According to many commentators, recent upticks in inflation will have a significant negative impact on investment returns.
This is understandable to some extent, as higher interest rates on bonds, which can happen during periods of rising inflation, can negatively impact company profitability.
Before considering changing your investment strategy based on inflation headlines, however, it is worth reviewing a paper published by Wei Dai and Mamdouh Medhat, titled US Inflation and Global Returns.
The paper speaks to the chart below, which illustrates U.S. stock market returns during periods of rising interest rates from 1950-2021 (see the gray columns and the rows of data above them).
As others have shown, even though periods of rising interest rates, which may be influenced by inflation, can lower equity market returns, some of the concerns about higher rates significantly impacting the market may be inflated. According to data covering 1950 -2021 compiled by Crandall, Pierce & Company, except for three periods of relatively large rate increases in the 1960s and 1970s, the U.S. stock market has performed quite well when interest rates rise. In particular, during an 11 month period in the early 1980s when short-term rates rose by over 9%, the U.S. stock market increased by almost 18%.
We certainly don’t have crystal balls, and the past does not equal the present, but the paper by Dai and Medhat provides additional information related to the following questions:
To arrive at their conclusions, Dai and Medhat looked at the relationship between inflation and 23 U.S. asset classes and strategies from 1927-2000 (inflation was defined as the Consumer Price Index for All Urban Consumers – CPI-U).
Similar to the illustration above, the researchers found that all but one asset class (short-term treasury bills) had positive average real returns in both low and high inflation periods.
Based on this, contrary to the latest inflation trade or product pitch, investors might not need to look too hard for any new asset classes or strategies, as the vast majority outpace inflation over the long term.
The answer to the second question is harder, because the researchers show weak correlations over time between nominal returns and inflation. The only exceptions identified by Dai and Medhat were energy stocks and commodities. But even in those cases, more than half of the assets’ nominal return variation was unrelated to inflation.
What should an investor do about inflation?
In the words of the authors:
“The right mix of assets for growth and hedging purposes ultimately depends on an investor’s goals and needs. The good news is that most of the global assets we study have been able to outpace US inflation over the long term. Hence, simply staying invested may by itself be an effective long-term solution to inflation concerns.”
Put another way…
The best long-term strategy is to stick to your long-term strategy.
US Inflation and Global Returns – Wei Dai and Mamdouh Medhat
Keep A Steady Hand on the Tiller – Fiduciary Wealth Partners
Stock Prices and Inflation – Kolari and Anari
Rock Science – Fiduciary Wealth Partners