latest nail biter: inflation

The financial media’s scare tactic du jour seems to be inflation and how it will negatively affect the markets and your portfolio. (Remember how the big worry last year was de-flation?) With this in mind, we decided to do a little research on the subject of market reactions to higher consumer prices. The chart below shows our findings.

Dramatic Changes in Inflation Rate

We looked at two of the most drastically changing periods in U.S. history. The CPI (Consumer Price Index) was used to represent inflation in the U. S. economy. The first period analyzed was January 1977 through June 1980. This period was chosen as representative of an extreme increase in consumer prices. During this period, we saw inflation go from around 5% to a whopping 15% in 3 ½ short years. These were the days of gas lines and malaise that many remember all too well. As the chart shows, the average annualized CPI during this time frame was around 10.5%. This number seems unreal to us in a decade that has seen sub 3% inflation readings. (Yes, we have been spoiled). At the same time this hyper-inflation was on a rampage the S&P 500 gained, but had a negative real return (gross return minus inflation). In other words, inflation of this type adversely affected its performance. As we look closer however, we see that international markets (MSCI EAFE) performed quite well – more than 10% ahead of inflation. Furthermore, a Market Return Portfolio™ represented by the MRP Index (100% diversified equities) also gained almost 19% per year with a healthy real rate of return.

Do stocks do better with lower inflation? Probably. The next line of the chart examines a period when inflation drops dramatically – July 1980 through December 1986. The CPI dropped from around 15% to 2% during this 6 ½ year period. As you can see, the average annualized CPI was 4.59%, but the S&P came back nicely, earning a plus 13% real rate of return. International markets and the super diversified Market Return Portfolio strategy did even better with lower inflation with each having gross returns over 20%.

The last line of the chart shows the results of the two time periods combined – a total of 10 years. Clearly all the equity indexes outpaced inflation by a wide margin over the longer term.

So does higher inflation negatively affect your portfolio? Perhaps to some degree for short periods of time. But for long term portfolios (and remember they all are long term – or should be) that are diversified properly the answer is no. After all, what is the textbook reason for owning stocks in the first place? As an inflation hedge that no other investment vehicle can match. Bonds are definitely non starters to accomplish this task. Real estate is regional in nature and very expensive to diversify into properly for the average investor. That leaves us with a super diversified Market Return Portfolio^TM using institutional asset class funds which represent all asset classes. This is the best answer for beating the ravages of inflation and allowing you to ignore the "doomsday" reports as you work or play at something more important. Stay the course!

 

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