savings and investments. Meanwhile the average Cash ISA is currently paying just 0.34% in interest, so many people will be looking to the stock market to help fend off inflation. That certainly makes a lot of sense, because companies at least have the opportunity to pass price rises onto consumers.

PLAYING THE LONG GAME

Investors need to play a long game when using the stock market to beat inflation. Over the course of one year, there is absolutely no guarantee that an investment in the stock market will beat inflation. But over the longer term, investing in the stock market is one of the key defences savers have against rising prices.

Investors should also consider what kind of companies might prosper in an inflationary environment. Those with pricing power should be well placed to be able to pass their costs onto customers. Consider the fashion brand, Burberry (BRBY), for instance. If you’re willing to shell out £2,000 for a Burberry trench coat, chances are you’re in a wealth bracket where inflation is a dim and distant problem, so a few extra pounds on the price tag aren’t likely to put you off a purchase.

Investors might also think about investing in the key sources of inflation, in particular energy and raw materials. It would be hard to see inflation continuing to be elevated without these prices also increasing, which would be positive for producers like, for example, Shell (SHEL), or Rio Tinto (RIO).

Some inflationary expectations are already baked into share prices in these sectors though, which explains their positive share price performance in the last six months.

BANKS’ PROFITABILITY BOOST

Financials might be another area that could benefit from inflation, albeit indirectly. Banks, for instance, make a return out of taking deposits and lending them out, and the difference between the rates at which they borrow and lend should increase with rising interest rates.

Investors might be tempted to invest in commodities like oil and gas through ETFs (exchanged traded funds), but these funds normally use derivatives to gain exposure, and often come with complex costs which mean that there can be a disconnect between the price movement of the commodity and the return from the ETF. As such, they should only be considered by sophisticated investors who have a very good handle on how these ETFs work.

ALL THAT GLITTERS

Gold often comes to mind whenever inflation raises its head. Unlike barrels of oil and cubic metres of gas, gold bars are (relatively) easy to store, which means there are some ETFs available which hold physical gold, such as iShares Physical Gold (SGLN), so you don’t have to worry about the complexities of derivative pricing. Gold can be volatile however, and it has been trading at around $1,800 an ounce for most of the last year, which suggests the recent inflationary surge isn’t hugely impacting pricing. Partly that may come down to the fact higher interest rates aren’t good for gold, because it doesn’t pay an income, and cash and bonds therefore become relatively more attractive when interest rates are on the up.

As well as thinking where to invest in an inflationary environment, investors should consider where not to put their money too. Cash is necessary for short term spending needs, but clearly it’s very exposed to the ravages of inflation, so you should only look to hold an emergency buffer of three to six months expenditure. Government bonds, and in particular long dated government bonds, are also extremely vulnerable to rising interest rates, and so investors should review any exposure they have to this asset class.

EXPENSIVE STOCKS UNDER PRESSURE

We may also see some highly valued areas of the stock market struggle too. There are some stocks, particularly in the tech sector, where their elevated price is built on expectations of future earnings, rather than profits they are making in the here and now. Tesla is a good example. However inflation, and higher interest rates, make distant cash flows in years to come less valuable, and in fact this calendar year we have already seen some frothy areas of the market sell off as a result of this dynamic. Sustained inflation, or fast interest hikes, could see this play out again.

The Bank of England reckons CPI inflation will be back to 2% by 2024. Maybe so, but the Bank’s forecasting capabilities haven’t exactly won any awards in recent times.

Inflation is extremely unpredictable, and it is entirely possible it will tail off. Investors should therefore take a balanced approach with their finances, which means not betting the entire farm on a continued inflationary environment, while also picking some investments which can do well if inflation proves stickier than the Bank of England expects.

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