Last Wednesday, Fed Chair Jerome Powell insinuated that future interest rate hikes will be smaller than the four consecutive 75 basis point increases made over the past five months. As Powell acknowledged, “It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down.”

The stock market celebrated that news. The tech-heavy NASDAQ Composite Index, which is especially sensitive to interest rates, jumped 4% that day.

Wall Street’s reaction to that development was predictable. However, what surprised me was a nearly 2% rise in the Fidelity Global Commodity Stock Fund (FFGCX). The fund owns shares of companies involved in mining, agriculture, and energy.

Since I recommended this fund to my readers in March 2020, it has generated a total return (share price appreciation plus dividends paid) of 185%. Over the same period, the SPDR S&P 500 ETF Trust (SPY) returned 72%.

As impressive as its performance has been, it was even better seven months ago. That’s when FFGCX peaked above $22 after the Fed began raising rates.

At that time, nobody knew when the Fed might start cutting back on rate hikes. Now, we know that will happen later this month.

If the Fed is correct in its assessment of inflation, then I don’t know if continuing to own FFGCX makes sense. As inflation drops, so do the profit margins of most of the businesses that it owns.

Going Against the Grain

Now that the immediate threat of inflation appears to be diminishing, the greater risk is a recession that dampens economic activity. If that happens, then most commodity producers will most likely experience falling sales.

Commodities are the building blocks of most tangible products that we consume. Declining sales for homes, cars, and electronics means less demand for the timber, steel, and petrochemicals that go into them.

That’s good news if you are a consumer of those goods, but bad news if you are a producer. The cost of producing commodities is fairly constant, but the prices at which they can be sold can be quite volatile.

When commodity prices rise suddenly, profit margins for producers expand disproportionately. But when demand for commodities softens, top-line revenue goes down while production costs remain the same.

During the past two years, most commodity producers benefitted from rapidly rising wholesale prices. In March 2020, a metric ton of wheat was selling for $170. By May of this year, its price had risen above $440.

That’s one reason why grocery prices have spiked during the past year. It is also why agricultural producer Archer-Daniels-Midland (NYSE: ADM) is up 50% over the past twelve months.

The energy sector has fared even better. Higher oil prices have recently pushed “supermajors” Chevron (NYSE: CVX) and Exxon Mobil (NYSE: XOM) to their all-time highs.

Coincidentally, those three companies are among the top five holdings of the Fidelity Global Commodity Stock Fund. How they fare in the months and years to come will have a big impact on the share price performance of that fund.

Bonds are Back

If you believe that high inflation is here to stay, then owning FFGCX makes sense. The companies it owns should directly benefit from rising prices for hard assets.

But if you think, as I do, that inflation will slow down next year, then commodity producers may struggle to maintain profit margins.

In that case, a hedge against recession might be more useful. The problem is, there isn’t an investment that is a direct play on a slowing economy.

That’s because there really isn’t such a thing as a “recession-proof” business. When the economy shrinks, there is less money to go around for everyone.

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However, interest rates tend to drop while the economy is in recession. And as interest rates go down, bond prices go up.

That is why I suggest the Fidelity Investment Grade Bond Fund (FBNDX) as a hedge against recession. As its name implies, 95% of the bonds it owns are rated BBB or higher. More than 40% of them are backed by the U.S. Government.

Since inflation started gaining momentum eighteen months ago, the fund’s share price has fallen 20%. At the same time, its 30-day dividend yield has risen to 5%.

As inflation slows down, the fund’s share price should start rising again. Even though its dividend yield will gradually decline, from a total return perspective the net result should be a gain.

I am proud of the call I made in March 2020 regarding inflation, and I hope you took my advice then. But now I believe it is time to hedge our portfolios against a new threat, and only time will tell if I turn out to be right this time, too.

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