James Davolos: The Best Businesses To Own During Inflation

Episode Summary

Executive Summary: James Davalos of Horizon Kinetics explains why persistent inflation matters far beyond CPI headlines: it raises discount rates, squeezes margins, and hurts long-duration equities and bonds. He outlines the thinking behind Horizon’s Inflation Beneficiary ETF (INFL), which favors capital-light hard-asset businesses and indirect inflation beneficiaries like royalties and exchanges over commodity producers or traditional inflation hedges like TIPS.

Main Topics: Inflation basics and why CPI matters (Priority: 5/5): Davalos distinguishes CPI from PPI and PCE, explains substitution and quality adjustments, and argues reported inflation can differ materially from lived experience because essentials like housing, education, and healthcare are underweighted relative to everyday price pressure. Why inflation is negative for risk assets (Priority: 5/5): He frames nearly all assets as discounted cash flows and argues inflation is especially damaging to long-duration equities and fixed income because higher rates materially reduce present values. The thesis behind Horizon’s Inflation Beneficiary ETF (Priority: 5/5): The ETF targets hard-asset exposure through capital-light businesses with pricing power, low leverage, and high operating margins, aiming to benefit from inflation without the balance-sheet fragility of commodity producers. Portfolio construction: direct, indirect, and opportunistic beneficiaries (Priority: 4/5): He breaks the fund into three buckets: direct beneficiaries like royalties and land; indirect beneficiaries like exchanges and brokers; and opportunistic beneficiaries that gain from inflation-linked end-market activity without owning the physical asset. Common mistakes in inflation hedging (Priority: 4/5): Davalos warns that investors often reach for TIPS or paper gold without understanding negative real yields, valuation, or the distinction between physical and synthetic exposure. Crypto, gold, and the debate over inflation stores of value (Priority: 3/5): He sees Bitcoin as a compelling supply-capped asset, views many other cryptocurrencies skeptically, and argues both gold and crypto can rise together in a world of currency debasement and negative real yields. What inflation hurts most (Priority: 4/5): He says labor-intensive reopening sectors such as hospitality, airlines, cruise lines, and some e-commerce fulfillment models are especially exposed once wage inflation becomes persistent.

Key Arguments: CPI is the Fed’s main consumer inflation gauge, but it can diverge from real-life price pressure because of substitution and quality-adjustment methods. Inflation raises discount rates, so businesses with distant cash flows—especially high-growth software names—can see large valuation declines even if revenues grow. Fixed income is structurally vulnerable in inflation because negative real yields can destroy purchasing power. The ETF seeks hard-asset exposure, but only through capital-light, high-margin businesses that can compound through cycles. Royalties are attractive because they provide exposure to commodities without operating mines or wells. Exchanges benefit from inflation and volatility because trading volume rises and liquidity is hard to displace. TIPS can disappoint because investors may pay too much for inflation protection and still lose in real terms. Bitcoin is viewed as a credible supply-constrained asset, while many other tokens lack a durable value proposition. Labor inflation is likely the next major pressure point and will hurt businesses with high wage exposure. Valuation discipline matters as much as the inflation theme; a good theme can still be a bad investment if the entry price is too rich.

Data Points: Recording date: Wednesday, May 12th - Episode recorded date mentioned at the start Ticker coverage: 50,000+ stocks globally - Sponsor description for Ticker.com Horizon Kinetics inflation beneficiary ETF holdings: About 40 names - Current portfolio size discussed by Davalos Additional watchlist universe: About 100 companies - Names being monitored for future inclusion or lower entry prices Expected turnover: 15% to 20% per year - Estimated rolling turnover over a three-to-five-year basis Target holding period: 5 to 7 years - Intended investment horizon if thesis plays out US portfolio exposure: About 50% - Geographic mix of the ETF Median baby boomer household net worth: About $140,000 - Used to illustrate retirement vulnerability under negative real returns Bitcoin supply: 20 million to 21 million finite supply - Cited as the key reason Bitcoin differs from other cryptocurrencies LSE valuation: Over 40x forward cash flow - Reason cited for avoiding the London Stock Exchange at that price ICE valuation comparison: About 20x forward cash flow - Used as a cheaper best-in-breed exchange alternative TPL reserve duration: About 70 years of reserves - Cited as a key reason Texas Pacific Land is attractive CME scale: Largest derivative exchange in the world - Example of a direct beneficiary of inflation and volatility Moscow Exchange yield/earnings example: 5% dividend yield at 16x earnings - Listener example of a market-monopoly exchange business Historical comparison: 2008-2009 market drawdown of 60%-70% - Used to challenge the idea that markets are always efficient

Pivotal Quotes: "The number one area that the Fed is concerned about and looks at in terms of how they manage monetary policy and fiscal policy is CPI, which is consumer prices." — James Davalos: Explaining why CPI is the central inflation metric despite other measures existing "A lot of people think, well, technology can push price... but if you're valuing it at 50 times free cash flow... the rate sensitivity is going to be far more damaging to the price of that asset than their ability to push prices up three, four, or 5% consistent with CPI." — James Davalos: On why inflation is especially harmful to long-duration equities "When that starts to move, companies exposed to that, I think people need to be extremely careful with." — James Davalos: Referring to wage inflation and its impact on labor-intensive sectors

Implications: Listeners should think of inflation as a valuation and margin problem, not just a commodity story. The best defenses may be capital-light businesses with real pricing power, while TIPS, high-duration growth stocks, and labor-heavy reopening plays may be vulnerable.