To The Moon

The scare of inflation is threatening the S&P 500. But if you know what to expect, signs of rising prices aren't always kryptonite to your portfolio. And that's if you should worry at all.

It turns out S&P 500 sectors follow a fairly predictable playbook in times of rising prices. If you're worried about inflation, S&P 500 sectors like energy, materials and real estate provide some safety, analysts say. "Investors have used the threat of a spike in inflation, and now the confirmation from ... surprise strength in headline and core Consumer Price Index readings, to take profits in stocks," said Sam Stovall, strategist at CFRA.

But knowing the facts goes a long way in dealing with any potential market shocks, including inflation.

Know The Reality In Inflation Numbers

It's important to understand what inflation numbers are truly telling you before you panic. It seems like many S&P 500 investors calmed down after digging into inflation numbers more closely. The world's most popular index jumped more than 1.2% Thursday, making up the bulk of Wednesday's 2% freak-out sell-off.

At first glance, inflation numbers looked scary. The 4.2% jump in headline inflation and 3% rise in core inflation was much more than anyone thought. Core inflation hasn't jumped that fast on a year-over-year basis since 2008, Stovall says.

But a big piece of the rise is due to the 21% jump in annualized used vehicle prices, says Nicholas Colas, co-founder of DataTrek Research. And that jump is due to new vehicle shortages arising from a shortage in semiconductors. Backing out this short-term disruption, headline inflation was a much more normal 3.6%, he says. Meanwhile, the unusual 49.6% jump in April gasoline prices added to the distortion.

The inflation number "just doesn't hold up to scrutiny as a warning bell about inflation," Colas said.

Understand How The S&P 500 Reacts To Inflation

Out-of-control inflation is widely feared. But times of lingering 5%-plus annual inflation are rare. Only twice since 1928 has U.S. inflation lingered: 1941 through 1951 and 1969 to 1982, Colas found.

Were these periods devastating for the S&P 500? Hardly. The S&P 500 jumped 310% from 1941 to 1951, that's 121.1% adjusted for inflation, Colas found. Even in the 1969-to-1982 period, seen as a terrible time for inflation, the S&P 500 actually rose 176%. Yes, that's a loss of 11.6% adjusted for inflation, but it's hardly catastrophic especially for those who enjoyed the 1980s bull.

Inflation itself doesn't steer the S&P 500. The reason for inflation matters more. Prices rose in the 1940s for "good reasons" like an post-war boom, Colas said. But in the 1970s, energy price hikes were largely a tax on the economy.

"Markets are volatile because they're not sure which sort of inflation we have at present, or what (if anything) the Federal Reserve may do to bring inflation down," Colas said. "That's enough uncertainty to create the volatility we're seeing, but not enough to say equities will necessarily underperform inflation in the years to come."

Look To The 1970s For S&P 500 Clues (But Not Gospel)

S&P 500 investors like to look back at the 1970s for a playbook for inflation. And it wasn't pretty, but it's not as devastating as many think either. And there were actually places to make big gains.

During the 1970s, the S&P 500 posted an average monthly loss of 0.3%, Stovall says. But over the entire period, the S&P 500 rose 17.2%. That's just 1.6% annualized, or a fraction of the S&P 500's typical 10% yearly return. S&P sectors, though, hold clues or how markets can shift, Stovall says.

It turns out even during the "bad" inflation of the 1970s, only one of the 11 S&P 500 sectors fell on an average monthly basis. That sole loser was financials, which lost 0.8% monthly on average during the 1970s.

So where where the places to be? S&P 50 energy, materials and real estate all posted average monthly gains of 1% or higher during the 1970s, Stovall says. Materials company Nucor gained 2,830% during the 1970s. That's more than any current S&P 500 members did at the time. Meanwhile, energy firms Schlumberger and Baker Hughes jumped 1,032% and 856%, respectively, during the 1970s.

Source: CFRA

Don't Overlook S&P 500 Commodity Strength

Digging deeper still, Stovall found robust gains in many commodities markets, even in the inflation-plagued 1970s.

Gold and precious metals companies in the S&P 500 posted average monthly gains of 3.9% in the 1970s. And aluminum companies rose 2% monthly followed by oil and gas drilling at 1.8%. And to some degree, investors are already nibbling on these areas. The Energy Select Sector SPDR is up 36.7% this year. That's the top run of any S&P 500 sector. Meanwhile, the Materials Select Sector SPDR is up 20% year to date.

Know, too, simply owning the S&P 500 may not offer great exposure to areas that held up to inflation before. These sectors hold small weights in the S&P 500. Energy holds just a 2.9% weight in the S&P 500. Meanwhile, materials account for 2.9% and real estate 2.5%. ETFs can fill in the gaps.

ETFs and exchange-traded notes, too, can offer inflation protection. The $60 billion in assets SPDR Gold Trust moves with the price of gold. The $3 billion in assets United States Oil Fund tracks the price of crude oil. And the iShares TIPS Bond ETF tracks U.S. Treasuries, adjusted for inflation.

But just know inflation, alone, doesn't determine S&P 500 returns. "Inflation is just one input into equity prices and returns, and on its own it explains very little about how stocks will do over the longer term," Colas says.

Top S&P 500 Stocks In The 1970s

Sources: IBD, S&P Global Market Intelligence