Mutual Fund Site

Rich Best

Although investors and analysts continue to focus on the relentless climb of the stock market and proffering their two cents on its near term direction, the 800 pound gorilla in the room is starting to beat its chest and becoming more difficult to ignore. For the most part, the prospect of inflation has been dismissed by economists and monetarists as an economic outlier that can be controlled.  Tell that to consumers at the gas pump or at the grocery store where prices have been steadily rising for the last month.

Has the Inflation Shift Already Occurred?

The question investors are struggling with is whether their portfolios are positioned for an era of increasing inflationary expectations.  Based on the repositioning that has been taking place in the stock market since the beginning of the year, they may very well be as evidenced by the inflow and outflow of funds that have occurred in the last few months:

• Bond funds, which are the most sensitive to inflationary expectations and the prospect of higher interest rates, have experienced record outflows.

• Small cap funds, after an impressive run-up have settled in due to profit taking and a rotation of funds into larger cap funds. Small cap companies are more vulnerable to inflationary pressures than large cap companies

• Emerging market funds have taken the biggest hit this year as inflation has already begun to savage developing economies.

• Precious metals funds have endured some profit-taking but their outflows have stabilized indicating that they remain a holding, albeit smaller one in portfolios.

• Large cap funds have taken the lead in the gains of the market this year and equity income funds are experiencing their strongest inflows in years. Whether done purposely, or as part of a natural rotation of investment dollars from over-heated and overpriced sectors to more value-based sectors, investors appear to be bracing for a shift in inflationary expectations.

Inflation Hedge Moves to Make Now

How does this translate into an inflation hedge strategy for investors who want to take a more deliberate approach?  There’s no new ground to cover here. Stocks are generally thought to perform well as an inflation hedge. And, of course, certain commodities are natural inflation eaters. And, if your portfolio adjustments thus far have paralleled the rotational flows of the market, then it may just require doing more of the same.

For instance, large cap funds have been setting the pace this year and those with heavier weightings towards industrials, energy and technology can be expected to ride the crest of any inflationary wave.  The bluest of portfolios with health dividends will perform the best in response to a devalued dollar.

Small cap funds, may still have some upside in them, however, they could take the biggest hit in an inflation cycle. Investors with a couple of year’s worth of gains may want to begin rotating into large cap funds if they haven’t done so.

Gold funds have seen increased volatility as of late, which may continue. Investors have been reducing their holdings in these funds in search of more stability. The question is whether the current price levels have all of the inflationary expectations of the next year already built in to them.

Inflation-Play Funds

The large cap value fund universe is vast, but if your selection criteria are based on inflation hedge factors, the field can narrow fairly quickly. One that popped up on the radar is First Eagle US Value (FEVAX), a five star fund heavily weighted in industrials, energy and technology, with a fair amount of exposure to gold commodities. It might have a little too much exposure to financial stocks which aren’t ideal inflation fighters, but their recent resurgence has helped the fund to a solid year-to-date return thus far.