Inflation vs. Stock Market Returns
Below are recent headlines that can make it feel like people are throwing in the towel on the idea of inflation being transitory:
There is no doubt that we are seeing inflation spike. Below is a chart showing the U.S. inflation rate since 2010.
|
Year |
Jan |
Feb |
Mar |
Apr |
May |
Jun |
Jul |
Aug |
Sep |
Oct |
Nov |
Dec |
Ave |
|
2021 |
1.4 |
1.7 |
2.6 |
4.2 |
5.0 |
5.4 |
5.4 |
5.3 |
5.4 |
|
|
|
|
|
2020 |
2.5 |
2.3 |
1.5 |
0.3 |
0.1 |
0.6 |
1.0 |
1.3 |
1.4 |
1.2 |
1.2 |
1.4 |
1.2 |
|
2019 |
1.6 |
1.5 |
1.9 |
2.0 |
1.8 |
1.6 |
1.8 |
1.7 |
1.7 |
1.8 |
2.1 |
2.3 |
1.8 |
|
2018 |
2.1 |
2.2 |
2.4 |
2.5 |
2.8 |
2.9 |
2.9 |
2.7 |
2.3 |
2.5 |
2.2 |
1.9 |
2.4 |
|
2017 |
2.5 |
2.7 |
2.4 |
2.2 |
1.9 |
1.6 |
1.7 |
1.9 |
2.2 |
2.0 |
2.2 |
2.1 |
2.1 |
|
2016 |
1.4 |
1.0 |
0.9 |
1.1 |
1.0 |
1.0 |
0.8 |
1.1 |
1.5 |
1.6 |
1.7 |
2.1 |
1.3 |
|
2015 |
-0.1 |
0.0 |
-0.1 |
-0.2 |
0.0 |
0.1 |
0.2 |
0.2 |
0.0 |
0.2 |
0.5 |
0.7 |
0.1 |
|
2014 |
1.6 |
1.1 |
1.5 |
2.0 |
2.1 |
2.1 |
2.0 |
1.7 |
1.7 |
1.7 |
1.3 |
0.8 |
1.6 |
|
2013 |
1.6 |
2.0 |
1.5 |
1.1 |
1.4 |
1.8 |
2.0 |
1.5 |
1.2 |
1.0 |
1.2 |
1.5 |
1.5 |
|
2012 |
2.9 |
2.9 |
2.7 |
2.3 |
1.7 |
1.7 |
1.4 |
1.7 |
2.0 |
2.2 |
1.8 |
1.7 |
2.1 |
|
2011 |
1.6 |
2.1 |
2.7 |
3.2 |
3.6 |
3.6 |
3.6 |
3.8 |
3.9 |
3.5 |
3.4 |
3.0 |
3.2 |
|
2010 |
2.6 |
2.1 |
2.3 |
2.2 |
2.0 |
1.1 |
1.2 |
1.1 |
1.1 |
1.2 |
1.1 |
1.5 |
1.6 |
Historical inflation rate based on U.S. Consumer Price Index, published by the Bureau of Labor Statistics.
You can see that U.S. inflation started to spike around March/April of 2021 and, so far, seems to have steadied itself around 5.5%.
However, is it transitory or is it permanent? Maybe this inflation will turn out to be a one-time spike that falls back to trend. Or maybe it will be here for years. It’s impossible to say at this point. No one knows how the combination of pandemic, unprecedented government support and the myriad underlying economic factors will play out. However, it is worth looking a bit more closely at two questions:
- How has the stock market fared historically in periods of higher inflation; and,
- What was causing the very low levels of inflation prior to April, 2021, and are those factors still with us? (Keep in mind, since 1956 U.S. inflation has averaged 3.56% so, prior to April 2021, inflation has been running well below its average for nearly 20 years.)
Let me start with the first question. If higher inflation does stay around, many seem to be predicting that it is a big risk to the stock market. However, there’s no clear sign of this from the historical data.
Here’s a look at the calendar year returns on the S&P 500 along with the annual inflation rate going back to 1928:
There’s no clear statistical pattern here. That could be because the stock market is forward-looking and inflation involves backward-looking data. Even when inflation has been as high or higher than it is right now, the stock market has held up pretty well through history.
Next is a table that ranks the highest 17 calendar year rates of inflation with the corresponding returns on the stock market:
Inflation is the U.S. Consumer Price Index provided by U.S. Bureau of Labor Statistics - S&P 500 Historical Total Returns from Stern Business College, New York University
The average returns for the S&P 500 in these 17 years was 9.4%. That’s about the long-term average of the S&P 500 over the past 90+ years. Eight out of the 17 years were double-digit returns.
Nearly one-third of the time, returns were more than 20% when inflation was the highest although, obviously, after taking the higher inflation into account, real returns were more modest.
It does make sense that the stock market will hold up in an inflationary environment if you think about it from the perspective of the corporations represented by the markets. Most companies will not willingly absorb higher costs but instead, pass these along as price increases to their customers keeping profits at least level.
Now let me move to the second question, “What was causing the lower U.S. inflation of the last 20 years or so and are those conditions still with us?” It is logical to assume that some of the factors driving the current inflation will eventually subside, e.g., compromised supply chains will work themselves out eventually , the pandemic will eventually wane, etc. But what about other conditions?
It was not that many months ago that the headlines identified that a major risk to the economy was not inflation, but deflation (you can see this in the first chart showing inflation back to 2000). Additionally, this was not just a U.S. problem, nearly every developed economy was experiencing it, and even many non-developed markets who managed their financial system reasonably well. Frankly, economists had not been able to reach a consensus as to the specific cause, but one theme seems to be settled upon by just about every expert – the massive number of baby boomers retiring (10,000 per day in the U.S.).
Prior to their retirement, their savings rate increased substantially and in retirement they were watching their spending more closely than they ever had, thereby affecting demand. It is probably not a coincidence that the countries experiencing the lowest inflation also have the highest number of near retirees and retirees than they have ever had. People are still retiring in unprecedented numbers and this is projected to continue to grow for another 15 to 20 years. Given the size of the baby boomer cohort, the impact will continue to be felt.
Another factor that is impacting developed markets across the globe is the dearth of workers. If this was the only factor in the economy this should cause inflation. However, prior to the pandemic it had not (apparently a worker shortage was unable to offset the impact of those retiring). Some pundits blame the pandemic and the policies that try to counteract its economic impact for the worker shortage we are experiencing but this shortage existed prior to the pandemic. The pandemic certainly accelerated that shortage by causing some 3 million U.S. workers to take early retirement. If these recent retirees do not return to the work-force we will have exacerbated our already developing worker shortage. We have previously written that in developed economies, including the U.S., deaths are being replaced with births. It is likely that the only way out of this worker shortage is increased immigration and there seems to be no policies addressing this. So, I expect that the problem will be here for some time.
To conclude, I’m not going to try to predict how inflation or the stock markets are going to play out. As we have said many times over the years, making such predictions is a fool’s errand. But if inflation does go higher, and stays higher, then history would tell us that while real returns might be lower, the stock market continues pretty much doing what it has always done. Personally, I’m much more concerned about what is going on in the economy when the pandemic is behind us (and eventually it will be). The U.S. is losing an unprecedented number of workers through retirement, and many of these workers are not being replaced. It is possible the prospect of higher inflation is nothing more than a blip on the proverbial inflation map, while our ability to get things done gets harder and harder because, relative to the growth that is possible, we have fewer and fewer people to do it.
About the Author: Milt Fullen is a CPA and CFP® fee-only fiduciary advisor with more than 30 years of experience in the financial services industry. He is a multi-year winner of Columbus Monthly’s Five Star Wealth Manager Award, and Fullen Financial Group ranks among Columbus Business First’s top fee-only financial planning firms in Central Ohio. We have helped over 200 individuals and families prepare for retirement, and we manage more than $180 million of assets on behalf of our clients. Our team of professional advisors has a wealth of experience and the best credentials in the industry, supported by the latest technology tools and a dedicated client service team.
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