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Inflation is something we have been discussing quite a bit lately, largely due to the influence it has over FOMC policymakers’ interest rate decisions and the drag it has on the overall economy. An interesting research report came out from YCharts that discusses another important impact of inflation and that is on the performance of asset markets. With inflation having come down significantly from its highs and currently sitting at 2.4% what could we expect from different asset classes going forward if inflation remains within the Fed’s target range of inflation?
First, it’s important to understand how the research was put together:
- The Fed’s target range is for a PCE of 1.5% to 2.5% and a midpoint of 2.0%.
- YCharts observed a difference of approximately .4% between the PCE and CPI.
- They therefore adjusted the target range to use the CPI at 1.9% to 2.9%.
- The FOMC first set this target back in 1996, so that is the starting point of the research.
- Finally, they identified periods where the CPI fell below 2.9% and the subsequent 12-month average remained within the target range.
There ended up a total of 326 periods looked at with 105 periods (32.2%) that the CPI fell within the range they are isolating. Note that there were 100 periods (30.7%) that were greater than 2.9% CPI and 121 periods (37.1%) that were less than 1.9% CPI.
However, there were only 6 periods that met all of the criteria of the CPI, falling to under 2.9% for the month followed by the subsequent 12-month average within the target inflation range. This is a limited sample size, but the results are interesting, nonetheless.
When looking at average returns over all six periods, US large cap equities were the top performers with the S&P 500 averaging 23.9%, followed by strong performance of US small caps and emerging markets.
The results were broken down to the individual periods and scored based on how many times an asset class was either the first, second or third top performer. The most consistent performers over these periods were emerging markets, real estate and US large and small cap equities. Scoring in the top 3 places 2 out of the six periods.
Interestingly, emerging markets and real estate came ahead here with both of their scores coming from placing in the number one spot. US large caps (S&P 500) followed with one top spot rank and one third place, finally US small caps took one second place and one third place.
What makes this interesting is the 3rd quarter had strong performance in some asset classes that had been lagging previously and this strength was consistent with the findings of this report. Over the quarter, real estate was the top performing asset class, with US small caps and emerging markets showing very strong results as well. While US large caps were not the top performer in this quarter, they easily outperformed the other asset classes so far this year.
These results do hint that we could have continued strength in US large cap equities as well as strong performance going forward in small caps, emerging market equities and real estate. However, it is important to note that, while interesting, the sample size is small and the analysis assumes that inflation will remain contained, staying within the target range over the next year. The consensus seems to be that this will be the case, although we are not convinced that the path forward will be an easy one and we could certainly see inflation heating back up above the 2.9%, particularly if the Fed becomes more aggressive than necessary on cutting rates.