Material world

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Articles by Jasmine

Jasmine Yeo

Fund Manager

8 May 2024

“Things last longer than emotions,” claimed Madonna in her 1980s hit Material Girl. And it has been an emotional ride for markets in recent months, with disinflation euphoria and hopes of multiple interest rate cuts making way for sticky inflation and interest rates staying higher for longer. Investors are increasingly questioning whether they need more exposure to the material world for a truly diversified portfolio.

The latest data – especially in the US – shows that disinflation has stalled. Core CPI rose at a three-month annualised rate of 4.5% in March and core PCE – the measure targeted by the Federal Reserve (Fed) – ticked up to a three-month annualised rate of 4.4%. Both uncomfortably above central banks’ 2% target.

There is a growing risk that inflation will be both higher and more volatile than the market (and the Fed) currently expects. Another uptick would threaten richly valued equity and credit markets but, at today’s prices, investors have an opportunity to prepare portfolios for a new regime.

This month’s chart looks at the relative pricing of ‘real’ and ‘financial’ assets over the past 50 years – shown here as the performance of commodities versus US equities since 1970. When the green line is high, commodities trade expensively compared to stocks, and vice versa. On this measure – with history as a guide – commodities are as cheap as they have ever been, even with the strong rally we’ve seen over recent weeks.

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Ruffer’s Head of Investment Strategy, Teun Draaisma, recently published research which explored asset class performance during inflationary episodes across the US, UK and Japan over the past 100 years. The findings were clear: bonds and equities tend to do badly, and commodities perform very well. In aggregate, commodities had a perfect track record of generating positive real returns during inflation regimes, averaging an annualised real return of 14%. This contrasts with non-inflationary periods when commodities typically produced low single digit returns.

We see the potential for commodities to be a key diversifying asset in a world where 2% is the inflationary floor rather than the ceiling. It’s also worth noting that whilst gold played a role in the broader historical outperformance of commodities, it was found to be unreliable on its own, having returned 13% annualised on average, but with positive returns only two thirds of the time. A diversified basket of commodities appears to be the key. The Ruffer portfolio has 10% in the commodity theme, across oil and gold mining equities, copper and silver bullion exposure (which proved effective through April, rising by around 20%).

So, whilst investors have been loading up on bonds and growth equities in the hope of imminent rate cuts, if interest rates stay higher thanks to a motoring US economy, the next market winners could look very different. But many portfolios appear to be anchored to those assets which worked well during the past two decades of disinflation.

To leave the herd carries risk – a risk many investors are unable or unwilling to take – but one we believe will be vital to successfully navigate the next phase in markets.

#gold, #inflation

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