Can Equities Provide a Hedge Against Inflation?

October 29, 2021 | Rodrigo De La Peña Alanis, Research Associate

Column chart showing stock indices performance during periods of rising inflation. Chart subtitle: U.S. stock indices have tended to rise during inflationary periods in the last several decades. Chart description: Y-axis shows annualized return, from -10% to 60%. X-axis shows seven periods of rising inflation (Jan 1979 - March 1980; Dec 1986 to Oct 1990; March 1998 to March 2000; June 2002 to July 2008; July 2009 to Sept 2011; Jan 2015 to July 2018; May 2020 to Sept 2021). Each stock index represented by a column: Russell 1000 Growth in blue, Russell 1000 Value in light blue, Russell Mid Cap Growth in purple, Russell Mid Cap Value light purple, Russell 2000 Growth in dark green, and Russell 2000 Value in green, CPI in dark gray. Almost all show positive returns. Chart source: Bloomberg; data as of September 30, 2021.

Inflation has been at the forefront of the minds of many investors in recent months as higher price levels have resulted from economic reopenings and supply chain dislocations across the globe. For instance, the consumer price index — which measures the cost of a basket of goods purchased for consumption by urban households in the United States — rose 0.4% during the month of September, coming in slightly above expectations and translating to a 5.4% jump on a year-over-year basis. Notably, the yearly spike in the CPI is the most significant in over a decade. While the debate on whether current inflation levels are transitory in nature or pose a longer-term threat to the economic health of the world is of great importance and will clearly continue for some time, the question of how investors can mitigate risks stemming from price level increases through the use of different asset classes is also worth exploring.

Real assets, including commodities and real estate, are known to be robust inflation hedges due to the fact that input costs, along with property values and rental income streams, tend to rise in tandem with overall price levels. The case for equities as a guard against higher inflation can be argued by pointing out that revenues and earnings of companies with inelastic demand for their goods and services may also rise along with inflation, due to the fact that firms with strong customer bases are able to pass on price increases to end consumers with relative ease. Generally speaking, this argument has held true in recent decades, as U.S. equity indices have tended to appreciate during inflationary periods going back to the late 1970s. Specifically, and as displayed in this week’s chart, equities have demonstrated hedge-like performance characteristics during periods of moderate inflation (CPI increases of 1–10%) and have largely generated positive real returns during those time frames. It is important to note that recent performance trends are likely aberrational, as equity indices have bounced back quite strongly after pandemic-induced troughs that occurred around the same time as the beginning of the current inflationary period. During times of significant inflation (CPI increases of 10% and above), equity performance has been more mixed, with returns of various style indices usually positive (though often coming in below the prevailing inflation rate). Regardless of whether or not the current inflationary regime is transient or long-term in nature, the data clearly indicate that equities can play a role in helping to lessen the impact of price level increases on the purchasing power of investment portfolios. Prudence and diversification across the asset class spectrum can also help investors endure elevated inflation levels that may persist into the near future.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Rodrigo De La Peña Alanis
Research Associate

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Line chart showing the personal savings rate and personal consumption amongst Americans. Chart subtitle: Personal savings rates have retreated from pandemic-induced highs, however several potential headwinds still face the American consumer this holiday season Chart description: Y-axis ranges from -15% to +30%. X-axis shows quarters from 3Q16 to 3Q21. Line for Personal Savings Rate is purple and line for Personal Consumption (Quarter-Over-Quarter Change) is dark green. Both lines were relatively steady up to 2Q20 as the coronavirus pandemic took hold of the economy. The Personal Savings Rate peaked in that quarter to 26.0% and the Consumption Rate Change decreased to the extremein 2Q20 then peaked the following quarter with a 10% increase. Both levels have returned to just slightly higher than normal levels in recent quarters. Chart source: Federal Reserve Bank of St. Louis as of September 30, 2021.

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