With elevated inflationary pressures and slowing economic growth, some fear that we are heading toward a period of stagflation, or a recession-inflation. Nevertheless, there are still some exchange traded fund strategies that investors can turn to.
“We see increased risk of stagflation ahead and expect this week’s CPI data to show that services inflation remains sticky,” Gargi Chaudhuri, Head of iShares Investment Strategy Americas, said in a note. “We do not believe a recession is imminent, but believe the risks are rising as U.S. economic data soften. Despite the recent rally in the stock market, we believe investors should position defensively in minimum volatility sectors of the market and gravitate towards high quality fixed income for ballast in their portfolio.”
Specifically, Chaudhuri highlighted the iShares Edge MSCI Minimum Volatility USA ETF (USMV) as a way to position defensively. The fund seeks the investment results of the MSCI USA Minimum Volatility (USD) Index, which measures the performance of large- and mid-capitalization equity securities listed on stock exchanges in the U.S. that, in the aggregate, have lower volatility relative to the broader U.S. equity market.
Additionally, Chaudhuri pointed to the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and the iShares Short-Term Corporate Bond ETF (IGSB) for high quality fixed-income exposure. LQD tracks the investment results of the Markit iBoxx® USD Liquid Investment Grade Index, which generally invests at least 95% of its assets in investment-grade corporate bonds. IGSB tracks the investment results of the ICE BofA 1-5 Year US Corporate Index, which measures the performance of investment-grade corporate bonds of both U.S. and non-U.S. issuers that are U.S. dollar-denominated and publicly issued in the U.S. domestic market and have a remaining maturity of greater than or equal to one year and less than five years.
Inflation hit four-decade highs and the Federal Reserve has enacted a series of aggressive interest rate hikes, with potentially more to follow after the recent strong jobs report. Consequently, many fear that an overly zealous Fed could cripple economic growth in its fight against inflation. Meanwhile, recession concerns are already mounting after the U.S. economy showed a contraction of -0.9% in the advance reading of Q2 GDP, the second consecutive drop in quarterly GDP and marking the technical definition of a recession.
“We are currently in such an atypical cycle that we are more inclined to favor a qualitative approach to a recession call and focus on our own recession monitor below which points to a dichotomy where three of the five metrics related to corporate health are now flashing red for recession and yet the two metrics related to the consumer are still green and strong, pointing to an economy that is slowing but yet showing some signs of strength as it pertains to the consumer and the labor market,” Chaudhuri said.
Along with minimum volatility and high quality bond picks, Chaudhuri argued that in an environment of slower growth and higher inflation, an allocation to shorter-dated inflation-linked bonds makes sense. Investors can look to something like the iShares 0-5 Year TIPS Bond ETF (STIP). STIP tracks the investment results of the Bloomberg Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Years Index (Series-L), which will invest at least 90% of its assets in the component securities of the underlying index and may invest up to 10% of its assets in certain futures, options and swap contracts, cash and cash equivalents. The index measures the performance of the inflation-protected public obligations of the U.S. Treasury, commonly known as “TIPS,” that have a remaining maturity of less than five years.
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