Buy these 5 funds to cushion the blow of 40-year-high inflation and how the Fed’s

• Darius Dale says inflation could remain high because of core services prices.
• He estimates the Fed has a six-to-nine-month window of tightening before the economy breaks.
• He recommends investors get liquid by holding cash and invest in assets that are uncorrelated. 

May’s Consumer Price Index (CPI), the measure of the average change in the prices of consumer goods and services, rose by 8.6% from a year earlier on Friday, the highest in 40 years. It clearly showed that the cost of living essentials such as food, rent, and gas are still on their way up. 

Darius Dale, an advisor who specializes in macro risk management, says the real question about inflation should be around core inflation. 

Right now, a decline in the CPI would mainly be driven by the decline in core goods inflation, which strips out volatile food and energy costs, he noted. This is to be expected. During lockdowns, stimulus spending flooded into products. But as people start getting back to pre-COVID routines, they’re pivoting to spending on services. This change could keep inflation from declining, he added.  

“Will we see enough of a continued disinflation in goods prices to keep this core CPI going lower in the rate-of-change terms, or will the continued acceleration in services prices, particularly core services prices, namely shelter prices, owners-equivalent rent, et cetera? Will that sort of wrestle the baton and start to really take over, driving the bus with respect to inflation,” Dale said. “If it does, we’re going to start to see inflation misbehave in the summer months.”

One thing he knows about market dynamics is that change is the only constant. Market cycles, narratives, and policy reactions to different dynamics change. For Dale, what’s important is that investors understand the variables that impact change so that they can make decisions in various environments. In 2021, he founded 42 Macro, a subscription-based research provider for market trends that helps investors navigate the macro environment. 

It’s still too early to determine how much economic growth is likely to slow down, he said. Right now, markets are still digesting the significant reduction in

liquidity

that was provided by the

Federal Reserve

and other central banks around the world. 

As for how many more interest rate hikes the Fed has in store, that’s a moot point, says Dale. The market is already pricing in a terminal Fed funds rate of around 3.5%. The real question should be, how much time do they have to do it? 

For Dale, the answer depends on how quickly an economic growth slowdown materializes and begins to weigh on consumer prices and financial markets. He estimates the Fed has a six-to-nine-month window to continue tightening before things really start to break in the economy and financial markets.

Get liquid, get uncorrelated 

If inflation isn’t tamed, then the Fed will likely continue pulling more liquidity out of the market as it shrinks the size of its balance sheet and raises interest rates. This is an environment where your overall exposure to financial markets needs to be lower, he said. 

In this type of environment, there’s no real safe haven in financial markets. He said that this environment has been proven to be very negative even for bonds. In fact, he added that 2022 is the worst year in recorded history for the bond market in price terms. 

The number one takeaway is you need more cash in your portfolio at times like this, he said. You may take a slight hit due to inflation, but it’s a lot less than losing 20% in the bond market or 30% in the stock market, he pointed out. 

Crypto investors may have assumed they had their bases covered by buying up different types of tokens with various utilities. But as the Fed reduces liquidity in the market, these tokens will plunge. 

“This is the kind of environment where you need to understand the risk you’re taking in your portfolio,” Dale said. “You can consider yourself diversified by having 10, 20 different exposures, but if they’re all highly correlated and they’re all reliant upon the same series of catalysts to help you make money on those exposures, then you’re not actually diversified.” 

When growth is slowing and liquidity is being drained, investors dump high-risk assets. If you have exposure to various types of cryptos and then you’re long on US tech stocks such as Meta, Apple, and Nvidia, at first glance, these asset classes have very different fundamentals. Yet, these are all risk-on assets that will see the steepest plunges as investors sell, Dale said. 

There are relative pockets of safety that may continue to go down in price but they’re likely to decline by a substantially lower degree than riskier parts of the market, he added. 

For example, the Invesco S&P 500 Low Volatility ETF (SPLV) is less sensitive to changes in the economic and liquidity environment than the Invesco S&P 500® High Beta ETF (SPHB), which has the highest sensitivity to market movements. 

If you’re the type of investor who has traditionally ridden high in tech types such as the Nasdaq, Invesco QQQ Trust Series 1 (QQQ), or the Technology Select Sector SPDR Fund (XLK), consider rotating some of that into energy, utilities, or healthcare. 

A few good pivots would be the Energy Select Sector SPDR Fund (XLE), Utilities Select Sector SPDR Fund (XLU), Consumer Staples Select Sector SPDR Fund (XLP), and Health Care Select Sector SPDR Fund (XLV), Dale said.