We believe it continues to make sense for investors to hedge inflation risk, despite headline inflation reports trending lower and various media outlets arguing that the worst is behind us.
Inflation-sensitive assets have participated in the broader value rotation in the past few weeks. $PPI is up 6.70% since its low on May 31, 2023. We think the broadening market leadership can continue, provided the recession is punted down the road. We’re not ready for the start of a new bull market, but nobody is positioned for this tactical rally, and value stocks could catch up to the significant YTD rally in growth stocks if recession risks are on hold.
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The stocks in $PPI are cheap (~8 PE ratio) and are levered to growth. Inflation has been falling, growth risks have temporarily subsided, and we’ve seen $PPI rally along with a broad set of value stocks. We believe there is a margin of safety in owning inflation-linked assets.
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Remember, in 2022, inflation was rampant, the S&P 500 fell 18%, and bonds had their worst year in half a century. $PPI was up 4% in 2022. It serves as a nice complement to a multi-asset portfolio heavy on duration and growth risk. This part is crucial to understand; when we had a violent increase in rates last year, inflation-linked assets provided a valuable ballast to portfolios. This low correlation to traditional assets is attractive in our view.
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It is difficult to find cheap stocks in a world where the S&P 500 is back to 19x P/E and tech stocks are back to 25x-30x. Even DM international markets are 14x-ish. Yes, people are jumping on the international bandwagon this year, but $PPI is trading at half the valuations of broad international developed stocks.
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Historically, inflation-sensitive stocks don’t just rally when inflation spikes. By definition, the stocks we own (approximately 70% of the PPI ETF is invested in cyclicals) are sensitive to the business cycle. If the cycle is nearing a trough, we’d expect cyclicals to maintain a bid. This is what has transpired in the past month.
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Most market pundits and media outlets will push back and argue the Fed has conquered inflation and rate cuts are around the corner, vilifying the need to own inflation-linked assets. Having studied inflation trends over the past half a century, we beg to differ. For instance, in the 1970s, CPI was above 5% for an entire decade. Go to the grocery store and see if your bill has fallen 50% like CPI has over the past year. The media often likes to play on the pace of inflation declining, but we believe it is disconnected from the real story, which is an elongated period of higher prices.
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Astoria has owned inflation hedges in our multi-asset portfolios since the day our doors opened in 2017. We never tried to time inflation but instead owned a small amount of insurance in the event inflation would rise. Aside from being a hedge against long-duration stocks (technology), it also serves as a hedge against bonds that view inflation as kryptonite. Remember, bonds had their worst return in the history of the Agg index last year when inflation was rampant. Inflation-linked assets are doing what we thought they would do: act as a ballast in our overall multi-asset portfolio.
This CPI chart portrays elevated levels of inflation lasting for a good 10-15 years in the 1970s:
Webinar: Why We Still Like Inflation-linked Assets
Best,
John Davi
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Please note that Astoria Portfolio Advisors serves as a subadvisor to the AXS Astoria Inflation Sensitive ETF. The information contained does not imply a recommendation for PPI. Readers should consult their financial advisor to determine if PPI is a suitable investment for their portfolio. For more information on PPI, please click here. Astoria is compensated for sub-advising the AXS Astoria Inflation Sensitive ETF (Ticker is PPI). The management fee for PPI is 0.70% and the total operating expense as of August 1, 2022, is 0.75%. Pursuant to the Sub-Advisory Agreement between AXS and Astoria, AXS has agreed to pay an annual sub-advisory fee to Astoria in an amount based on the Fund’s average daily net assets. AXS is responsible for paying the entirety of Astoria’s subadvisory fee. The Fund does not directly pay Astoria. Full returns are available upon request.
Important Risk Information
There is no guarantee the sectors or asset classes the advisor identifies will benefit from inflation. Fund may invest a larger portion of its assets in one or more sectors than many other funds, and thus will be more susceptible to negative events affecting those sectors.
Equity Securities Risk: Equity securities may be particularly sensitive to rising interest rates, as the cost of capital rises and borrowing costs increase. Equity securities may decline significantly in price over short or extended periods of time, and such declines may occur in the equity market as a whole, or in only a particular country, company, industry or sector of the market.
Commodities Risk: Commodity prices can have significant volatility, and exposure to commodities can cause the value of the Fund’s shares to decline or fluctuate in a rapid and unpredictable manner. The values of commodities may be affected by changes in overall market movements, real or perceived inflationary trends, commodity index volatility, changes in interest rates or currency exchange rates, population growth and changing demographics, international economic, political and regulatory developments, and factors affecting a particular region, industry or commodity.
Futures Contracts Risk: The Fund expects that certain of the Underlying ETFs in which it invests will utilize futures contracts for its commodities investments. The risk of a position in a futures contract may be very large compared to the relatively low level of margin the Underlying ETF is required to deposit. In many cases, a relatively small price movement in a futures contract may result in immediate and substantial loss or gain to the investor relative to the size of a required margin deposit. The prices of futures contracts may not correlate perfectly with movements in the securities or index underlying them.
TIPS Risk: Principal payments for Treasury Inflation-Protection Securities are adjusted according to changes in the Consumer Price Index (CPI). While this may provide a hedge against inflation, the returns may be relatively lower than those of other securities. Similar to other issuers, changes to the financial condition or credit rating of the U.S. government may cause the value of the Fund’s exposure to U.S. Treasury obligations to decline.
Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the ETF. Brokerage commissions will reduce returns. NAVs are calculated using prices as of 4:00 PM Eastern Time. The closing price is the midpoint between the bid and ask price as of the close of exchange. Closing price returns do not represent the returns you would receive if you traded shares at other times.