Inflation nation, how to prepare and capitalize

As Americans anticipate an uptick in inflation ahead, exchange traded fund investors should begin thinking about re-evaluating their investment portfolios.

Consumer prices have risen at such a sluggish pace that economists have grown wary of the United States’ economic health, despite the steadily expanding economy and robust job market. The depressed inflationary levels have also been a key factor behind the Federal Reserve's decision to maintain interest rates at historical lows.

More recently, the price index for personal-consumption expenditures, the Fed's main measure of inflation, rose to 1.8% in November year-over-year, which remained short of the Fed's 2% target annually.

However, expectations have risen in recent months. According to Tradeweb data, expected annual inflation over the next five years was up to 1.85% and for the next decade increased to 1.95% - both numbers were taken from the differential between nominal and inflation-adjusted Treasury yields, the Wall Street Journal reports.

According to a new University of Michigan Survey, consumer expectations for inflation over the next year was up to 2.7% in December from 2.5% in November and 2.4% in October. Over the next five years, expected inflation is 2.4%.

Furthermore, market observers warned that President Donald Trump's economic plans including the recent tax bill could push growth higher and fuel inflationary pressures. Meanwhile, falling unemployment rates and rising wages could also add to higher consumer prices.

Consequently, investors should be prepared for a higher inflationary environment and can utilize targeted ETF strategies to hedge against the negative effects of inflation on a portfolios purchasing power.

For example, the IQ Real Return ETF (NYSEArca: CPI) invests in a number of various ETFs with the objective of providing a hedge against inflation or provides a multi-asset inflation hedging approach. Specifically, the ETF includes exposure to short-term Treasuries, short contracts on Treasury bonds, the S&P 500 and Russell 2000.

The iShares Floating Rate Bond ETF (NYSEArca: FLOT) is one of the largest ETFs dedicated to floating rate notes. Floating rate notes, like the name suggests, have a floating interest rate and may limit the negative effects of rate risk, especially as the Fed considers raising interest rates to fight off an overheating economy with rising inflationary pressures.

ETFs that track Treasury inflation protected securities such as the iShares TIPS Bond ETF (NYSEArca: TIP) track a type of Treasury security that is indexed to inflation as a way to shield investors from the negative effects of inflation. The securities’ par value rises with inflation as measured by the Consumer Price Index while interest rate remains fixed. TIPS also offer investors another layer of diversification as many aggregate bond funds exclude TIPS from their holdings.

Precious metals and gold ETFs, such as the SPDR Gold Shares (NYSEArca: GLD), are a great way to fight inflation. Inflationary pressures could serve as a catalyst for the yellow metal and for gold-related ETFs. By some metrics, the Fed has under-estimated U.S. inflation, which could prove beneficial to gold because the yellow metal is historically a popular inflation fighter or act as a physical store of wealth.

Additionally, investors can also gain broad commodities market exposure through something like the United States Commodity Index Fund (NYSEArca: USCI). Academic studies have found that commodities protected against inflation better than stocks and bonds and consistently outperformed traditional assets during periods of rising inflation.

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