Investments and Inflation

pennies

This question seems to pop up in online forums all the time. Are equities or stocks a good hedge during high inflationary times? According to the data of S&P 500 returns and historical inflation data, I have constructed a table comparing the two side by side.

Year S&P Returns Inflation Rate Gold Price
1926 11.62 1.1 20.67
1927 37.49 -1.7 20.67
1928 43.61 -1.7 20.67
1929 -8.42 0.0 20.67
1930 -24.9 -2.3 20.67
1931 -43.34 -9.0
1932 -8.19 -9.9
1933 53.99 -5.1
1934 -1.44 3.1
1935 47.67 2.2
1936 33.92 1.5
1937 -35.03 3.6
1938 31.12 -2.1
1930 -0.41 -1.4
1940 -9.78 0.7
1941 -11.59 5.0
1942 20.34 10.9
1943 25.90 6.1
1944 19.75 1.7
1945 36.44 2.3
1946 -8.07 8.03
1947 5.71 8.03
1948 5.50 8.1
1949 18.79 -1.2
1950 31.71 1.3
1951 24.02 7.9
1952 18.37 1.9
1953 -0.99 0.8
1954 52.62 0.7
1955 31.56 -0.4
1956 6.56 1.5
1957 -10.78 3.3
1958 43.36 2.8
1959 11.96 0.7
1960 0.47 1.7
1961 26.89 1.0
1962 -8.73 1.0
1963 22.80 1.3
1964 16.48 1.3
1965 12.45 1.6
1966 -10.06 2.9
1967 23.98 3.1
1968 11.06 4.2
1969 -8.5 5.5
1970 4.01 5.7
1971 14.31 4.4
1972 18.98 3.2
1973 -14.66 6.2
1974 -26.47 11.0
1975 37.2 9.1
1976 23.84 5.8
1977 -7.18 6.5
1978 6.56 7.6
1979 18.44 11.3
1980 32.50 13.5
1981 -4.92 10.3
1982 21.55 6.2
1983 22.56 3.2
1984 6.27 4.3
1985 31.73 3.6
1986 18.67 1.9
1987 5.25 3.6
1988 16.61 4.1
1989 31.69 4.8
1990 -3.11 5.4
1991 30.47 4.2
1992 7.62 3.0
1993 10.08 3.0
1994 1.32 2.6
1995 37.58 2.8
1996 22.96 3.0
1997 33.36 2.3
1998 28.58 1.6
1999 21.04 2.2
2000 -9.11 3.4
2001 -11.89 2.8
2002 -22.10 1.6
2003 28.68 2.3
2004 10.88 2.7
2005 -4.91 3.4
2006 15.79 3.2
2007 5.49 2.8
2008 -37.00 3.8
2009 26.46 -0.4
2010 15.06 1.6
2011 2.11 3.2
2012 16.00 2.1
2013 29.6 1.5

Legend:
S&P Green: 30% or higher returns
S&P Red: -20% or worse returns
Inflation Green: Any deflation (negative inflation)
Inflation Red: 10%+ inflation (high inflation)

Analysis: Although stocks are overall a much better investment than other asset classes, it does fluctuate very wildly and doesn’t seem to correlate with inflation very much. For example look at year 1974. S&P500 had -26.47% and to add to the pain, inflation was another 11%. So that year, you actually lost 37% as an investor! On the other hand, during 1931, S%P500 gained an impressive 53.99% and the icing on the cake is that inflation was at -9%!

Below are examples of great returns made sweeter because of negative inflation:

Year S&P Return Inflation Real Return
1927 37.49 -1.7 39.19
1928 43.61 -1.7 45.31
1933 53.99 -5.1 59.09
1938 31.12 -2.1 33.22
1949 18.79 -1.2 19.99
1955 31.56 -0.4 31.96

And of course, on the other end of the spectrum, is a table of crashes made more painful because of high inflation:

Year S&P Return Inflation Real Return
1941 -11.59 5.0 -16.59
1946 -8.07 8.03 -16.1
1973 -14.66 6.2 -20.86
1974 -26.47 11.0 -37.47
1981 -4.92 10.3 -15.22
2008 -37.00 3.8 -40.8

However, there are a few instances where stock gains and inflation have “hedged” each other. For example, in 1931, stock losses were in 43% range, but that was partially mitigated by the fact that inflation was -9% as well. In 1980, stocks had an impressive 32.5% run but cooled by the 13.5% inflation.

Year S&P Return Inflation Real Return
1931 -43.34 -9.0 -34.34
1932 -8.19 -9.9 1.71
1942 20.34 10.09 10.25
1951 24.02 7.9 16.12
1979 18.44 11.3 7.14
1980 32.50 13.5 19

Conclusion: If you were to correlate annual S&P 500 returns with annual inflation, then no, there is hardly any correlation. However, since S&P 500 has a long term return of 10% and inflation has historically been 3%, then yes, stocks are a good overall “investment”, but not a good “hedge”.

Even though S&P500 averages out to 9-10% per year over the long run, it rarely produces that number. What I’ve learned so far with the stock market is that when it rains, it really pours. An earnings hiccup or a chip in the economy turns into crazy sell-off. An earnings beat or small signs of recovery turns into a crazy cash influx.

Sources:
http://www.onlygold.com/TutorialPages/Prices200yrsFS.htm
http://www.usinflationcalculator.com/inflation/historical-inflation-rates/
http://www.istockanalyst.com/article/viewarticle/articleid/2803347

Posted in Investment Analysis.

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