An official gauge of business activity worldwide showed signs of vigor, but that doesn’t mean the global economy is out of the woods or that stocks will inevitably rise from here. Geopolitical tensions and some stubbornly high inflation are still posing some notable risk to output and markets. And that might have you looking to add a little protection to your portfolio. Let’s take a look…
What’s this gauge, and what does it say?
The S&P Global Purchasing Managers Index (PMI) measures economic activity by surveying some 28,000 manufacturing and services companies in over 40 advanced and emerging market countries. The monthly survey asks managers, in effect, whether they see things at their work getting better or getting worse. Any result above 50 indicates an expansion in economic activity, while a reading below 50 suggests a shrinking. This chart shows results for the services sector for the past six months in the US, UK, Germany, China, and Japan.
The services PMI has stayed above 50, or in expansion territory, so far this year. Source: Trading Economics.
The results in manufacturing overall weren’t as strong. However, each of the economies tracked has shown improvement over the past six months and most landed near the important 50 mark – with Germany the one notable outlier on that front.
The manufacturing PMI results were better in April than they were six months earlier for major global economies. Source: Trading Economics.
Overall, the results suggest that these economies are on relatively firm footing. And, historically, that’s been a positive omen for stocks. This chart shows how tightly connected PMI manufacturing results tend to be with US stock performance, with the two traveling hand-in-glove most of the time.
US stocks have tended to move in tandem with manufacturing PMI trends. Sources: MarketDesk, Institute of Supply Management.
If things are going so well, then what’s the problem?
Well, there are a few key risks out there, but, for me, the big one comes down to geopolitical risk and inflation. See, there’s the potential that geopolitical tensions in the Middle East will escalate further, leading to supply disruptions and, as a result, higher oil prices. In other words, inflation. Oil price shocks make for a sticky situation worldwide: they generally add to production costs for businesses while also creating financial stress for households. And as folks face higher prices and start to tighten their purse strings, that tends to stifle corporate profit, threatening stock performance.
What’s more, this is just a really bad time for inflation. A surge now could compel the world’s major central banks to keep their interest rates high for longer, risking a recession because of the adverse drag they create.
So, what can you do to protect your portfolio against those risks?
To hedge against the risk of an oil price shock or some potentially unexpected inflationary scenario, you could add some commodity-related assets to your investment mix. Commodities – including energy, agriculture, industrial metals, and precious metals – have a tendency to deliver steady returns even when other assets are falling, because of their essential role in processes such as manufacturing and agriculture. Precious metal commodities such as gold, meanwhile, have a reputation for holding value over time and have a historically accepted status as a store of wealth.
What’s more, commodities can be a smart play when economic activity is strong and when inflation is higher than usual.
This chart shows the average monthly returns of the Bloomberg commodity total return index (darker blue) and the S&P 500 gross total return index (lighter blue) at various points in the business cycle, from January 1960 to January 2023. Sources: WisdomTree, Bloomberg, S&P.
Diversified commodity ETFs are an easy way to invest in the asset class, giving your portfolio exposure to a basket of different commodities – often for cheap. The abrdn Bloomberg All Commodity Strategy K-1 Free ETF (ticker: BCI; expense ratio: 0.26%) is available in the US. For investors outside the US, the L&G All Commodities UCITS ETF (BCOG; 0.15%) could be a good, low-fee alternative. Both track the Bloomberg Commodity Index and provide diversified exposure to energy, precious metals, industrial metals, livestock, grains, and other commodities.
