We hope everyone had a great long weekend. Labor Day was established in 1882 to show respect and appreciation for the workers that historically have been at the foundation of U.S. Economy. However, looking at the economy today, we note a twist of irony to two facts. First, we should be proud that the U.S. unemployment rate, at 5.2%, is close to a historic low. The twist is that such a low rate is arguably what could make U.S. economic growth vulnerable to inflation. (See Investopedia article titled “What happens when inflation and unemployment are positively correlated” see section on the Philips Curve). Second, inflation is the enemy of most fixed income portfolios.
Look for ETF Solutions
There are 13 obvious Inflation-Protection ETF solutions with varying degrees of duration, but of course, this is not the only answer. Two other solutions that embrace the volatility expected in the fixed income market that could come from inflation include:
- The Quadratic Interest Rate Volatility and Inflation Hedge (IVOL): https://www.ivoletf.com/
- Simplify Interest Rate Hedge (PFIX): https://www.simplify.us/etfs/pfix-simplify-interest-rate-hedge-etf
The degree of risk and volatility varies across all these ETF solutions, which is why the ETF Think Tank is positioned to add value to its membership. Most index-based portfolios do not have exposure to inflation protection because inflation has been benign for so many years. Financial advisors who are not addressing this issue openly are in turn ignoring the risk – especially if they are modeling portfolios after a classic 60/40 portfolio. Put differently, the active vs passive debate, when it comes to inflation, should be over. Since we are on the cusp of this risk, all financial advisors need to focus on the wrapper, and either own the decision-making process as an active and/or tactical decision or outsource the role to an active manager.
Will Inflation Forecast as Measured by CPI Prove Accurate?
We all know that there are high expectations for the Fed to manage inflation. Wishful thinking? Think through the question about the person who just received a raise or incentive to be hired. In a good economy, that person will be demanding, given their value has a higher price tag. In a bad economy, this same person will be less confident, and the employer will be in more control. This why CEOS who build moat-like businesses with great business cultures will shine. If you are looking at the duration of your TIPS portfolio, you should consider how confident you are in the accuracy of the below forecast.
Living through Covid, readers know that the unemployment rate peaked in April 2020 at about 14.8%, and GDP collapsed by 32.9% in 2020[i]. To be honest, the rebound of economic prosperity feels awesome - maybe too good. Markets have not seen a correction of 5% in over 10 months. We also say “too good” because the benefits of the free-Fed-money safety net has made it difficult to hire people, made some employees feel overly entitled, and put the power back into the power of the labor force. Happy Labor Day! Maybe not for everyone, though.
US Unemployment Rates by Year
Congratulations if you, as an employee, have enjoyed the benefits of wage inflation. However, if you are an investor and or employer, watch out. Those benefits will not necessarily transfer to you. If you are an investor or financial advisor, there are things you can do to hedge against this risk. Be active in your decision-making process; this decision will come with volatility in the fixed income markets.
DisclosureThe information provided here is for financial professionals only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Toroso nor any of its affiliates guarantees any rate of return or the return of capital invested. This commentary material is available for informational purposes only and nothing herein constitutes an offer to sell or a solicitation of an offer to buy any security and nothing herein should be construed as such. All investment strategies and investments involve risk of loss, including the possible loss of all amounts invested, and nothing herein should be construed as a guarantee of any specific outcome or profit. While we have gathered the information presented herein from sources that we believe to be reliable, we cannot guarantee the accuracy or completeness of the information presented and the information presented should not be relied upon as such. Any opinions expressed herein are our opinions and are current only as of the date of distribution, and are subject to change without notice. We disclaim any obligation to provide revised opinions in the event of changed circumstances.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Toroso or its affiliates or any of their officers or employees of Toroso accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Toroso. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of and observe such restrictions (if any).