pile of money to represent inflation

Inflation? What Inflation?

Inflation worries have been rising as we see increases in the Consumer Price Index (May’s CPI hit 5% year-over-year) and we see price increases in our local food stores and at the gas pump. The housing market is another source of accelerating inflation where the demand is high relative to supply.  This past week the Federal Reserve Chair, conceded the jump in inflation has been higher than expected but announced there will be no rate increases, at least for the time being (possibly not until late 2023).  Many believe the current pressure on prices is due to transitory factors which are temporary and will eventually correct. For example, the supply issues caused by the shutdowns during the pandemic are expected to correct themselves as factories ramp up production.  Tightness in the labor market gauged by comparing the number of job openings with the number of unemployed people is expected to recover as people become comfortable with returning to work.  Many government officials and economists speculate inflation will not be a problem for any length of time.

The Fed seems so certain of this transitory state that in addition to keeping rates low, they are maintaining their bond-buying strategy which is a way the Fed can inject additional cash into our money supply. The Fed is on target to maintain their $120B bond buy indefinitely which consists of Treasuries and Mortgage Back Securities (MBS).  MBS are pools of home loans often packaged by Fannie Mae, Freddie Mac, or Ginnie Mae (which are mostly backed by the US government) and are sold on the open bond market to investors who receive a return from interest payments and return of principal.  Since housing is a large part of the US economy, the Fed supports homeowner borrowing by artificially keeping mortgage rates low by purchasing MBS securities.  This may sound a bit like déjà vu and that we are heading for another housing bubble but many believe the stricter laws governing mortgage underwriting and consumer protection reduce the likelihood of a repeat of 2008. 

Still, the idea that the US government can continue to print money without inciting inflationary pressures is controversial and is opposed to conventional economic theory.  The idea is encapsulated in something called Modern Monetary Theory which says that increased spending will not generate inflation as long as there is economic capacity or unemployed labor.  Traditional economists have concerns with this and no one knows the efficacy of this new and provocative theory.  Regardless of uncertainty around the theory, there seems to be a wholesale abandonment of traditional theory propelled by emotion and agendas.  As scientists who base our decisions on mathematical modeling, we find this unsettling.

Why Should You Care?

Increased prices are signs the economy is heating up which can cause problems for anyone on a fixed nominal income or reliant on savings not positioned for growth.  At Atlas Fiduciary we pay particular attention to inflation since many of our clients are either retired or are nearing retirement and will not receive the benefit of inflationary income.  Excessive inflationary pressures beyond the norm (historically 3% annually) could alter the probability of success of an otherwise solid financial plan.

But alas we continue to recommend an all-weather strategy when investing which protects portfolios in all types of economic climates.  The mathematical modeling reveals that a statically designed portfolio should hold asset classes that do well in inflationary environments.  One important asset class which hedges against inflation is commodities or natural resources.  This asset class is a great diversifier from the stock market since it has a different source of risk.  Commodities are influenced by supply and demand and tangible assets don’t file for bankruptcy.  Further commodities can provide strong growth prospects but can also be volatile so they should remain a section of a portfolio, not the whole portfolio.  It has been empirically shown that portfolios are more efficient over the long run when commodities are included.

How does Atlas Create Commodities Exposure?

There are a variety of ways you can get exposure to this asset class but using an ETF is by far the best.   We use an ETF to provide the most diversified exposure into x number of commodities……, ease of trading, lower fee and do not trade on margin like futures do. The ETF we use, Invesco Optimum Yield Diversified Commodity Strategy (PDBC) has significant advantages over a mutual fund including expense ratio, tax efficiency, and strategy. It provides pure exposure to commodities prices and therefore provides a strong hedge against inflation.


[1] https://www.etftrends.com/tactical-allocation-channel/muni-bond-defaults-remain-rare-through-2019/https://youtu.be/8gHmYgl2uCE

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