Insights

Does higher inflation mean lower stock returns?

INSIGHT ARTICLE  | 

Authored by RSM US LLP


The answer to this question is not straightforward. Over the past 20 years, stocks1 have generally performed very well when inflation — as measured by the year-over-year change in the Consumer Price Index (CPI) — was under four percent, averaging the highest returns over the subsequent 12 months when readings were under two percent. However, the inflation trends also provide insight about its impact on stock performance. As the chart above illustrates, when inflation was below two percent at the beginning of the period, it tended to rise very modestly over the following year (green bar) which resulted in strong equity performance (blue bar). When inflation was in the 3-4% range it tended to revert towards two percent over the following year. Though relatively lower, the data show stocks posted a still-respectable 7.4% average return in this environment. Most notable were periods where inflation was above four percent, which saw significant negative performance over the following year, on average. However, CPI growth quickly stalled, averaging just 0.7% one year later.

It’s worth drilling down further on this last segment because CPI readings have been in this range recently. Looking at the high-level data may lead to investor angst about whether the Fed could begin hiking interest rates prematurely in an effort to rein in inflation, potentially stifling equity performance.

During the three broad periods exhibiting inflation of four percent or more, 1991 and 2007-2008 were characterized by a loosening of monetary policy (declining fed funds rate), yet performance in the former period was positive while the latter — taking place during the Financial Crisis — saw stocks post significant declines. In contrast, the Fed was in the midst of raising interest rates in 2005-2006, yet equities provided above-average returns2.

So while inflation, as well as the Fed’s interest rate policy, certainly influence equity prices, other factors may have a greater influence on stocks. So when the Fed announces its intention to begin raising the fed funds rate, be it sooner or later, expect market volatility to ensue; however, don’t expect higher rates or higher inflation to necessarily prevent stocks from posting additional gains. In this case, higher inflation and interest rates would likely come on the heels of above-average economic growth. Consequently, we would not expect either to serve as likely catalysts for a sustained drawdown in equities. For additional insights on current inflation trends and our thoughts on whether they are likely to persist, please see our recent Investor Insights: Inflation is back: Is it here to stay?



1S&P 500 Index

2The Index posted an average rolling 12-month return of 16.0% during the period versus an average of 13.0% during the overall sample period.

Let's Talk!

Call us at +1 213.873.1700, email us at solutions@vasquezcpa.com or fill out the form below and we'll contact you to discuss your specific situation.

  • Topic Name:
  • Should be Empty:

This article was written by RSM US LLP and originally appeared on 2021-06-11.
2020 RSM US LLP. All rights reserved.
https://rsmus.com/what-we-do/services/wealth-management/does-higher-inflation-mean-lower-stock-returns.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

​Vasquez & Company LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.

For more information on how ​Vasquez & Company LLP can assist you, please call +1 213.873.1700.

Subscribe to receive important updates from our Insights and Resources.

  • Should be Empty: