I – Global information and fundamental analysis about inflation
An exchange traded fund (ETF) is a type of security that involves a collection of securities—such as stocks—that often tracks an underlying index. In this report, we’ll focus on the inflation ETF.
The beginning of 2021 has been marked by inflationary fears. These fears proved to be true at the beginning of this second quarter.
Chart 1 : Consumer Prince Index (CPI – USA)
Source : Moodys
The october U.S. Consumer Price Index will not satisfy financial markets and the Fed may need to strengthen its report to ensure that inflation expectations remain stable. The headline CPI rose 1,4 points in October, which was well above our expectations. Used car prices rose sharply and airline ticket prices increased by at least 10%.This distortion will last for several months.
We can distinguish 4 potential problems related to the rise or fall of prices, as shown in the graph below.
The 1st situation concerns a rise in inflation with a fall in growth, which corresponds to stagflation. This situation is feared by all economists. The second situation is linked to inflation and growth is increasing, which is what seems to be happening in the current situation with an increase in growth following the end of the health crisis, in addition to which there is the beginning of inflation. The other situation is like what happened in Japan. Price declining with economic climb. The last situation is the deflationnary boom : economic growth associated with a price decrease.
Chart 2 : Different prices situations
Source : overblog
Our situation is quite similar to China in the past : big increase of economic associated with climb of prices. Why inflation is so negative for the markets ?
First, inflation doesn’t just affect the products we put on our shelves. It also affects other things that are a little less visible. Basically, the company has to charge higher prices, but it also has to spend more.
The second issue is wages. If wages don’t move, then the price increase naturally makes us poorer. And as a result, we consume less. Let’s take another example: you like to go to lunch in a small brasserie every Saturday at noon… until inflation hits the prices. And then, your dish of the day + glass of wine menu is 5€ higher than its initial price. The next Saturday at noon, you may decide to stay home with pasta with butter (and a little grated Gruyere).
To make a long story short, when inflation increases, people can’t afford to consume as they used to. As a result, companies see their sales decrease and profits fall accordingly.
Rising prices are particularly worrisome for another reason: when inflation rises above a certain level (about 2%), central banks in turn raise interest rates to limit it.
Stay with us a little longer because this is super important (and it makes the markets hysterical): if inflation makes the money in your jeans pocket worth less, you have to counterattack. Raising interest rates would then be the first weapon. Otherwise, think of it as a kind of seesaw: if the inflation rate gets too high, interest rates counterbalance to bring them down.
This increase in prices was first of all reflected in the price of raw materials. We can see it on the price graph below for lumber. This mechanism can be applied to the entire raw materials sector
Chart 4 : Lumber price
Lumber has soared since last spring. Up 256% over one year and 40% over the last 30 days, it is now at a record high of $1180 per 1000 board feet (a US and Canadian unit of volume measurement used for rough sawn lumber) compared to about $300 just a year ago.
The surge in lumber prices is getting little attention in Europe, where housing is mostly built of concrete. But on the other side of the Atlantic, lumber is essential to the construction industry and has become a major concern for the sector.
The main reason for the surge in lumber prices is demand pressures. The fall in mortgage rates since the crisis of the covid has made the demand for new housing in the United States jump while the « stock » of available housing is historically low. As a result, housing starts are surging and are now at their highest level since 2006.
Lumber prices are also being supported by supply-side pressures. Sanitation restrictions have slowed freight movement, causing trucking delays. In addition, the lumber industry is reporting a labor shortage in some U.S. states.
In times of inflation, our money in passbooks loses value. Indeed, since the prices increase, the famous adage « a euro of today is not worth a euro of tomorrow » is here a beautiful conclusion. We are going to propose you here a solution of investment in a tracker which invests in assets which will allow to fight the inflation and to make return.
II – ETF Analysis
The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL)
We are going to introduce a fund that will allow us to expose ourselves to inflation and take advantage of this situation :
In conclusion, we are likely to experience persistent inflation following the end of the health crisis. The Central Banks are struggling to act and are unlikely to lower their interest rates, which is putting pressure on the markets, which are constantly fueled by quantitative easing and securities buybacks. The best solution is not to let too much money sleep on your passbook and to invest in solutions as proposed.