Protecting against inflation has been a low priority for the majority of the investment world during the meat of this economic recovery. Years of weakening commodity prices, coupled with falling interest rates, and tepid wage trends have created an insulated environment from this threat. Outside of health care costs and other niche areas, consumer prices have shown a slow path to hitting inflationary targets that the Federal Reserve has long outlined in its efforts to stimulate the economy.
Many of the exchange-traded funds that track inflation-based assets have also shown a parallel track of tepid or feeble performance over the last several years. Multiple commodity sectors, inflation protected treasuries, and real estate are often cited as having a high sensitivity to inflationary forces. More recently, funds that track these assets have perked up and may be signaling a change in the inflationary picture.
For instance, the PowerShares DB Commodity Index Tracking Fund (DBC) recently hit a low in January of this year and is attempting to break out of a multi-year downtrend. DBC tracks a basket of 14 highly liquid commodities futures contracts. The fund owns a diverse array of sectors including precious metals, energy, and even agricultural commodities such as soybeans and sugar. Many of these basic materials form the building blocks of finished goods that consumers ultimately purchase in one form or another.
DBC has now gained over 10% from its lows and continues to show signs of diverging strength. Much of this burst has been driven by a sharp rebound in crude oil and precious metals such as gold and silver. An extension of this rally would boost input costs and likely lead to a bolstering of the inflation theme in the near-term.
Another important indicator of inflation expectations is the price action in treasury inflation-protected securities (or TIPS). The iShares TIPS Bond ETF (TIP) has $16.2 billion dedicated to 40 TIPS, whose face value is tied to the Consumer Price Index.
The purpose of TIP is to create an easy-to-access pool of securities with built-in inflation protection. This ETF has been steadily stair stepping its way higher through the first quarter of 2016. It has also demonstrated a uniquely deviating price pattern when compared to conventional fixed-coupon Treasury bonds of similar duration.
Lastly, those who want to view these themes through an all-inclusive index may want to keep an eye on the SPDR SSGA Multi-Asset Real Return ETF (RLY). This ETF is structured as a “fund of funds” that invests in a multitude of inflation-sensitive asset classes.
Top holdings in the RLY basket include TIPS, natural resource stocks, diversified commodities and real estate holdings that all are accessed through individual ETFs. This makes for a highly diversified way to monitor or invest in sectors of the market that are correlated with rising prices for goods and services.
RLY has tread a similar path of descent over the last several years that is just now being broken by a significant rally from its lows. If this fund can push through its 200-day moving average on the upside, it may indicate that a notable trend change is in the works.
The Bottom Line
While it’s far too early to say that we are entering a new era of above-average inflationary forces, the funds mentioned above can serve as key indicators of these trends. Astute investors can use these tools to monitor the progress of inflation expectations and even use them in their portfolio if they complement existing holdings.
Disclosure: At the time this article was written, some clients of FMD Capital Management owned shares of TIP.