Banks make a substantial portion of their money from interest, so it might seem like an inflationary environment (which is usually accompanied by rising rates) could be a good thing for them. However, that's not always the case. In this Fool Live video clip, recorded on April 12, Fool.com contributor Matt Frankel, CFP, and Industry Focus host Jason Moser discuss why banks can help hedge your portfolio against inflation -- but only to a point.
Matt Frankel: Bill says, do you consider financials to be inflation hedges? Are insurance companies or banks more or less negatively or positively responsive to inflation? As far as profitability, they are absolutely inflation hedges, but I'd put a big asterisk on that. They are inflation hedges to a point where that if you have a manageable level of inflation, it usually produces margin expansion for banks. If the going rate for an auto loan right now is 3%, and then a year from now, it's 5%, banks are going to be making more money off auto loans. The caveat I would put in there is if inflation rises too fast, it has a big adverse effect on consumer demand a lot of the time. It doesn't matter if you can charge 10% on an auto loan if nobody's buying cars. I would put them in the inflation hedge category as long as inflation is manageable. The best time to own bank stocks since the financial crisis was the time when the Fed was raising interest rates every quarter, which I think was what, 2018, 2019 around there.
Jason Moser: Something like that. I mean, we always talk about that. The banks having difficult time at low interest rate environment with profitability and those rates start ticking back up that makes a little bit easier for them.
Frankel: The key is, if inflation is rising at a manageable rate, it's good for banks. If inflation is rising in a very strong economy, it is good for banks. If inflation's rising and it leads to a recession, it's not good for banks. In that way, I wouldn't call them a hedge. As far as insurance companies, the primary way most insurance companies make their money and I'm not talking Berkshire Hathaway or Markel or the ones that are invested in other stuff, most insurance companies make their money from investing their float in the meantime, before they're paying out claims. The way they usually do it is fixed income. In times of inflation, fixed income instruments tend to pay more. I'd put insurance companies in more of the hedge category because they provide something that's an essential service. People need to keep paying their car insurance no matter what the economy is doing. People don't need to take out a loan to buy a new car during bad times if their old car is working fine. I look at insurance companies as more of an essential business during inflationary times that tends to do well. They both depend somewhat on the health of the economy. But I wouldn't exactly put them into hedge basket, but they're definitely better to own during inflationary periods than say, tech stocks or things like that.
