Persistent inflationary pressure reading has been hitting headlines across the developed markets for more than a year. Though price levels started cooling this year, the figure is still stubborn. Annual inflation rate in the United States accelerated to 3.2% in July 2023 from 3% in June, but below forecasts of 3.3%. It marks a halt in the 12 consecutive months of decline.

Though the Fed hiked rates by only 25 bps in July, the U.S. Central bank chief clearly stated that inflation is still elevated. The Fed also indicated that some additional policy firming may be appropriate, should the need be as there is “upside risks” on inflation.

Against this backdrop, we suggest a few sector ETFs that can be worth investing at the time of higher inflation. Below we highlight those.

Sector ETFs in Focus

Energy – iShares U.S. Oil Equipment & Services ETF (IEZ Quick QuoteIEZ - Free Report)

The energy sector, which includes oil and gas companies, has historically offered upbeat performance in a rising inflationary environment. Such firms beat inflation 74% of the time and delivered an annual real return of 12.9% per year on average, per a research report of Hartford Funds.

The revenues of energy stocks are tied to energy prices, a key component of inflation indices. This time also, rise in oil prices increased inflation globally. Oil is likely to hit $91 per barrel by the end of the year amid record demand and tightening supply, according to UBS strategists, quoted on Yahoo. And energy ETFs should emerge outperformers. IEZ is up 5.3% in the past three months (as of Aug 16, 2023).

Real Estate – Hoya Capital Housing ETF (HOMZ Quick QuoteHOMZ - Free Report)

Per a research report of Hartford Funds, equity REITs outperformed inflation 66% of the time and posted an average real return of 4.6%. Equity REITs own real-estate assets and may provide a limited inflation hedge via the pass-through of price increases in rental contracts and property prices.

Notably, shelter makes up 32.77% of U.S. consumer price index, of which 7.8% is rent and 23.68% is private housing, per data from MacroMicro. Shelter costs rose 7.7% in July. The fund HOMZ added about 10% in the past three months (read: Sector ETFs Likely to Gain on July Inflation Data).

Materials – First Trust Materials AlphaDEX ETF (FXZ Quick QuoteFXZ - Free Report)

The Materials sector is riding higher on higher demand for materials and will likely continue its trend as the economy gains steam. The sector has been underinvested for long. The valuation of the sector is still cheaper even after beating the S&P 500 in the past year. Moderate supply chain woes and the resultant high inflation will keep the prices of materials higher.

Basically, these companies tend to own physical assets and sell commodity-based products. Since the value of their assets and the prices of their products increase with inflation, their stock prices become beneficiaries of inflation. The fund FXZ is up 7.3% in the past three months.

Consumer Staples – Consumer Staples Select Sector SPDR ETF (XLP Quick QuoteXLP - Free Report)

This sector is also believed to perform better in a rising inflationary environment. The sector has historically delivered positive performance in such a situation. Staples companies tend to pass their rising input costs to customers. And since the sector is non-cyclical in nature, the demand for its products remains steady in any economic condition.   

The food index increased 0.2% sequentially in July. This shows that high food prices are also driving U.S. inflation. Investors thus can play consumer staples ETF XLP as it is non-cyclical in nature and the companies within the fund have the ability to pass on higher prices to consumers.