An Analysis of Inflation Threshold Effects on Sectoral Equity Returns: Insights for Investment Strategists

Abstract

This article investigates how equity returns respond to monthly inflation across nine sectors in the United States (January 1999–February 2024), utilizing the price return on ETFs (exchange-traded funds) as a hedge against inflation. The findings demonstrate that the effect of monthly inflation on returns is contingent upon the annual inflation level. We identify sector-specific inflation thresholds, ranging between 1.14% and 3.44%, which investors can use as pivotal points. Certain sectors stand to gain or lose when inflation remains below these thresholds. However, once surpassed, the influence of inflation turns the other way around or becomes insignificant. During high inflation, sectors like energy, consumer staples, and utilities are effective hedges. The findings suggest that consumer discretionary returns exhibit the highest sensitivity to inflation, consistently and unconditionally experiencing a negative impact as inflation rises within this sector. The findings provide useful information for investment and hedging strategists, utilizing sector-specific inflation tolerance levels to adjust sectoral weights effectively when transitioning from high to low inflationary regimes.

Keywords: Inflation Threshold Effects, Sectoral Equity , Investment Strategists