Looking at the performance of different areas of the global financial markets so far in 2014, global stocks are basically flat and bonds are slightly positive, but the best performers are commodities and U.S. Real Estate Investment Trusts (REITs).  

 

Commodities and REITs belong to an asset category we call "real assets" because they are tangible - you can actually touch a bushel of wheat, a bar of gold, or an office building. When it comes to portfolio management, real assets have been shown to have long-term ties to inflation risk and act as an inflation hedge because their prices tend to rise at the same time as inflation. For us, that begs the question - is the recent strong performance of real assets a harbinger of future inflation?

 

Looking at recent numbers, stated inflation is still low. According to the Bureau of Labor Statistics, over the last 12 months (through February), the Consumer Price Index (CPI) increased 1.1% over the last 12 months, and the CPI excluding volatile food and energy numbers increased 1.6%. Both of these numbers are still below the implicit 2% threshold the Fed has for inflation. 

 

However, even though stated inflation numbers are low, we are seeing some potential early inflation warning signs. One of the most notable is that U.S worker hourly wage growth has turned higher. Wage growth is increasing from a low level, so it's far from being a problem today, but since "wage inflation" is one of the factors which is tied to bigger inflation concerns, the increase is worth watching. 

 

Strategas Chief Economist Don Rissmiller recently talked about an "inflation scare" being more likely this year rather than true sustained inflation. Rissmiller says many conditions are right for such a "scare" - the market is expecting low inflation, new Fed Chairman Janet Yellen is widely expected to err towards high growth (higher inflation) policies, and geopolitical tensions could put upward pressure on commodity prices (for example, the Ukraine is a major exporter of wheat). However, Rissmiller notes that inflation itself is self-reinforcing, while an "inflation scare" is self-correcting. With a "scare," the rising interest rates and higher prices will tend to depress demand, thus bringing ithe actual inflation numbers back down. 

 

If we do see an "inflation scare," real assets like commodities and real estate should continue to perform well but we are likely to see downward pressure on bonds and potentially downward pressure on stocks too. However, until we see signs that the inflation signals are more than a scare, our base case is that the Fed is keeping interest rates low for longer and that we should "buy on the dips" when it comes to financial assets. 

 

Have a great week!

 

The Joseph Group

 

Wealthnotes discusses general market activity, global, industry, or sector trends, or other broad-based economic, market, or political conditions and should not be construed as research or investment advice.  Views and opinions are for informational purposes only and do not constitute a recommendation by The Joseph Group to buy, sell, or hold any security or asset class.  Views and opinions are current as of the date of this publication and may be subject to change without notice.