One of the factors that have been investors’ mind for the past many months has been inflation. Soaring inflation rates led the Federal Reserve to raise interest rates multiple times to tame inflation. Their effort might be bearing fruit soon. The recently release report from BLS showed inflation is cooling. The CPI rate was 3.2% in October compared to a year ago. Inflation rate has declined significantly from the 9% seen last summer. The latest news from BLS was a good news and investors bid up stocks last week based on the expectation that the Fed could stop increasing rates further.
According to an article at Dimensional Fund Advisors inflation is not always impact stock returns adversely. From the piece:
A look at equity performance in the past three decades does not show any reliable connection between periods of high (or low) inflation and US stock returns.
Since 1993, one-year returns on US stocks have fluctuated widely. Stock returns can be strong, or weak, or in between when inflation is high. For example, returns were relatively strong in 2021 but poor in 2022. Twenty-two of the past 30 years saw positive returns even after adjusting for the impact of inflation (see Exhibit 1).
2Based on nonseasonally adjusted 12-month percentage change in Consumer Price Index for All Urban Consumers (CPI-U). Source: US Bureau of Labor Statistics.
Source: Will Inflation Hurt Stock Returns? Not Necessarily., Dimensional
For the period shown in the chart, stocks returned an average annualized return of 7.0% after adjusting for inflation. This is an excellent rate of return when considering other assets during high inflation times. Their research also shows the long-term average after inflation rate was 7.0% for stocks in the long run from 1926.
So the key takeaway is that equities are the best asset class regardless of inflation rates. Just because inflation rates are high investors shouldn’t sell out their stock holdings.
