By Mark DeCambre
Happy, Thursday! Inflation continues to be a persistent theme in financial markets. And for a good reason.
A reading of consumer price inflation for June on Tuesday showed that the cost of living leapt by the largest amount since 2008 as inflation spread more broadly through the economy. Meanwhile, the pace of wholesale price increases over the past 12 months rose to 7.3% from 6.6% in May, marking the highest level since the producer-price index was overhauled in 2010, and likely representing one of the highest readings since the early 1980s.
So what does that mean for exchange-traded markets and how can investors play that dynamic as the Federal Reserve Chairman Powell insists that pricing pressures are transitory , or temporary, and that the U.S. central bank has all the tools necessary to beat it back should it prove unwieldy?
MarketWatch’s ETF Wrap spoke to Gargi Pal Chaudhuri , head of iShares investment strategy Americas at BlackRock Inc . /zigman2/quotes/207946232/composite BLK -1.96% , to glean some key ETF and macro insights from the inflation pro.
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How to play inflation
For a bit of context, to say that Chaudhuri is an inflation pro may be a bit of an understatement.
She spent nine years on Wall Street building out U.S. inflation trading desks for Jefferies & Co., growing the institution’s Treasury inflation-protected securities business. In the early 2000s, she was on the trading desk of Merrill Lynch (now a part of Bank of America /zigman2/quotes/200894270/composite BAC -3.44% ) making a market in TIPs and Treasurys.
Still, she told ETF Wrap that she’s never had more questions about inflation than she has had in this recent period.
“In 20 years, mostly focused on inflation, I [have] never been asked more questions than I have over the last three or four months…on the higher inflation regime,” she said.
Chaudhuri said that investors are confounded by the lower move for yields that has taken the 10-year Treasury /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y +0.39% market to around 1.33%, as of late-morning Thursday from around 1.7% in May. Inflation is anathema to Treasurys because it chips away at its fixed value.
The iShares pro also said that clients are unsure of how to play the next six months of this phase of the economic recovery cycle from COVID, particularly in light of growing concerns around variants of the coronavirus, which, incidentally, may also be a factor driving some demand for Treasurys, and a stock market that has the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA -1.51% , the S&P 500 index /zigman2/quotes/210599714/realtime SPX -1.84% and the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP -2.60% trading near records despite some recent softness.
“How should investors and clients position their portfolios in a world that is looking beyond just the restart, ”Chaudhuri said.
The analyst and manager said that iShares 0-5 Year TIPS Bond ETF /zigman2/quotes/203441491/composite STIP -0.19% has become a popular trade among clients and one that she endorses, especially given concerns about inflation. STIP, referring to the ETF’s ticker symbol, has been around since 2010, is up 1.9% on the year, and carries an expense ratio of 0.05%, which means that investors will pay 50 cents annually for every $1,000 invested. She warned, however, that investors should recognize that inflation-protected notes also carry duration risks if yields eventually swing higher.
Chaudhuri also said she expects financials to continue to perform well as the economy improves and as yields head back toward 1.7% and 1.8% toward the end of 2021. The iShares U.S. Financials ETF /zigman2/quotes/207031846/composite IYF -2.14% , so far, is up 23% so far this year and over 1% in the month to date, FactSet data show. Its expense ratio is 0.42%.
Although the recent drop in yields has called into question the so-called reflation trade, Chaudhuri says investors should expect value to outperform growth.
“We still like the value trade and a lot of that is based on the view that inflation and growth will be robust in the U.S.,” she said. The BlackRock executive also sees opportunities in small-caps /zigman2/quotes/208653303/composite IJR -2.60% . IJR’s expense ratio stands at 0.06%.
She recommends that investors also think outside the U.S., pointing to iShares Core MSCI Europe ETF /zigman2/quotes/202336288/composite IEUR -1.48% as a good diversification play. IEUR costs 90 cents annually for every $1,000 invested.