These stocks may outpace the S&P 500 if inflation continues to slow

Since there have been only a couple trading sessions since this week’s report, we have only early indications of how the stocks mentioned in March are now performing. But since the report, they on average have nearly tripled the return of the benchmark S&P 500 Index
SPX.

For this column I am going through the same process I did in March, producing an updated list of stocks that should do well in a declining-inflation environment.

I’m not predicting that the trailing-12-month inflation rate will fall in each of the next number of months. It’s likely that some individual months will see an uptick. But I think there’s a good chance that inflation will be much lower a year from now than it is today. The inflation-forecasting model from the Cleveland Federal Reserve Bank, which is based on a number of inputs such as Treasury yields, surveys of professional forecasters and inflation swaps, is projecting that CPI inflation over the next 12 months will be 3.3%.

To review how I came up with my March list of stocks that should do well when inflation is receding: I analyzed the historical returns of a number of different stock-picking styles — growth, value, small-cap, large-cap, high momentum and low momentum, to name a few. Only if a particular style consistently reacted in one way when inflation was rising and the opposite way when it was declining did I consider it of potential interest.

Based on data back to 1963, only two such styles emerged: Small-cap and low momentum. Specifically, I found, small-cap stocks tend to outperform the large-caps in declining-inflation environments, and low momentum stocks tend to outperform high momentum stocks. (You will notice that, contrary to a widespread narrative on Wall Street, the growth and value styles didn’t emerge from my tests. That shouldn’t come as a surprise, however, as I argued last month in a column for Barron’s.)

Since not all small-cap low-momentum stocks are good bets, I focused only on those that are currently recommended for purchase by at least two newsletters monitored by my performance-auditing firm. I further narrowed the list to include only those whose market caps are no bigger than the largest in the Russell 2000 index (a standard benchmark for the small-cap sector) and only those that historically have exhibited a tendency to do well when momentum strategies are struggling.

The stocks that survived this winnowing process are listed below, in ascending market cap order.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected].