Given the similar energy supply dynamics driving shows that a shock to inflation and growth is current inflation, it is easy to draw parallels to reflected in commodity prices only for as long the 1970s, when oil embargos in the Middle East as the inflation/growth pressures remain. contributed to inflation pressures in the U.S. and This means that to realize the full benefit of commodity returns provided a useful hedge. commodities as an inflation hedge, investors Our research indicates that commodity returns must be able to time their entry into and exit are a function of realized inflation and the from the position or accept a persistent return economic growth environment. We also find that drag because of a lower Sharpe ratio for shocks to these drivers are both quickly reflected commodities than for U.S. and international 18 in commodity prices and short-lived. Figure II-16b equities. FIGURE II-16 (CONTINUED) Commodities are not an investor’s only tool to fight inflation b. Commodity returns are sensitive to growth and inflation but can decay quickly after a shock % %     s Persistent shock s n  over years – n  One-off ur ur shock in year  t  t  e e r r   ual ual n n n  n  A A – – – – – –         Forecast horizon (years) Forecast horizon (years) Shock range Baseine Notes: The figure shows the impact of a shock to inflation and the Vanguard leading economic indicator (VLEI) on nominal commodity returns over time, based on the distribution of return outcomes from the VCMM derived from 10,000 simulations. The solid lines correspond to the median forecast and the shaded area highlights the range from the 25th to the 75th percentile after a shock of the given persistence. The turquoise line and area show the impact of a persistent shock increasing annualized inflation over years 1–3 by one standard deviation and increasing VLEI in years 1–3 by 0.5 standard deviation. The yellow line and area show the impact of a temporary shock increasing inflation in year 1 by one standard deviation and increasing VLEI in year 1 by 0.5 standard deviation. The red dotted line shows the baseline forecast without any additional shocks. See the Appendix section titled “Indexes for VCMM simulations” for further details on asset classes. Source: Vanguard calculations, as of September 30, 2022. IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of September 30, 2022. Results from the model may vary with each use and over time. 18 The Sharpe ratio is a measure of return above the risk-free rate that adjusts for volatility. A higher Sharpe ratio indicates a higher expected risk-adjusted return. Based on the VCMM median return and volatility forecasts for U.S. and global ex-U.S. equities, cash, and commodities in Figure II-5a and Figure II-9a, global ex-U.S. equities have the highest expected Sharpe ratio (0.24), followed by U.S. equities (0.10) and commodities (0.02). 55