If You're Fearful of Stagflation, This Brand-New ETF Could Be for You

Wednesday saw the Federal Reserve hike interest rates by 50 basis points, which it hasn't done since May 2000. It took this action to help rein in inflation, which sits at levels we haven't seen since the early 1980s. Last week saw the first GDP contraction outside of the pandemic since 2014. I am not an economist, nor do I play one on TV, as the saying goes. Still, there are two things I want to mention. The first is based on a 2009 paper available through the Boston Fed titled Inflation Persistence that spends about 65 pages talking about how difficult, if not impossible, it is to affect any sharp change to inflation once it becomes embedded in the economy. The paper ties in concepts such as Newton's Second Law of Motion and what the author references as the Sacrifice Ratio, which is described as the number of point-years of elevated unemployment required to reduce inflation by a percentage point. My big takeaway from this paper is the implication that inflation does not move freely and requires significant economic effort in the form of lost output to reduce its level. The second is that while the Fed has started to take steps to tame inflation, many observers do not expect these actions to have any immediate effect and that its actions more likely than not will induce a recession, as has been called for by at least two major banks in the past month, primarily based on the current tightening cycle. So, what do you get when you have an economy that is flat or in recession plus high inflation? Something we haven't talked about seriously since the 1970s - stagflation. And as of this week there is an ETF for that. Merk Stagflation ETF Issuer Merk Funds has brought some innovative products to market over the years. One that comes to mind is the VanEck Merk Gold Trust , which not only allows shareholders to invest in physical gold but also to take delivery of actual gold instead of cash when selling shares. The latest innovation it has brought to market is the Merk Stagflation ETF , which launched just this week (May 3 to be precise). The fund has a 45-basis-point expense ratio, meaning that a shareholder with $1,000 invested over a calendar year would pay $4.50 in fees over that period. Unlike some funds that look for strategy solutions in individual company names, STGF utilizes a macro approach and focuses on asset classes. It is set up as a fund-of-funds product and currently holds the Schwab U.S. TIPS ETF (63.39%), Invesco DB Oil Fund (13.62%), Vanguard Real Estate ETF (11.67%) and the aforementioned OUNZ (11.43%). Because this fund invests in other funds, there are some additional carried costs of 5 (SCHP), 77 (DBO), 12 (VNQ) and 25 (OUNZ) basis points, respectively, that, while not called out in the stated expense ratio, will show up in other fund documentation. Based on the current fund positions STGF is carrying an additional 17.91 basis points of embedded average weighted expense by my calculation. The fund is passive and tracks the Solactive Stagflation Index, which went live on March 14, 2022, so both the index and fund are pretty much brand-new. In reading through the index methodology I looked for the section that describes how components are selected, but the only section I found that discusses security selection is the boilerplate that talks about how any discretion used in the index shall be made in accordance with strict rules regarding the exercise of discretion or expert judgment. In reviewing the fund prospectus, there is a table showing that the four asset classes of TIPs, Real Estate, Gold and Oil make up the selection universe. Further, there are set allocation ranges, with TIPs getting the largest exposure with a minimum of 55% and a maximum of 85%, and all the other asset classes ranging between 5% and 15%. The secret sauce of this index seems to be in the daily weighting methodology, which utilizes trend tracking to help forecast near-term returns and position weights. This is not a simple momentum approach. There are several look-back periods for each holding, and from there t-statistics and position volatility are calculated and a standard normal distribution is developed using these initial results. The final signal is calculated by taking the average of trend signals for each asset. Weights are adjusted based on the strength of the signal for each asset, with the upper and lower position limits also taken into account. Again, this process is run every day, so unlike some strategies that rely on 50- or 200-day moving averages, this approach is a lot more reactive. My Take While all the market concerns mentioned at the top of the article are real, there are some conflicting signals, such as a strong first-quarter earnings season that so far has seen more than 80% of companies posting upside surprises. Then there's the labor market. Unemployment currently sits at 3.6%, which, outside of February 2020, is among the lowest it has been in the past 30 years. Even if you look at the spread between top-line unemployment (U-3) and the broader U-6 measure you will find that difference to be well below the five- or 10-year average spread and also the tightest it has been, outside of January 2022 and July and December of 2019, in the past decade. As usual, economic analysis is more art than science. I do like the construction and what I'll call active weighting methodology of this fund. I'm not sure how many more quarters of data the National Bureau of Economic Research (NBER) will need to see before it declares a recession or a regime of stagflation, but it usually makes these calls well after the economy has moved on. If you feel like the current economic environment resembles the classic definition of stagflation, then perhaps STGF is worth a closer look.

If You're Fearful of Stagflation, This Brand-New ETF Could Be for You

Launched just this week, the Merk Stagflation ETF is a fund-of-funds that focuses on four asset classes.

Columnist Conversation

An Interesting Chart

This Weekend on Real Money

Stocks Under $10 Portfolio

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.