With headlines declaring inflation has hit a 39-year high, the Federal Reserve (and other central banks) have no choice but to start raising interest rates sooner rather than later.
The following chart from Bloomberg breaks down the components of the consumer price index. It looks like inflation is now striking across the board. With labor shortages everywhere, workers will be demanding steep hikes in wages. Additionally, once inflation becomes part of labor, it is no longer "transitory" but embedded. Its very hard to tell an employee that he should take a pay cut if inflation goes down next year without motivation taking a big hit. It is just easier for the business to let him or her go and then hire a new employee at a lower rate. This dynamic can lead to the dreaded stagflation, like that seen in the 1970s, as well as high inflation and high unemployment.
While stock indexes remain high, changes are occurring below the surface. The highly valued tech sector looks like it is stalling, and lower price-earnings value and resource and commodity stocks are perking up. I think this rotation will be a major theme for this year.
One idea I have recently come across is an exchange-traded fund called the ProShares Equities for Rising Rates ETF (EQRR, Financial).
The ETF provides exposure to a basket of U.S. stocks designed to outperform broader U.S. large-cap equity markets during periods of rising U.S. Treasury interest rates.
It also targets sectors that have the highest correlations to U.S. 10-year Treasury yields and, within those sectors, stocks that have a strong tendency to outperform as rates rise. The ProShares Equities for Rising Rates ETF outpaced the S&P 500 Index by 7% over the past 12 months.
With U.S. 10-year Treasury yields expected to climb above 2% in 2022, the ETF is expected to continue its outperformance. It also trades at a valuation discount relative to the S&P 500 Index. Financials, energy and basic materials constitute 75% of the ETF, providing largely cyclical exposure for investors.
The ETF is composed of the following sectors:
| Financials | 31.56% |
| Energy | 23.54% |
| Basic Materials | 19.99% |
| Industrials | 15.27% |
| Telecommunications | 9.64% |
ProShares Equities for Rising Rates has an expense ratio of 0.35% and a 12-month yield of 1.71%.
Therefore, it could be a good option for the changing dynamics of the market.
