Inflation and Markets

Wooster Corthell |

To our clients,

Over the past year and a half market headlines have been dominated with the fallout and recovery of COVID. Recently headlines have shifted from COVID to inflation.

We have all started to observe inflation. It’s at restaurants, gas pumps and many other places. In fact, the Social Security Administration announced a 5.9% increase to benefits for 2022, the highest increase in 41 years!

So how has higher inflation affected markets previously? On one hand, investors may demand a higher return on their investments to compensate for higher prices. This tends to put downward pressure on stocks. Conversely, higher inflation can positively impact revenues and earnings, and as earning increase, stocks tend to increase as well. This tug of war between higher returns causing downward pressure on stocks and higher earnings causing upward pressure on stocks can add some volatility to the mix.

To see which side typically wins the tug of war, I reviewed some historical inflation and market return data. For each of the last three months, inflation has exceeded 5% year over year. Naturally I wondered, who wins the tug of war when inflation is over 5%? I reviewed the returns of the S&P 500 for the 12 months after the CPI data exceeded 5% on a quarterly basis from 1948 to 09/30/2020. The results were as follows:

  • S&P 500 on average returned: 10.12%
  • S&P 500 was positive 67% of the time

Of course, past performance does not guarantee future performance. However, these results are right in line with the long run market averages. By diversifying across many asset classes, we are prepared for a broad swath of market environments as we don’t tilt too heavily in any one direction. This typically gives us the opportunity sell some securities in times of strength and buy other securities in times of weakness. This is done because market environments change over time.

By design our portfolios contain asset classes that respond to different market environments in different ways. Some benefit from inflation (Treasury Inflation Protected Securities and Stocks), others benefit from economic downturns (Government Bonds) and of course many benefit from improving economic conditions (Stocks and Corporate Bonds).

As famed microbiologist Louis Pasteur once said, “Fortune favors the prepared mind.”

Wishing you good health!

Matt Corthell

Past performance is not indicative of future results. Loss of principal and/or loss of portfolio value are possible.