Domestic Bonds

Stagflation protection against an unexpected source

July’s consumer price index (CPI) reading rose to 8.5% from the eye-popping 9.1% seen in June, with jobs data proving strong, a scenario of stagflation probably isn’t at the top of investors’ lists of concerns.

Still, it pays to be prepared, and investors can achieve that readiness with assets that are driven by factors beyond stagflation. Perhaps surprisingly to some market participants, emerging market equities are credibly part of this conversation, indicating that exchange-traded funds such as the Franklin Emerging Market Core Dividend Tilt Index ETF (DIEM).

DIEM, which tracks the Morningstar Emerging Markets Dividend Enhanced Select Index, could be an ideal avenue for investors chastised by previous bouts of emerging markets disappointment to revisit the asset class. At the very least, market participants have compelling reasons to value the Franklin Templeton ETF.

“Stocks and bonds from poorer countries have sunk this year amid Federal Reserve tightening and soaring consumer prices, and could sell even more if the global economy stagnates,” reported Bloomberg. “Yet it is in the pockets of emerging economies that the antidotes to stagflation exist: faster growth, accommodative policy and inflation-adjusted returns. This could unlock opportunities in everything from Indian stocks to Brazilian currency to Chinese bonds.

Home to 516 stocks, DIEM focuses on high-dividend stocks from developing economies. In the United States this year, high-dividend tariffs dominate the overall market. In emerging markets, these stocks offer opportunities, as many of them come from commodity-related sectors and have clear value characteristics – strategies that are working well in emerging markets this year.

Additionally, DIEM has potential sources of appeal through its geographic exposures, including a combined 39% allocation to China and India.

“China’s bias for looser monetary policy, a popular theme for global investors since the start of the year, could become even more compelling. Declining factory-gate inflation, a slump in the housing sector and a fragile recovery clouded by Covid blasts are keeping policymakers determined to continue easing,” according to Bloomberg.

As for India, Asia’s third-largest economy may have some protection against a broader global contraction due to the economy’s domestic orientation. Likewise, DIEM’s 8.30% weighting in Brazil, Latin America’s largest economy, is attractive on its own with falling inflation and high real yields.

“The country’s consumer price growth fell in July, responding to one of the most aggressive rising cycles in emerging markets. This leaves Brazil with an actual yield of 3.68 percentage points,” Bloomberg noted.

For more news, insights and strategy, visit the Volatility Resource Channel.

Opinions and predictions expressed herein are solely those of Tom Lydon and may not materialize. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.