The Effect of Inflation on Real Stock Returns

I’ve been doing more splicing of the Ibbotson data. Today, let’s look at the effect inflation has had on real stock returns. This may seem counter-intuitive but the more consumer prices rise, the worse stock prices have done. This makes sense since stocks are in competition with bonds, not consumer prices, and bonds do worse as inflation rises. At the other end, real stock markets have done very poorly under deflation. Historically, what the market appears to like best is low, stable inflation.

Now let’s look at some numbers. I took all of the monthly returns from 1925 to 2012 and broke them into three groups; there were 75 months of severe deflation (greater than -5% annualized deflation), 335 months of severe inflation (greater than 5% annualized), and 634 months of stable prices (between -5% and +5%).

The 75 months of deflation produced a combined real return of -46.77%, or -9.60% annualized. The 335 months of high inflation produced a total return of –70.84%, or -4.32% annualized. The 634 months of stable prices produced a stunning return of more than 177,000%. Annualized, that works out to 15.21%, which is more than double the long-term average.

Here’s an interesting stat: The entire stock market’s real return has come during months when annualized inflation has been between 0% and 5.1%. The rest of the time, the stock market has been a net loser.

Posted by on November 12th, 2013 at 11:54 am

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