WThe US Consumer Price Index for All Urban Consumers (CPI – U) for March 2022 was published in April. This was the first time that the index had grown by more than 8% annually in over 40 years. This is only the fifth time that this has occurred since January 1948. In addition, the annual inflation was still above 8% in April CPI-U numbers announced in May 2022. Below is a table showing the other periods in which the annual CPI has increased by more than 8%.
Table 1: Periods Post 1948 with an Annual CPI Increase of >8%
Recent inflation has been driven by energy prices. The gasoline index increased annually by 48% in March 2022. However, there was some relief in April when the index fell 6.1%. However, inflation has been broad-based with the food index increasing by 8% annually between March 2022 and rising again in April 2022. This is the seventeenth consecutive monthly increase of this index. Other than food and energy, inflation rose 6.5% annually in March, and rose again in April. This was due to rising rents and sharp increases in airline fares.
It is unclear how long inflation can be sustained since the Fed Funds rate hike of 50 basis points on May 4, 2022 will likely be followed by 50 basis point increases this year, and multiple quarter-point hikes through 2023. This will likely be accompanied with other forms of quantitative tightening. For now, however, U.S. investors and consumers appear to be entering a unique inflationary period. Since the median annual CPI rise over the last 74 year has been 2.8%,
Rising Rates: Investor Response
Investors will need advice on how to rebalance their portfolios in an inflation- and rate-driven environment. Analysis by Sam Stovall, CFRAs Chief Investment Strategist, shows that as of end-April 2022, the S&P 500s 12.4% year-to-date (YTD) decline was the deepest selloff during that calendar period since WWII, and history says, but does not guarantee, that the market may continue to be challenged, since the S&P 500 rose only 30% of the time in May following the 10 worst YTD-April declines.
Typically, investors will adopt a variety strategies during periods of rising rates or inflation. As real assets can be considered an inflation hedge, you could invest in commodities or REITs. Another strategy is to switch to shorter-term bonds, as they are more likely to outperform longer-dated bonds during rising rates.
Investors will want to keep their equity sleeve in place, but may also wish to invest in strategies that could perform better in this environment. Investors would have to create such portfolios in the past. There have been a few equity ETFs created in the last few decades that are specifically designed for rising and inflationary rates.
Stock ETFs to Support Inflationary Conditions
The Fidelity Stocks for Inflation (FCPI) is one of two equity ETFs that are designed for inflationary conditions. The other is the Horizon Kinetics Inflation Beneficiaries (INFL). Investors have the option of an index-linked option at a competitive 0.2%. It tracks Fidelity Stocks For Inflation Factor index. This index includes large- and middle-cap U.S. stocks that the index provider believes have the potential to outperform under inflationary circumstances. The Russell 1000 index measures the market. This index is designed in relation to the wider market and is therefore more favorable for sectors that will benefit from inflation such as energy, materials and healthcare. CFRA has rated the ETF 5 stars due to its high scores in CFRA’s quantitative ETF rating system.
INFL is an option that investors can actively manage, although it comes at a higher cost at 0.85%. This ETF scores well on both CFRAs risk and reward dimensions. It has an overall rating of 4 stars in CFRAs model because it has a slightly lower cost parameter score.
Table 2: Stock Based ETFs in the U.S. Designed for Inflationary Environments
These ETFs have very different approaches to their constituent holdings. INFL had the highest exposure to the financials (26%), materials (26%), and energy (23%) sectors as of May 9, 2022. It owned energy stocks like Viper Energy and PrairieSky Royalty, as well as staples such Archer Daniel Midlands and Bunge Limited (BG). It also held materials stocks, such as Franco-Nevada and Glencore, as well trading-oriented financials stocks such as the Intercontinental Exchange and ASX Limited (AS NR), and Deutsche Boerse.
In the same time frame, FCPI had a significantly higher weight in technology (21%), healthcare (18%) and consumer staples (11%). It is important to compare the ETF with the broader market, as its sector allocations are based on the Russell 1000 Index. It is overweight by 5% relative to the U.S. stock market in the energy, materials and healthcare sectors and underweight sectors like financials and IT. As of May 9, 2022 the largest FCPI holdings were Apple (APPL), and Microsoft (MSFT), with the ETF also holding healthcare stocks such UnitedHealth (UNH), Pfizer (PFE), and Anthem (ANTM ).
Figure 1: Comparison of Sectors between INFL & FCPI
Source: CFRA ETF database. Sponsor websites. As of May 9, 20,22.
Stock ETFs for Rising Rate Conditions
There are two equity ETFs that are specifically designed to rise rate conditions in the U.S., and they are both index linked. The ProShares Equities for Rising Rates ETF is linked to a Nasdaq Index that tracks stocks and sectors within these sectors. It has a high correlation with 10-year U.S. Treasury yields. Fidelity Dividend ETF For Rising Rates(FDRR) contains large- and middle-cap dividend-payors that also have positive correlations to U.S. Treasury yields of 10 years.
Table 3: Stock-Based ETFs In the U.S. Intended For Inflationary Environments
These ETFs also have different GICS industry exposures. EQRR’s concentration in financials, energy, and materials was higher than expected as of May 9, 2022. Some of the largest holdings were energy stocks like Valero Energy (VLO ***) (3.4%) and Marathon Petroleum (MRO ***) (3.1%) as well as financials like M&T Bank (MTB ***) (3%) and JP Morgan Chase (JPM ***) (2.8%).
The FDRR holdings are spread over a wider range of sectors. The ETF rebalances annually to a sector-neutral profile. As of May 9, 2022, IT was the largest sector (27%), and it also had >10% exposure to the healthcare, consumer discretionary, and financials sectors (see Figure 2).
Figure 2: Sector Comparison between EQRR & FDRR
Source: CFRA ETF database. Sponsor websites. As of May 9, 20,22.
Looking ahead
CPI-U as well as the Fed Funds rate will both be closely monitored throughout 2022 to gauge investor sentiment. Investors will explore other strategies if inflation persists despite rising rates, quantitative tightening and increasing rates. Investors will likely consider stock-based ETFs to increase their equity exposure in an environment with rising rates and inflation.
The views and opinions expressed in this article are those of the author and not necessarily those of Nasdaq, Inc.
