Valuation of popular asset classes for inflation protection

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Defining the inflationary environment

Reference is made to the University of Michigan: Inflation Expectation© (MICH) series.

Surveys of Consumers, University of Michigan, University of Michigan: Inflation Expectation© (MICH), retrieved from FRED, (accessed 5/4/2022)

Surveys of Consumers, University of Michigan, University of Michigan: Inflation Expectation© (MICH), retrieved from FRED, (Accessed 5/4/2022) (FRED)

For In this study, an inflationary environment was assumed to exist when simultaneously the MICH is above 3.2% and the 6-month moving average of the inflation rate is also above 3.2%.

Both series contain monthly data, but are not point-in-time. Series values ​​are listed with the date of the first day of the month to which they refer. Since MICH values ​​are only known at the end of the month and inflation rate values ​​near the end of a month, a month must be added to the series dates for a real-time series.

Valuation of popular asset classes for inflation protection

The Investopedia article “9 asset classes to protect against inflation” considers the following asset classes and corresponding ETFs for inflation protection:

  1. Gold – SPDR Gold Shares ETF (GLD)
  2. Commodities – iShares S&P GSCI Commodity-Indexed Trust (GSG)
  3. A 60/40 equity/bond portfolio – 60% SPDR S&P 500 ETF (SPY) / 40% Vanguard Total Bond Market Index Fund (BND)
  4. Real Estate Investment Trusts (REITs) – Vanguard Real Estate ETF (VNQ)
  5. The S&P 500 ETF – SPDR S&P 500 (SPY)
  6. Real Estate Income – VanEck Vectors Mortgage REIT Income ETF (MORT)
  7. The Bloomberg Aggregate Bond Index – iShares Core US Aggregate Bond ETF (AGG)
  8. Leveraged loans – Invesco Senior Loan ETF (BKLN)
  9. TIPS – iShares TIPS Bond ETF (TIP)

Table 1 below lists the total returns and excess returns relative to SPY for the various asset class ETFs when invested during the defined inflationary periods of the Risk-on and Risk-off phases signaled by the iM-Multi-Model Market Timer. The performance was obtained by backtesting over the period 2005-2022 using the online portfolio simulation platform Portfolio 123 which provides historical data for stocks and ETFs from 1999 as well as historical economic data.

Table-1 Total returns of inflationary periods with and without risk 2005-2022
Symbol Risk Periods Total Return Risk periods Excess return on SPY Risk-free periods Total return Risk-free periods Excess return over SPY Risk-on & Risk-off periods Total return Risk-on & Risk-off periods Excess return
(VNQ) 113% 50% -45% -5% 68% 45%
(GSG) 84% 21% -62% -22% 22% -1%
60% SPY / 40% (BND) 32% -31% -22% 18% ten% -13%
(GLD) 23% -40% -12% 28% 11% -12%
(POINT) 0% -63% -1% 39% -1% -24%
(AGG) -2% -65% 5% 45% 3% -20%
(TO SPY) 63% -40% 23%
Risk-on & Risk-off Inflationary periods Total returns 2011-2022*
(BKLN) ten% -14% -1% 4% 9% -ten%
(DEAD) 8% -16% -1% 4% 7% -12%
(TO SPY) 24% -5% 19%

* The performance of the MORT and BKLN ETFs relates to the period 2011-2022 because their creation dates are in 2011.

It is evident that for all inflationary periods during the Risk-on and Risk-off phases, only the ETF (VNQ) provided some inflation protection relative to the benchmark ETF (SPY), while that none of the other asset classes provided protection.

Best asset classes for inflation protection

Better protection against inflation during risk-on phases is provided by ETFs in the energy sector. Energy Select Sector Fund SPDR (XLE) posted excess returns over SPY of 204% and Invesco Dynamic Energy Exploration & Production ETF (PXE) provided the highest excess return of 283%. During Risk-off phases, the ProShares Short S&P 500 ETF (SH) produces the highest excess return versus SPY.

Table-2 Total returns of inflationary periods with and without risk 2005-2022
Symbol Risk Periods Total Return Risk periods Excess return on SPY Risk-free periods Total return Risk-free periods Excess return over SPY Risk-on & Risk-off periods Total return Risk-on & Risk-off periods Excess return
(PXE) 346% 283% -58% -18% 288% 265%
(XLE) 267% 204% -50% -ten% 217% 194%
(SH) -48% -111% 47% 87% -1% -24%
(TO SPY) 63% -40% 23%

Figure 1 shows the performance of PXE for all inflation periods during the risk phases signaled by the iM-Multi-Model Market Timer. Note that in the “General Info” the Number of Positions = 0 and Last Trades (1) = 05/02/22. This indicates that the model sold PXE and the Risk-on phase ended on May 2, 2022.

PXE performance over periods of inflation

iMarketSignals

Conclusion

It would seem that the best protection against inflation is provided by funds in the energy sector and to a lesser extent by funds in the real estate sector. However, analysis shows that during periods of market decline, they also underperform SPY, thus offering no protection during Risk-off phases. During these phases, bond funds or the Short S&P500 ETF (SH) will offer better protection.

For better returns on investment, it is important to have good timing information for the Risk-on and Risk-off phases that the iM-Multi-Model Market Timer could provide. This timer, updated weekly on iMarketSignals.com, recently switched to Risk-off. Since the current inflationary period is not over, the current best asset allocation from the Investopedia list would be AGG, or SH from the “Top Asset Classes” list.

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