Trend-following and inflation - It is all about the uncertainty

 

Trend-following has been generating strong returns during this surge in inflation. This is not just a recent phenomenon. The data since 1979 supports the relationship between trend-following and inflation.  If the CPI is above 2.5%, trend-following will generate strong returns. If inflation is high and there is upside surprise, the returns are even stronger. 2022, the year of upside inflation, is showing exceptional returns as report in the FT article, "Inflation is a friend of your trend" by Nick Baltas. 

What is causing these huge trend-following gains? It is easy to say that commodity markets are the driver, but we have seen strong price reversals since the highs in March. 

The real reason for stronger trends is uncertainty. Inflation adds significant uncertainty on the direction of prices. Are the price increases caused by a general increase in prices, inflation, or just an increase in demand?

Inflation creates uncertainty for managers and investors who have to make real and financial decisions. Uncertainty creates noise. Uncertainty creates an environment that slows decisions. We are anchored in our past and that macro past has been one of stable prices. We are afraid of being wrong and suffering from regret.

The uncertainty that comes from higher and more volatility inflation is not just manifested in commodity markets. We see it in fixed income. We see it in stock indices, and we see it in currency markets. The core markets associated with trend-following are all affected by inflation is way that impacts decision-making. Every decision is slowed, and the results are trends.