This week, I'm here's what to expect from a declining inflation

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This week, I'm here's what to expect from a declining inflation

This week s report of lower-than expected inflation reminded you that your portfolio shouldn't only include stocks that thrive in environments of rising consumer prices.

In March, five months ago, I dedicated a column to a list of stocks to consider for a declining-inflation environment. It was ridiculed by some at the time, since inflation was going higher. These stocks seem to be relevant in the wake of the latest CPI report earlier this week, and the emerging consensus that inflation has peaked.

Since there have been only a couple of trading sessions since this week's report, we don't have early indications of how the stocks mentioned in March are performing. Since the report, they have nearly tripled the return of the benchmark S&P 500 Index SPX. For this column I am going through the same process in March, producing an updated list of stocks that should do well in a declining inflation environment.

I am not predicting that the trailing 12-month inflation rate will fall in each of the next 12 months. It is likely that there will be an increase in individual months. I think there is 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, based on a number of inputs such as Treasury yields, surveys of professional forecasters and inflation swaps, is projected to be CPI inflation over the next 12 months, at 3.3%.

To review how I came up with my March list of stocks that should do well when inflation is receding, I looked at the historical returns of a number of different stock-picking styles, growth, value, small-cap, large-cap, high momentum and low momentum. I considered it potential interest only if a style consistently responded when inflation was rising and the opposite way when it was declining.

Based on data from 1963, only two such styles emerged: small-cap and low momentum. I found that small-cap stocks tend to beat the large-caps in declining-inflation environments, and low momentum stocks tend to outperform high momentum stocks. The growth and value styles didn't emerge from my tests, contrary to a widespread narrative on Wall Street. That shouldn't come as a surprise, 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 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 the winnowing process are listed below, in ascending market cap order.

Mark Hulbert is a regular contributor to MarketWatch.