How to help guard against fast-rising inflation

Gargi Pal Chaudhuri Jun 10, 2021

Consumer prices are surging all over, from coffee beans, to lumber, to used cars. Fast-rising inflation could have major economic consequences with implications that reach far beyond the checkout aisle.

For investors, a key question is whether the rising-price trend will pass quickly (transitory inflation) or stick around for years to come (sustained inflation). We believe that the rising-price trend has legs in both the short and medium terms.

While we don’t expect to see 1970s-style runaway inflation, determining the root of the recent uptick in prices can tell us a lot about how long it may stick with us. For the long and medium terms, investors may want to consider the use of exchange traded funds (ETFs) to help insulate their portfolios from the impact of higher inflation.

Sticker shock

Year-over-year price changes for lodging, airline fares, and used cars and trucks.

Year-over-year price changes for lodging, airline fares, and used cars and trucks.

Source: BlackRock, Bloomberg, U.S. Bureau of Labor Statistics - Division of Consumer Prices and Price Indexes (May 2021). Unadjusted percent change over trailing 12 months for Consumer Price Index for All Urban Consumers (CPI-U): U.S. city average, in the following categories 1) Lodging away from home 2) Used cars and trucks 3) Airline fares. Past performance does not guarantee future results.

Running the numbers

The best-known measure of inflation, the Consumer Price Index (CPI), rose 5% in May 2021 compared with the same month last year — the biggest annual rise since August 2008.1 Core personal consumption expenditure (PCE), the Federal Reserve’s preferred measure of inflation, rose 3.1% in April, the highest level since 1992.2

Supply bottlenecks due to supply chain disruptions and shifts in consumer demand as the U.S economy reopens (think higher airline prices and hotel prices) can partially explain sharp price gains. One example is an ongoing microchip shortage, which has caused temporary automobile plant closures and production delays, pushing consumers to the used car market, where inventories were already low. Pair these supply issues with a rise in vaccinations and a strong desire to hit the road and used car and truck and prices rose 7.3% in May from the prior month, and 10% in April — the largest one-month increase since recordkeeping began in 1953.3

Some manufacturers estimate that the chip shortage may last for 12-18 months, and strong automobile demand and higher used car prices (as well as prices for other electronics) could linger as a result.4 Thus the discussion about “transitory” inflation should be understood as something that can stretch beyond just one or two months.

Over the medium term, a few other factors may cause inflation to stay more elevated than it has been over the previous decade, including higher production costs and the Fed’s new commitment to achieving above 2% target inflation (known as Flexible Average Inflation Targeting).

Playing inflation with bonds

One of the biggest investment trends in the bond markets this year has been the search for ways to protect against fast-rising inflation. Inflows this year into U.S.-listed ETFs dedicated to Treasury Inflation-Protected Securities (TIPS) were $13.5 billion through June 4, already annual record with more than six months remaining in 2021; for comparison, TIPS ETFs took in $12.1 billion for all of 2020.5 TIPS are designed to pay more interest as inflation increases and their face values adjust based on CPI readings.

We favor short-duration TIPS, which have tended to be less sensitive than long-duration bonds during periods of rising interest rates. High yield bonds also tend to perform well during periods of higher inflation due to their lower sensitivity to inflation and the generally strong economic growth that tends to coincide with periods of reflation.

Playing inflation with stocks

Certain sectors of the stock market have tended to perform better than others during periods of higher inflation. In particular, we favor owning shares of smaller companies and those that are concentrated in the “value” investment style, including financial and energy stocks.

Playing inflation with commodities

Historically, investors often thought of gold when looking to protect against price surges because gold has historically demonstrated moderate sensitivity to changes in inflation. Recently, the relationship between gold prices and inflation has been less pronounced than in cyclical commodities such as energy, which is more directly tied to consumer and manufacturing activity. 

We favor investing in exposures to baskets of commodities that can help to hedge against inflation, since they are inputs in inflation gauges and can benefit from an upswing in consumer prices.

Summing it up

While the debate continues over how long inflation will rise, now is a sensible time for investors to think about the sensitivity of their portfolios to fast-rising consumer prices. We see the potential for short-maturity TIPS, value stocks, and commodities to help counter the inflation trend.

In each of these asset classes, ETFs can offer convenient, diversified access at an affordable price.

Gargi Pal Chaudhuri

Gargi Pal Chaudhuri

Head of iShares Investment Strategy Americas at BlackRock