Should we adjust our all-weather ETF portfolio for inflation?

It’s too early to batten down the hatches for our ETF model portfolio, but price pressures are increasing.

A year ago, the outlook for the global economy was extremely unclear. You could make a case for deflationary depression, pent-up inflationary boom, or even stagflation (high inflation and stagnant growth). The odds were in favour of inflation in some form since it’s now widely accepted that governments should print and spend money without limit to support economies at times like this. But even so, it was impossible to say how long it might take for inflation to kick in.

So when I last updated MoneyWeek’s all-weather ETF portfolio in June, the decisions reflected that. This model portfolio aims to provide long-term growth while offering some protection from the worst in a crisis. It had performed satisfactorily during the panic, down by a maximum of 13% at the point of peak fear, much less than UK stocks (the FTSE 100 was down 33%). The immediate crisis had passed and the risk of much higher inflation in the medium term prompted me to increase the amount of gold in the portfolio from 5% to 10%. Beyond that, the prospects were too murky to make changes one way or another.

One year into a new world

Since then, the portfolio is up by around 11%. This lags behind the 15% in the FTSE, but that was to be expected in a recovery rally like this. Emerging-market stocks have done very well, but so has the US (both up 25% in sterling terms). Other stockmarkets have ranged from okay (Japan – up 10%) to excellent (UK mid caps – up 30%). The safe-haven assets have been weak: bonds, inflation-linked bonds and gold are all down 5%-10% (and cash still pays no interest).

Now that the balance between inflation and deflation looks like it’s tipped towards inflation (see right and page 4), there’s a temptation to add more inflation protection and perhaps sell down conventional bonds. But it still seems early to make that call. First, the increase in gold last year was intended to get ahead of inflation risks; since that call isn’t yet paying off, it’s not prudent to double-down on it. Second, the most likely scenario for the next year is an moderate inflationary boom rather than runaway inflation. That should benefit equities, but not hurt bonds much so long as central-bank rates remain anchored near zero. 

That said, it’s time to make one change. The portfolio had a very low weighting in the US, because it seemed expensive compared with other markets. It still does. But America should recover well from the crisis. The Federal Reserve seems committed to very loose monetary policies. This increases the chances that US stocks will continue to do well in an inflationary-boom scenario. So let’s increase the amount of US stocks in the portfolio to 10%, taking the extra from Europe.

An all-weather ETF portfolio
Vanguard S&P 500 (LSE: VUSA)10%
Vanguard FTSE Dev. Europe (LSE: VEUR)10%
Vanguard FTSE 250 (LSE: VMID)10%
Vanguard FTSE Japan (LSE: VJPN)10%
iShares Core MSCI Em. Markets (LSE: EMIM)10%
iShares Dev. Market Property Yield (LSE: IWDP)10%
Vanguard UK Gilt (LSE: VGOV)10%
iShares $ TIPS (LSE: ITPS)10%
iShares Physical Gold (LSE: SGLN)10%
Cash10%

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