As you are probably aware, inflation has been running high in the US in recent readings. The Consumer Price Index (CPI) and Personal Consumption Expenditures Price Index, which is the Fed’s preferred measure, recently posted their fastest year-over-year inflation rates since 1982.[i] Accordingly, preventing rising prices from eroding savings’ long-term purchasing power has become important for many—rekindling a longstanding debate over which investments are best during periods of high inflation. Now, Fisher Investments thinks letting past inflation drive forward-looking investment decisions is erroneous, as markets aren’t backward-looking. The past year’s inflation is already baked into asset prices, in our view. Still, we think this is a teachable moment—there will likely be future episodes of accelerating inflation. So let us revisit the debate and show you why Fisher Investments thinks a global stock portfolio is better against inflation than many investors presume—and actually tops several popular alternatives.
Certain assets have a reputation as good inflation hedges—one being physical commodities. This, in Fisher Investments’ view, seems rooted in the idea that when consumer prices rise, precious and industrial metals’ prices will likely mirror the move. Gold is chief among these, often receiving extra attention as a hedge due to its rarity, historical backing of the dollar and ancient usage as money. Some simply see the fact humans have long deemed it precious, making it a stable store of value. Cryptocurrencies also receive some acclaim as the next great inflation hedge, due to their limited issuance and lack of affiliation from government entities—unrelated to the effects of central bank policy. Some see them as digital versions of hard currency.
However, these alleged hedges aren’t as reliable as many believe. In the 12 months through December, CPI increased 7.0% y/y.[ii] Over the same period, gold prices dropped -3.5%.[iii] From December 1986 to October 1990, gold fell -2.9% cumulatively as CPI accelerated from 1.2% y/y to 6.4%.[iv] Similarly, from March 1998 through March 2000, CPI sped from 1.4% y/y to 3.8%. Yet gold fell -8.1%.[v]
Cryptocurrencies? The oldest is bitcoin, and it has existed for only about 10 years, so it lacks enough performance history to support a claim either way. But that limited history holds little evidence cryptocurrencies rise with inflation. Bitcoin returned a whopping 3,438.3% from January 2015 to July 2018—a period of relatively low inflation.[vi] Bitcoin reached its peak in mid-December 2017, and then tumbled -59.7% through July 2018’s end.[vii] Over that span, inflation accelerated from 2.1% y/y to 2.9% y/y.[viii] In our view, an ideal inflation hedge should have a strong positive correlation with price gauges—meaning when prices rise, your hedge’s returns should increase, too—by at least as much as prices do. Bitcoin doesn’t demonstrate that.
No investment is perfect, but we believe global stocks actually hold better hedging characteristics—having historically beaten inflation. This is because stocks’ earnings usually perform well alongside inflation. Companies can pass rising costs onto consumers, preserving margins. Some use strong gross margins to absorb higher costs, gaining market share through competitive pricing. They can also swap one input for another, minimizing costs to preserve margins. The exhibit below shows the effect of this, in our view, showing S&P 500 returns during periods of above-average inflation. Fisher Investments’ analysts excluded recent inflation as there is not yet sufficient forward return data (though we will note the S&P 500 rose 26.8% last year, outstripping CPI).[ix]
Exhibit: S&P 500 Forward Returns When the CPI Inflation Rate Is …
All the median returns shown above are positive, suggesting higher inflation isn’t inherently bad for stocks. In our view, when high inflation coincides with a bear market, it generally isn’t inflation itself that does the damage. Most trouble arrives when the Federal Reserve overshoots, trying to contain inflation by raising short-term interest rates. A well-known example is in 1980, when former Fed Chair Paul Volcker raised short-term rates from 11.0% to 17.5%, attempting to combat the 1970s’ double-digit inflation. Though the medicine worked, the rate hikes caused a deep yield curve inversion, froze credit markets and drove a bear market from November 28, 1980, to August 12, 1982, as stocks priced in the economic recession that ran from July 1981 through November 1982.
Monetary policy errors are always worth watching for, but presently we see little indication of this happening in the near term. For the time being, the mere existence of higher inflation isn’t a reason to shun stocks, in our view.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: FactSet, as of 2/15/2022. Statement based on Consumer Price Index and Personal Consumption Expenditures Price Index, 12/31/1981—12/31/2021.
[ii] Source: US Bureau of Labor Statistics, as of 01/14/2022.
[iii] Source: Gold price per ounce, 12/31/2020–12/31/2021.
[iv] Source: Gold price per ounce, 12/31/1986–10/31/1990, and CPI, December 1986–October 1990.
[v] Source: FactSet and Federal Reserve Bank of St. Louis, as of 10/26/2021. Gold price per ounce, 03/31/1998–03/31/2000, and CPI, March 1998–March 2000.
[vi] Source: Global Financial Data, as of 05/27/2021. CPI and bitcoin price change in USD, 11/30/2010–09/30/2011 and 01/31/2015–07/31/2018.
[vii] Source: Global Financial Data, as of 05/27/2021. Bitcoin price change in USD, 12/16/2017–07/31/2018.
[viii] Source: US Bureau of Labor Statistics, as of 05/28/2021.
[ix] Source: FactSet, as of 02/15/2022. S&P 500 total return, 12/31/2020–12/31/2021.