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Inflation in the United States picked up in December after dropping for two consecutive months. The Consumer Price Index grew at an annual rate of 3.4% in December, up from 3.1% annual inflation in November and the 3.2% reading expected by economists.

Higher costs for housing, energy, dining out, and car insurance led to an increase in inflation. Excluding volatile food and energy costs, so-called core prices rose just 0.3% from the last month, unchanged from November's increase. Core prices were up 3.9% year-over-year, down from November's 4% annual gain.

The data has dampened market expectations about an interest rate hike in March. Against such a backdrop, investors should focus on high-quality investing. Quality stocks and funds possess a sustainable competitive advantage and demonstrate consistent growth, profitability, and operational excellence over time. Below, we have highlighted solid reasons for investing in quality stocks and funds.

• Long-Term Outperformance: Historically, high-quality companies and funds consistently deliver superior risk-adjusted returns than the broader market over the long-term. This is because quality companies have strong fundamentals that can weather economic downturns better than their weaker counterparts.
• Consistent Profitability: Quality companies tend to have a high return on equity (ROE), return on invested capital (ROIC) and profit margins. These are indicators of a company's ability to generate profit consistently.
• Lower Volatility: Quality stocks and funds tend to exhibit lower volatility compared to the broader market. Their robust business models and financial strength make them less susceptible to market fluctuations, leading to a smoother investment journey.
• Defensive Nature: During economic downturns, quality stocks and funds often prove more resilient as they have strong balance sheets, low levels of debt, and cash reserves to tide them over during challenging times.
• Compounding Effect: Investing in quality companies allows investors to benefit from the power of compounding. As these companies consistently grow their earnings and reinvest them, shareholders can achieve exponential returns over time.
• Strong Brand and Moat: Quality companies and funds often possess strong brands and competitive moats, which protect them from competition. This can lead to a sustainable competitive advantage, ensuring long-term profitability.
• Transparency and Governance: High-quality companies usually have transparent financial reporting and sound corporate governance. This reduces the chances of any unwelcome surprises and can potentially reduce investment risk.
• Value Preservation: In uncertain or declining market environments, quality stocks and funds can serve as a relative safe haven, preserving capital better than more speculative or lower-quality investments.
• Growth Potential: Even if they are established leaders, many quality companies still have significant room for growth, especially if they operate in expanding industries or have opportunities to penetrate new markets.
• Dividend Payouts: Quality companies often have a history of paying consistent dividends, providing a source of income for investors. Moreover, since they are usually in a strong financial position, there's a good chance for steady or even increasing dividend payouts in the future.

ETFs to Invest In

While there are several funds available to invest in, we have highlighted five popular ETFs that may benefit from inflation.

iShares MSCI USA Quality Factor ETF (QUAL - Free Report)

With an AUM of $36 billion, this ETF provides exposure to large- and mid-cap stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth, and low financial leverage) by tracking the MSCI USA Sector Neutral Quality Index. QUAL holds 125 stocks in its basket, with each making up not more than 5% share.

The ETF charges 15 bps of annual fees, and it trades in an average daily volume of 1.5 million shares.

Invesco S&P 500 Quality ETF (SPHQ - Free Report)

This ETF tracks the S&P 500 Quality Index, a benchmark of S&P 500 stocks with the highest-quality score based on three fundamental measures, such as return on equity, accruals ratio, and financial leverage ratio.

Holding 101 stocks in its basket, this ETF amassed $7 billion in its asset base, and it trades at an average daily volume of 981,000 shares. SPHQ charges 15 bps in fees per year.

JPMorgan U.S. Quality Factor ETF (JQUA - Free Report)

This ETF provides domestic equity exposure with a focus on companies with strong quality and profitability characteristics, as well as the potential to enhance returns. It tracks the JP Morgan US Quality Factor Index and holds 245 stocks in its basket, with each accounting for no more than 2.3% share.

This ETF has amassed $3.3 billion in its asset base, and it charges 12 bps in fees per year. It trades in average daily volume of 636,000 shares.

FlexShares Quality Dividend Index Fund (QDF - Free Report)

This fund is designed to provide exposure to a high-quality income-oriented portfolio of long-only U.S. equity securities, with an emphasis on long-term capital growth and a targeted overall beta that is similar to that of the Northern Trust 1250 Index. QDF is home to 134 stocks in its basket, with none making up for more than 9% of the assets.

This fund has accumulated $1.6 billion in its asset base, and it trades in an average daily volume of 47,000 shares. QDF charges 37 bps as fees per year from investors.

SPDR MSCI USA StrategicFactors ETF (QUS - Free Report)

This ETF offers exposure to stocks that combine low volatility, quality, and value factor strategies. This is done by tracking the MSCI USA Factor Mix A-Series Capped Index. The ETF holds 608 stocks in its basket, with each accounting for less than 3% share.

The ETF has attracted $1.1 billion in its asset base, and it trades in an average daily volume of 29,000 shares. QUS charges 15 bps of fees per year from investors.

Bottom Line

Quality ETFs often provide a hedge against market volatility and uncertainty. Adding any of the discussed products to one’s long-term portfolio could be a healthy move, given their creditworthiness and soundness.

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