Banks get a significant portion of their money from interest, so it may seem that an inflationary environment (which is usually accompanied by a rise in rates) could be a good thing for them. However, it is not always the case. In this Fool live Video clip, recorded on April 12, Fool.com Contributor Matt Frankel, CFP, and Focus on industry host Jason Moser discusses why banks can help protect your portfolio against inflation – but only up to a point.
Matt Frankel: Bill says, do you see financials as hedges against inflation? Do insurance companies or banks react more or less negatively or positively to inflation? As far as profitability goes, these are absolutely inflation hedges, but I would put a big asterisk on them. These are inflation hedges to such an extent that if you have a manageable level of inflation, it usually produces margin expansion for banks. If the current rate on a car loan is 3%? 100, then in a year it’s 5%. The banks will make more money from auto loans. The caveat I would give here is that if inflation rises too quickly, it often has a negative effect on consumer demand. It doesn’t matter if you can charge 10% on an auto loan if no one is buying a car. I would place them in the inflation hedge category as long as the inflation is manageable. The best time to own bank stocks since the financial crisis was when the Fed hiked interest rates quarterly, which I think was what, 2018, 2019 around then.
Jason Moser: Something like that. I mean, we’re still talking about it. Banks are having a hard time in a low interest rate environment with profitability and those rates are starting to rise which makes them a little easier.
Frankel: The key is if inflation rises at a manageable rate, it’s good for the banks. If inflation rises in a very strong economy, it is good for the banks. If inflation rises and causes a recession, it is not good for the banks. That way, I wouldn’t call them a hedge. When it comes to insurance companies, the main way most insurance companies make their money and I’m not talking about Berkshire Hathaway or Markel or those who are invested in other things, most insurance companies make their money by investing their float in the meantime, before paying the claims. The way they usually do is fixed income. In times of inflation, fixed income instruments tend to pay more. I would put insurance companies more in the category of coverage because they provide something that is an essential service. People have to keep paying for their auto insurance no matter what the economy does. People don’t need to take out a loan to buy a new car during tough times if their old car is performing well. I see insurance companies as a core business in times of inflation and one that tends to do well. They both depend somewhat on the health of the economy. But I wouldn’t exactly put them in a hedge basket, but it’s certainly better to own them during times of inflation than to say tech stocks or things like that.
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