By David Schassler
Head of Quantitative Investment Solutions
The tradition of monthly inflation report critiques (the subject has dominated headlines since inflation became elevated in early 2021), is now fully underway. In these critiques, economists selectively pick through the data and, more often than not, come to the conclusion that inflation has peaked and the worst is behind us. Often times, this is an example of confirmation bias, where our interpretation of the data aligns closest with our own beliefs. Then, another month goes by and, lo and behold, the next CPI report confirms what consumers are experiencing every day: inflation is getting worse, not better.
Inflation reporting day arrived on Wednesday, May 11, and delivered an increase of 0.30% month-over-month in headline CPI. The year-over-year rise in prices now stands at 8.3%. This is higher than the consensus estimate of 8.1%. Last month the message was that inflation likely peaked. Why? Because core inflation, which is a key statistic for those who neither eat nor use energy, was up only up 0.30% month-over-month. Then, to the dismay of many, this month core inflation was up 0.60% month-over-month. However, the headline CPI, which includes the volatile food and energy components, decreased from 8.5% to 8.3% year-over-year primarily because of falling energy prices. Inflation must have peaked because headline CPI fell from 8.5% to 8.3%! Oh wait … commodity prices are back up again and, if these prices hold, it will put upward pressure on headline CPI next month. And so this game continues each month.
The simple fact is that the market is bad at predicting inflation. The chart below shows the one-year ahead break-even inflation rate, which is the expectation of nominal yields minus real yields, versus year-over-year CPI. As you can see, the market has significantly underestimated the severity of the current inflation problem. Remember this chart the next time someone tells you that inflation will normalize soon because the market is pricing it in.
Break Even Inflation Rate vs. Consumer Price Index
Source: VanEck QIS Group, Bloomberg. As of 4/30/2022. Past performance is not a guarantee of future results.
History tells us that bouts of significant and sustained inflation are not easily controlled. We do not believe this time will be different. Additionally, reading too much into monthly data points and drawing firm conclusions is a fool’s game. The CPI calculation uses a volatile and highly-debated data set. What we do know is that inflation is high, it is broad and the current policy actions—while getting more hawkish—are far from what has been needed historically to control this level of inflation.
Fighting inflation is an ugly business. Expect a recession. Removing liquidity from an overleveraged economy has predictable results. The market is expressing its concerns. Year-to-date, the S&P 500® Index is dangerously close to bear market territory, down almost 20%. Bonds are down approximately 10%. And the VanEck Inflation Allocation ETF (“RAAX”) is up around 5%. Volatility is rising. The VIX Index, which measures expected volatility, is up to 33, which is well above its one year mean of 21.
A common question that we get: How do you expect real assets to perform in a period of declining economic activity and stubbornly high inflation, otherwise known as stagflation? Our answer: We expect real assets to prosper and traditional assets to suffer. The chart below demonstrates the performance of real assets during the Great Inflation of the 1970s. It shows quarters of falling economic activity coupled with high inflation.
Average Quaterly Returns When GDP is Negative and CPI is Above Average (September 1969 – September 1982)
Source: VanEck QIS Group, CRSP Database, Bloomberg. As of 9/1982. Past performance is not a guarantee of future results.
This outcome makes intuitive sense. Periods of high inflation have historically coincided with high commodity prices. High commodity prices are good for companies that source, refine and distribute commodities. The chart below shows that the classic real asset segments of the market, which include energy and materials, are also experiencing the highest change in earnings per share. We believe that this trend will continue as high inflation persists and results in further outperformance of real assets.
Sector-Level Change in Fwd. 12-Month EPS vs. Price: Since Mar. 31
Source: FactSet. Past performance is not a guarantee of future results.
RAAX has continued to outperform traditional assets by a wide margin since high inflation materialized. The chart below demonstrates the fund segments’ year-to-date contribution to performance. The top performing segment of the portfolio was Resource Assets while Financial Assets contributed moderately. The exposure to Income Assets detracted from performance.
VanEck Inflation Allocation ETF
Contribution Bubble
RAAX Tier 1
12/31/2021 to 4/29/2022
Source: VanEck QIS Group, FactSet. As of 4/29/2022. Past performance is not a guarantee of future results.
The fund’s largest overweight, Resource Assets, lead performance higher during the period. Within the Resource Assets, the fund’s exposure to commodities returned +32.65% and its exposure to natural resource equities returned +15.47%.
VanEck Inflation Allocation ETF
Contribution Bubble
RAAX Tier 1
12/31/2021 to 4/29/2022
Resource Assets
Source: VanEck QIS Group, FactSet. As of 4/29/2022. Past performance is not a guarantee of future results.
RAAX’s exposure to Financial Assets returned a more modest +2.45%. Within this segment of the portfolio, the fund’s exposure to gold, which includes both gold bullion and gold equities, returned +4.72%. The fund’s exposure to bitcoin returned -16.94% and detracted 0.35% from overall performance.
VanEck Inflation Allocation ETF
Contribution Bubble
RAAX Tier 1
12/31/2021 to 4/29/2022
Financial Assets
Source: VanEck QIS Group, FactSet. As of 4/29/2022. Past performance is not a guarantee of future results.
The Income Assets detracted from performance with a loss of 3.25%. Within Income Assets, MLPs, which benefited from higher energy prices, were up 18.50% and were the top contributor to performance. The largest detractor from performance were REITs, down 9.85%. REITs have been negative impacted by rising interest rates. REITs were a great performer in 2021 and we expect strong relative performance going forward as real estate prices and yields continue to adjust to the inflationary pressures.
VanEck Inflation Allocation ETF
Contribution Bubble
RAAX Tier 1
12/31/2021 to 4/29/2022
Income Assets
Source: VanEck QIS Group, FactSet. As of 4/29/2022. Past performance is not a guarantee of future results.
Investors should brace for an extended period of elevated volatility across all asset classes. High inflation and the policy responses to combat it are now weighing heavily on the economy. Gold bullion has been behaving as a store of value asset and a strong portfolio diversifier as investors contend with higher volatility. RAAX has been gradually increasing its exposure to both gold and gold equities. RAAX’s total exposure to gold now exceeds 20% of the portfolio.
Originally published by VanEck on May 26, 2022.
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CPI – US CPI Urban Consumers YoY NSA Index measures U.S. consumer prices (CPI) as a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate.
Gold – Gold spot price in U.S. dollars per troy ounce.
Bloomberg Commodity Index (BCOM) is made up of 23 exchange-traded futures on physical commodities, representing 21 commodities, which are weighted to account for economic significance and market liquidity.
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