The rate of inflation did not rise last month, but this looks set to be a pause for breath rather than an end to its recent rise. Since the EU referendum, the rate of inflation has risen from 0.8% to 2.3%, with a higher figure forecast by the Bank of England.
Income investors could therefore face difficulties in obtaining a real-terms income return over the medium term. Similarly, investors in consumer goods sectors could see their portfolio valuations coming under pressure if higher inflation squeezes consumer spending.
Despite this, higher inflation could present an opportunity rather than being a problem for Foolish investors. Here's how to overcome it.
While a higher rate of inflation means that dividend yields are worth less in real terms, income-seeking investors can still stay ahead of price rises over the medium term. One means of doing so is to focus on companies which are forecast to grow dividends at a relatively high rate.
In some instances, double-digit dividend growth is anticipated on an annual basis in 2017 and 2018. While such companies may not have the headline-grabbing dividend yields which historically popular income stocks offer, their share price performance and overall returns could allow Foolish investors to outperform the wider market.
In fact, a higher rate of inflation could signal the transition of income investors away from high yields and low single-digit dividend growth and towards stocks with lower yields but which are expected to raise shareholder payouts at a rapid rate. Therefore, an opportunity to generate above-average returns could be on the horizon.
A higher rate of inflation is likely to cause consumer spending to come under a degree of pressure. At the present time, wage growth is tied with the inflation rate, but this could easily change if inflation moves higher. In such a scenario, consumer disposable incomes will fall in real terms and this could lead to lower spending on consumer goods and particularly on non-essential items.
On the one hand, this could mean that consumer goods companies are worth avoiding. However, on the other hand it could present an opportunity for long-term investors to pick up bargains. While the short term may prove disappointing and earnings forecasts may be downgraded across the consumer industry, valuations are likely to offer wide margins of safety which suggest significant upward re-ratings are on the cards.
A higher rate of inflation is possibly the most significant change affecting investors at the present time. While it brings a degree of difficulty, it also presents an opportunity. It is still likely to be possible to generate inflation-beating returns, but the onus may be on dividend growth rather than a high headline yield.
Similarly, buying troubled consumer stocks could be another means for Foolish investors to benefit. Either way, successfully adapting to a higher rate of inflation is likely to be a necessity in 2017 and beyond.
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