It’s CPI day, and hopes are high that the inflation will be further tamed and take rate-hiking pressure off the Fed.
Good news on that front could drive the S&P 500 further toward the key psychological level of 4,000 level, say some
All that inflation talk brings us to our call of the day from asset manager and exchange-traded fund provider Wisdom Tree, whose commodities expert offers up more reasons to put money in one of 2022’s best-performing assets.
“While inflation has been a key concern for investors over the past 2 years, and will continue to be an important consideration for the coming year, we believe that there are more reasons to consider allocations to commodities than just inflation,” Nitesh Shah, head of commodities and macroeconomic research, told clients in a note on Thursday.
Firstly, he lays out how commodities remain one the best inflation hedges around, via long-term historical data that shows them as one of the most inflation-sensitive asset classes.
He divides inflation into “expected” using the T-Bill interest rate as a proxy, and “unexpected inflation” via the realized inflation rate minus the T-Bill rate. When it comes to the latter, of which we’ve definitely seen over the last two years, very few assets have risen like commodities, says Shah, providing the below chart:
And as broad commodities also do well against expected inflation, the asset class could remain an “important hedging instruments,” he says.
What about the next business cycle? Shah sees inflation remaining stubbornly high, at least above 3.5%, keeping the world in a high inflation/low-growth phase for longer.
“We stress that this is not bad for commodities. In fact, with the U.S. dollar no longer appreciating, broad commodities and gold have one headwind restored. With U.S. bond yields appearing to have peaked, gold also has another headwind removed,” writes Shah.
As for what makes it more than just an inflation hedge, Shah points to the low correlation between commodities and most other assets, making it a useful diversifier.
And those low correlations have even held in times of crisis, such as when U.S. equities have dropped more than 5%, says Shah.
“On average, in all the months since the 1960s where U.S. equities have lost more than 5%, commodities have lost 0.65%. In all the months where U.S. equities gained more than 5%, commodities gained 1.13%,” he notes,.
“So, while commodities are cyclical (that is, they tend to lose and gain broadly at the same time as equities), the amplitude of such gains is significantly more muted. So, any investors fearing further downside to equities, could hedge with commodity exposure,” he said.
Lastly, commodities are the place to be ahead of big changes that he sees coming as last year’s energy crisis will speed up Europe’s transition to renewable sources, he says.
“We believe that that will be metal demand positive. An electrification of energy production (that comes with a move to renewables instead of combusting hydrocarbons) will require more distribution and transmission cables, more energy infrastructure and more batteries,” says Shah.
And with most countries well behind on climate change targets, an acceleration of decarbonizing technology is also likely. Plus an underinvestment in traditional energy sources, on which the world still very much depends, has left tight oil and gas markets. “Commodities provide the essential materials to manage this transition and are likely to benefit,” says Shah.
Stock futures are steady ahead of CPI, with bond yields mixed and the dollar steady. Oil and gold prices are higher.
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Due at 8:30 a.m. is December CPI, which economists expect will fall 0.1% in the first decline since May 2020. Year-over-year inflation is expected to slow a sixth straight month to 6.5% from 7.1%. Due at the same time are weekly jobless claims, followed later by the federal budget. Investors will also hear from Philadelphia Fed President Patrick Harker, St. Louis Fed President James Bullard and Richmond Fed President Tom Barkin.
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