Powell's Perpetual Pivot: Impact On Real Assets

Sep. 03, 2022 1:41 PM ETRAAX
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  • U.S. Federal Reserve may have finally come to terms with the inflation problem at hand, and that spells trouble for the markets.
  • Soft landings, by design, are not supposed to be painful, and this is what has the markets rumbling. Unfortunately, we believe that the final and most painful pivot has yet to come.
  • Has inflation peaked? Probably. But, we think that this is the wrong question to ask.

Porcelain piggybank interrupting the domino effect

Dorin Puha/iStock via Getty Images

In Powell's never-ending rabbit hole of pivots, Jackson Hole was just another stop. This commentary outlines the Fed's recent pivots and how peaking inflation could affect various asset classes.

The Jackson Hole Symposium concluded and left the markets rattled. It appears that the U.S. Federal Reserve (FED) may have finally come to terms with the inflation problem at hand, and that spells trouble for the markets. It also marks one of many pivots from the Fed, and it is unlikely to be its last.

It started with Fed Chair Jerome Powell being dismissive of inflation.

December 16, 2020: "I think you have to be honest with yourself about inflation these days. There are significant disinflationary pressures around the world. And there have been for a while," he said. "It's not going to be easy to have inflation move up."

Then, Powell pivoted to "high inflation is here but only temporary."

August 27, 2021, Jackson Hole Symposium: "Inflation at these levels is, of course, a cause for concern. But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary."

Powell then calmed the markets with its message of a soft landing.

May 4, 2022: "We have a good chance to have a soft or softish landing."

And most recently, Powell pivoted away from the soft landing and told us to prepare for pain.

August 26, 2022, Jackson Hole Symposium: "While higher interest rates, slower growth and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation."

Soft landings, by design, are not supposed to be painful, and this is what has the markets rumbling. Unfortunately, we believe that the final and most painful pivot has yet to come. That is when the Fed eases its fight against inflation and allows inflation to run above 2% for an extended period of time. This view is underpinned by the growing global debt bubble, which requires more and more stimulus to keep it from bursting. All attempts to reduce accommodative policies, as we are experiencing today with higher interest rates and a smaller Fed balance sheet, will likely only be short-lived and ineffective.

I think Milton Freedman said it best: "There's only one way to stop inflation and that's by having the government create less money and spend less money." Yet, the government continues to overspend. Look no further than the recent student loan forgiveness program and the Inflation Reduction Act.

Our view is simple: The inflationary forces will continue to overwhelm the disinflationary ones, albeit to a lesser degree, and real assets, as natural beneficiaries of inflation, will continue to outperform.

There remains, of course, another question: Has inflation peaked? Probably. But, we think that this is the wrong question to ask.

We believe that inflation likely peaked because new money creation and federal overspending are way below the absurd levels of the previous two years. In addition, future attempts at ludicrous spending initiatives will be more heavily scrutinized.

Knowing how long it will take for all of the excess liquidity to work its way through the system is interesting but likely unhelpful. Time will tell. And one month of slowing inflation-especially when it is being driven by volatile components- while "core" inflation continues to march higher, offers few hints.

The right question to ask is: When will prices return to "normal"? Recent history will define normal as inflation of 2% or less. This would likely signal a return back to the status quo of ridiculously low interest rates, growth outperforming value, and a continuation of the seemingly never-ending bull market in bonds.

Alternatively, it is worth considering that the last decade may be the outlier, excluding the past year. The average inflation rate since the inception of the CPI in 1913 is in excess of 3%. It is reasonable to conclude that, at minimum, we will revert to the long-term average. And if that's the case, the investments that are best positioned to outperform for the foreseeable future will likely be different from the ones that led the market higher in the past decade.

The VanEck Inflation Allocation ETF (RAAX), as a diversified inflation-fighting solution, in our view, presents a compelling investment proposition whether the Fed can quell inflation or not. On the one hand, persistent inflation will allow for further outperformance of the commodity and natural resource equity allocations. Eventually, gold and gold equities, which have lagged during the initial phase of the inflationary cycle, are likely to participate in the rally and outperform other real asset sectors, as has been evidenced in previous inflation periods.

On the other hand, a slowing economy, which often leads to lower interest rates, may be favorable to our REIT, infrastructure, and once again gold (and gold equity) positions. Historically, these assets have been attractive during falling interest rate regimes.

The wildcard, of course, is a swift and harsh economic collapse, such as the ones experienced in 2001, 2008 and 2020, which leads to a repricing of all risk assets. RAAX, on a relative basis, has the ability to generate strong performance due to its diversification, large allocations to defensive assets, such as gold and global infrastructure, and its ability to adapt to different economic regimes.

In closing, we believe RAAX offers an inflation hedge with compelling risk reward for a myriad of possible future price and growth outcomes.

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