Stocks Have Been a Poor Inflation Hedge

Larry SwedroeNew research shows that stocks have historically been a poor hedge against inflation over anything but very long horizons, and investors worried about preserving the real value of their income and assets should prepare for a wider range of economic outcomes.

The conventional wisdom is that because stocks represent the ownership of real assets, they should be a good hedge against inflation. Unfortunately, conventional wisdom about stocks is often wrong. Stock returns have been about 10 times as volatile as inflation (about 19% versus about 1.8%), making them an unreliable hedge over anything but long horizons. For example, over the period December 1968 through December 1982, the S&P 500 Index returned 6.3% per annum, while the CPI increased at a rate of 7.5%. The result was a cumulative loss in real value of 38%. It’s hard to make the case that stocks are a good inflation hedge when they lost almost 40% in real terms over a 14-year period.

Eugene Podkaminer, Wylie Tollette and Laurence Siegel, authors of the study, “Protecting Portfolios Against Inflation,” published in the April 2022 issue of The Journal of Investing, examined the historical performance of various assets and liabilities relative to inflation and concluded that equity indexes only worked over a very long-term horizon. They also found that stocks were a negative hedge over shorter time frames, tending to fall when inflation rates rose.

Their findings are broadly consistent with those of Henry Neville, Teun Draaisma, Ben Funnell, Campbell Harvey and Otto Van Hemert, authors of the study, “The Best Strategies for Inflationary Times,” published in the August 2021 issue of The Journal of Portfolio Management. They analyzed the performance of a variety of asset classes for the United States, the United Kingdom and Japan since 1926 to determine which have historically tended to do well (or poorly) in environments when year-over-year inflation was accelerating and when the level moved to 5% or more. They found that no individual equity sector offered significant protection against high and rising inflation. Even the energy sector was only slightly better than flat in real terms. Weak sectors included those with a high exposure to the individual consumer, such as durables (-15%) and retail (-9%). Technology was also weak, at -9%. Financials were weak (-9%) because default risk dominated the benefits of possibly rising rates and because there can be a lag between an inflationary regime and central bank tightening.