Evaluate inflation hedges

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The Bundesbank has estimated that Germans have accumulated around 200 billion euros in cash at home and safes in banks in 2020. In addition to the risk of losing money at home in the event of theft, damage to water or fire, cash loses its value in real terms every day due to inflation.

In 2020, inflation was below 1% in Germany, but rose to almost 10% in 2022 due to global supply chain issues and the war in Ukraine. In other words, at the current rate of inflation, more money is lost in real terms in Germany by hoarding cash than by investing in German startups by venture capital funds, which amounted to 19.7 billion euros in 2021 according to Dealroom. This is terrible for savers and the economy.

Most investors are aware of the damage inflation does to their portfolios, but protecting a portfolio against inflation is not easy. In this research note, we will explore which stocks have the best inflation hedging properties.

Inflation indicators

One of the challenges with inflation is that it is measured differently across and within countries. Official statistics are retrospective, but there are also forward-looking statistics from surveys or markets, as well as shadow statistics from market participants who do not trust official data. Unfortunately, this abundance of data makes it difficult to form a clear picture of the current inflation rate.

In this article, we focus on two measures, namely the US consumer price index for all urban consumers (CPI) and the US 10-year inflation rate (BEIR). The CPI is available as a monthly time series, is seasonally adjusted, and represents the price change of a broad basket of goods and services, including housing and energy. This is the most watched inflation figure, but also complicated because the basket changes regularly and some components like power and energy are volatile, leading to large movements in the data.

BEIR is even more difficult to understand because it is obtained by subtracting the yield on US Treasury inflation-protected securities (TIPS) from the yield on the 10-year US Treasury bond. Theoretically, this represents the market’s expectation of inflation over the next 10 years. Higher or increasing spreads indicate rising inflation expectations, while negative or falling spreads imply lower inflation expectations.

Contrasting the two time series in a graph shows that the trends have been almost identical between 2003 and 2022, despite the fact that the CPI is retrograde and the BEIR is forward-looking. The magnitude is different because the CPI is reported monthly and the BEIR is calculated daily.

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