Inflation-Sensitive Investments Providing Diversification Benefits
Prepared by Brandon Yee, CFA, CAIA, and Thomas Connelly, CFA
Japanese Market Picks Up
In the month of August, international developed stock markets returned 1.60%. Japan and the U.S. recorded returns of 3.07% and 2.91%, respectively. Canada and Pacific ex Japan lagged other markets. The Canadian stock market, which has a large natural resource exposure, is up 20.69% YTD. Inflationary pressures will help resource-heavy countries. International developed markets are up 12.42% YTD. The spread of the Delta COVID variant has introduced more short-term risk to the global economic recovery, but U.S. economic activity remains strong.
Emerging Markets Rise in August
Broader emerging markets posted a 3.32% return for the month. Mexico and India recorded returns of 5.56% and 10.94%, respectively. Korea and Brazil lagged other markets in August. The Chinese market was flat after a tough July that was caused by increased regulatory scrutiny of many large technology companies. Emerging markets in the aggregate are up 4.29% YTD, lagging due to a retracement in technology shares and a COVID-19 resurgence. Commodity-oriented markets may continue to receive a boost as monetary and fiscal stimulus flows through the global economy. These countries may benefit from any infrastructure projects or alternative energy initiatives.
Telecommunications and Information Technology Outperform
Telecommunications and information technology recorded returns of 4.02% and 3.71%, respectively, in August. Energy and materials lagged other sectors. The energy sector, after a strong six-month period, was negatively affected by the accelerating spread of the Delta Covid variant. However, governments and corporations are encouraging more people to get the vaccine, which would help sustain the economic recovery.
DOMESTIC EQUITY FACTORS
Small-Cap Value Continues Strong Run
In August, value underperformed growth in the large-cap space but outperformed in the small-cap space. Momentum recorded a return of 4.57%. Small-cap value stocks started the year strongly and are now up 25.43% YTD. Even after value’s strong performance this year, relative valuations between value stocks and growth stocks are still high based on many different valuation metrics. Value-oriented sectors such as energy, financials, and materials may still have more room to run.
FOREIGN EQUITY FACTORS
Growth Outperforms in International Markets
In the international developed markets, growth outperformed value in the large-cap and small-cap space. Momentum recorded a return of 1.25% while small-cap emerging market stocks posted a return of 2.37% this month. Small-cap emerging market stocks are up 15.72% YTD. The rotation from growth into value may resume as investors become wary of high valuations in growth stocks. Rising interest rates may also pose more of a risk to growth stocks than value stocks.
Federal Reserve to Maintain Low Interest Rates
In August, the three-month Treasury bill index returned 0.00% for the month. Interest rates on Treasury bills and money market funds are close to 0%. The Federal Reserve continues to keep interest rates near 0%, but the recently high inflation numbers, labor scarcity, and pending stimulative legislation may reopen the possibility of higher interest rates. However, savers will still face low short-term interest rates for the foreseeable future. If inflation continues to rise and rates are still artificially suppressed, then retirees will be negatively impacted because their purchasing power will decrease. The CPI has increased by 5.28% over the past year through the end of July.
DISINFLATION DEFLATIONARY HEDGES
Municipal Bonds Up YTD
The returns of deflationary hedges were mostly negative for the month. Long-term government bonds returned -0.21% in August. They are only down -4.68% YTD. The Bloomberg Barclays U.S. Agg Bond Index returned -0.19% in August. Catastrophe bonds are up 2.73% over the past year, providing a competitive yield without the equity-like volatility of leveraged loans and high-yield bonds. Real yields continue to remain around historical lows.
INFLATION SENSITIVE INVESTMENTS
Infrastructure and Natural Gas Post Strong Month
Inflation-sensitive investment returns were mixed for the month. U.S. natural gas and infrastructure were up 10.78% and 1.81%, respectively. The Bloomberg Commodity index posted a return of -0.30%. WTI crude oil is up 44.09% YTD and 59.65% in the past year. Inflation-sensitive investments are benefiting from the reopening of economies, supply constraints and pent-up consumer demand.
U.S. Dollar Depreciated Over the Past Year
Over the past year, the U.S. dollar depreciated against most other major currencies. The U.S. dollar appreciated against the Japanese Yen and Swiss Franc but depreciated against the U.K pound, Chinese Yuan, and Mexican Peso. The continuation of large U.S. fiscal deficits may weigh on the U.S. dollar in the medium-term to long-term.
Brandon Yee, CFA, CAIA – Research Analyst
Brandon conducts investment due diligence for Versant Capital Management, and designs and implements tools and processes to support the firm’s research. His background in biology and finance help him to look at challenges from multiple angles, resulting in unique and well-rounded approaches and solutions.
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