Overtime

Mailtime

Good morning,

You guys brought the heat this month. We’ve got a jam-packed Mailtime ahead of our week off for vacation, so no time to waste on an intro.

Let’s get to those questions and chart requests!

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Questions

What are your overall thoughts on where inflation is headed?

Loaded question, and I could probably do a whole report on it, so let’s start by just focusing on the market’s view. 5-year breakevens are up 76 bps in the past 5 months and hitting their highest level since March 2023.

However, at the same time, 5-year, 5-year forwards are heading lower. The 5-year, 5-year forwards are market-implied expectations for the 5-year period starting 5 years from now. So if the market is pricing in higher inflation in the next 5 years but lower inflation in the five years after that, it’s pretty obvious there is a repricing taking place based on President Trump and his policies.

Don’t shoot the messenger. Doesn’t mean the market will be right. That’s just what is happening. You can also see it in the recent disconnect between breakevens and crude oil, which typically track each other perfectly.

As for that the inflation data says, the YoY change in the core CPI rate has fallen precipitously since the middle of 2022 but since last summer, the rate of change has stalled just above 3.2%.

If I’m putting on my technical hat, it sure looks like inflation is stabilizing above the prior 20-year regime but certainly not accelerating.

As for my purely personal opinion, inflation staying right around 3% sounds right to me. As many people have pointed out, the Fed’s 2% inflation target is basically made up and the long-run inflation rate is closer to 3%.

The economy is generally healthy and none of the ingredients that caused inflation to spike in 2021-2022 (sending free money checks, oil prices spiking, supply chain disruptions, and 0% interest rates causing a housing frenzy) are present now.

While the commodities complex (more on that in the next question) is trending higher, if crude oil isn’t participating, that isn’t likely to feed into the economy. Egg prices might be fun to complain about but they aren’t going to change consumer or business behavior like oil prices can.

Would love to get your take on the continuation of trends across the commodities complex and best ways for advisors to play various commodities?

So, there are definitely a lot of strong commodities out there, gold is hitting new highs, and skyrocketing prices for various soft commodities have pushed DBA (agriculture commodities fund) to its highest level since 2014.

2 questions advisors should always ask themselves before investing in commodities:

1. Is the commodity showing relative strength vs. the thing in my portfolio or benchmark I will have to sell or underweight to add the commodity?

2. Is there a product/fund available that I have confidence will track the commodity well enough to capture gains if I’m right on question 1?

Unfortunately, question #2 eliminates a lot of possibilities. Funds that use futures to track commodities or baskets of commodities are often expensive, track the underlying poorly due to roll costs, or liquidity, and can come with the headache of a K-1 at tax time.

Question #1 is also overlooked but very important if our goal is to outperform a benchmark without commodity exposure.

However, right now, one position looks very intriguing and potentially passes our two-question test: