Inflation and ETFs: Not All Recommendations Are Created Equal

Most diversified investment portfolios have struggled over the first half of 2008. Investing in commodities and commodity-related manufacturers represent the only bright spots.

The impetus for success in natural resources? A potent combination of increasing demand, disrupted supply, heightened speculation and a weak U.S. dollar.

The latter has seen price stabilization. However, since the Fed is unlikely to raise rates to combat inflation in an election year, traditional hedging against inflation should continue. And that means commodities will still have support.

Yet, for all of the talk about inflation-fighting investments in 2008, not all of the historical inflation-fighters have been working out. Consider the most frequently cited inflation-fighters:

• Inflation-Protected Securities [TIPS]
• Real Estate
• Commodities
• Value-Oriented Stocks

Let's start with the first two via their corresponding ETFs: iShares Lehman TIP Bond (TIP) and Vanguard REIT Index (VNQ). While the overall stock market is down 7% in the year, these two have managed a 0% return.

Clearly, TIP and VNQ have helped a diversified portfolio weather the pain of market-based investing. Still, they've hardly been successful hedgers the way that commodities have.

The Dow Jones Total Commodity Index (DJP) remains an ideal way to maintain exposure to the asset class. (See why I've pounded the pavement for DJP since its inception in "ETFs That Beat Back The Bearish Downturn.")

Of course, even with a YTD run of nearly 30% for total commodity investing, United States Oil (USO) has a 40% run-up. In my mind, oil is in the midst of irrational exuberance.

It's hard to disagree with the fine researchers at Bespoke, who have suggested that oil is becoming like the housing market, and the Nasdaq before that. I discussed the idea of the "oil bubble" in "We're 'Running Out Of Oil" Causes June Gloom."

So if Lehman TIP Bond and Vanguard REIT Index have helped diversified portfolios weather the inflation storm, and if the Dow Jones Total Commodity Index has given portfolios a monumental boost, what about deep value equities?

Value stock indexes have been slaughtered. Whether you wish to look at value through the eyes of solid dividend payers in WisdomTree's Total Dividend Fund (DTD), or whether you favor the marker cap weighted Russell 1000 Value Index (IWD), value stocks have underperformed growth. Just look at how they've performed against the growth-oriented Nasdaq 100 (QQQQ).

Indeed, not all inflation-fighters have fared equally. That said, a diversified portfolio with an inflation tilt has certainly outperformed one that has disregarded the rising costs of goods and services entirely.

While the 2nd half of 2008 may see the U.S. dollar stabilize (perhaps even oil prices subside), inflation is still going to be a part of the foreseeable future. Knowing that, positions in inflation-fighting investments still make sense.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.