FCPI ETF: Equity Inflation Hedge Expected To Keep Outperforming

Equities are considered to be an inflation hedge, albeit to a lesser extent than commodities, TIPS and real estate. The Fidelity Stocks for Inflation ETF (BATS:FCPI) focuses on stocks that thrive when inflation is high.

FCPI is striking the right balance between diversifying among the different equity sectors and overweighting the best inflation hedging sectors.

In this inflationary environment it is outperforming the S&P 500. We expect that inflation will not return quickly to the 2% Fed-target. And hence, we expect FCPI to continue to outperform: buy the Fidelity Stocks for Inflation ETF.

Inflation hedges in theory

The best Inflation hedging asset classes are well-known: commodities TIPS, and real estate.

Sometimes equities are also seen as an inflation hedge. Research by Vanguard shows that equities can indeed hedge to (unexpected) inflation, albeit to a lesser extent compared to commodities, TIPS and REITs.

Certain equity sectors hedge better against inflation than others. Energy, REITs and Metals & Mining are the best performing equity sectors in inflationary environments.

Inflation hedges in 2022

Inflation is high this year. Are all inflation hedges performing as expected? All major asset classes are posting negative returns YTD, with one exception: commodities. TIPS, REITs and equities are down this year.

This commodity outperformance is also visible when we look at the performance of equity sectors: only Energy is doing great.

On an industry level, the best performing ones are of course the two Energy industries, Oil & Gas Exploration & Production and Oil & Gas Equipment & Services, followed by Metals & Mining (part of the Materials sector).

Fidelity Stocks for Inflation ETF

Both in theory and practice it’s best to focus on certain sectors if you want to hedge against inflation with equities.

Does the Fidelity Stocks for Inflation ETF do this?

It certainly claims it does: it focuses on “stocks of large and mid-capitalization U.S. companies with attractive valuations, high-quality profiles, and positive momentum signals, emphasizing industries that tend to outperform in inflationary environments.”

Let’s check this by looking at the sector allocation.

Hmmm. At first sight this isn’t really the case. Energy and Materials aren’t immediately the biggest sectors in the fund. Also real estate isn’t amongst the biggest allocations. But we cannot deny that the fund is well diversified across the different sectors.

At second sight things look better. If we compare the sector allocation to the S&P-500 the biggest over-weights are Energy and Materials, followed by Healthcare, Consumer Staples and Real Estate. The biggest under-weights are Technology, Consumer Discretionary and Communication Services. FCPI does indeed focus on sectors that tend to outperform in inflationary environments.

We prefer to invest in sectors that are in a long term uptrend and FCPI is on this level also picking the right sectors!

When we look at the individual names in the portfolio, we get at first sight again the feeling that the biggest allocations aren’t the biggest inflation hedges.

But compared to the S&P 500 the biggest over-weights are again labelled “inflation hedge”.

In this inflationary environment FCPI is indeed outperforming the S&P 500.

Valuation

Has this outperformance led to a higher valuation for FCPI compared to the S&P 500?

The SPDR S&P 500 ETF Trust (SPY) has a forward P/E of 18 and a P/B of 3.9. It’s 30-day SEC yield is 1.49%.

FCPI is cheaper on each measure!

Conclusion

We believe inflation is here to stay. It will probably cool, but we will not return quickly to the 2% Fed-target.

If you agree and you’re looking for a fund that can be expected to continue to beat the S&P 500, you can stop looking and buy FCPI.