These Are The Good And Bad Inflation Hedges

Posted: Sep 23, 2021 12:00 PM
These Are The Good And Bad Inflation Hedges

Source: AP Photo/Koji Sasahara

Last time we set up an historical experiment about which indices had done well during high (and low) inflation periods. We divided all the available data (which meant time periods where we had both quarterly inflation data and quarterly index performance data overlapping with one another) into the periods with the highest fifth and the lowest fifth, and then looked at how 26 different indices performed during high times (purple) and the low times (gray).

(Source: Bloomberg, St. Louis Federal Reserve, Bowyer Research, as of 3/31/2021)

Let's zoom in and look at some of the indices in various groupings so that we can compare various characteristics, such as asset class (stock, commodity, real estate, bonds); cap size (large, mid, small); style box (growth, value), and national status/domicile (Global, Developed Market, U.S., Emerging Market).

First, we'll look at asset classes, since they give us a fairly widely dispersed return divergence in this analysis:

(Source: Bloomberg, St. Louis Federal Reserve, Bowyer Research, as of 3/31/2021)

For energy commodities, we used a broad-based energy company index. For industrial commodities, we used a broad-based index of material companies. In one case we created our own index, which is based simply on the price-per-ton of copper in global markets in dollars. For a broad base of U.S.-based large companies, we used the S&P Growth index; for real estate we used the U.S. Diversified Real Estate Index; and for bonds, we used the Vident Core Bond Index, as well as FTSE’s Investment Grade Bond Index.

In very general terms, energy and material indices were relatively good to hold during inflationary periods; global almost as good. Bonds performed fairly poorly comparatively, and real estate acted as a sort of “middle” category, which tended to perform between stock and bond classes. The indices' portfolios hold equity, but the underlying value of real estate is tied to leases, which have bond-like characteristics. In other words, a significant part of the value of commercial real estate is made up of the contracts made to rent it, and rents are a steady, recurring item, kind of like interest payments on bonds.

But what if you aren't in a high inflation period? What if you're in the bottom quintile of inflationary periods? What does the average return look like for those indices?

It looks like the gray bars below:

(Source: Bloomberg, St. Louis Federal Reserve, Bowyer Research, as of 3/31/2021)

In general, the performance during low inflation periods was kind of a mirror image of the high inflation periods. Admittedly, it's more a fun house mirror image, not a perfect symmetry -- but in general, it looks like the indices that you wanted to hold when inflation was high were not as much fun when inflation was low.

Next time, let's look at the world of equity, or stocks: the big ones and the little ones and the expensive ones and the cheap ones.