Stocks Are Not an Inflation Hedge (But Own Them Anyway)

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Per Wikipedia, a financial “hedge” is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. Wouldn’t be nice if for every Investment A, there was another Investment B that would always move in the opposite direction? Unfortunately, things aren’t so easy.

A common question: Should we own stocks as a hedge against inflation? The Institutional Investor article Here’s Proof That Stocks Were Never an Inflation Hedge provides a little of clarification:

“Equities are not an inflation hedge. When inflation is high, they tend to do poorly. But in the long run, they have beaten inflation, so a lot of people claim they’re an inflation hedge, but [that claim is the result of confusion]. In the long run, stocks beat inflation, but they do it because of the equity risk premium. They are not an inflation hedge. They have a negative correlation with inflation,” said Marsh.

Historically, stocks actually tend to go down when inflation goes up.

Here’s a chart of the correlations between inflation and various asset classes over the last 120+ years from the Credit Suisse Global Investment Returns Yearbook 2023:

Here is Warren Buffett in his 2022 Berkshire Shareholder letter (emphasis mine):

During the decade ending in 2021, the United States Treasury received about $32.3 trillion in taxes while it spent $43.9 trillion.

Though economists, politicians and many of the public have opinions about the consequences of that huge imbalance, Charlie and I plead ignorance and firmly believe that near-term economic and market forecasts are worse than useless. Our job is to manage Berkshire’s operations and finances in a manner that will achieve an acceptable result over time and that will preserve the company’s unmatched staying power when financial panics or severe worldwide recessions occur. Berkshire also offers some modest protection from runaway inflation, but this attribute is far from perfect. Huge and entrenched fiscal deficits have consequences.

We can’t predict inflation, and we can’t expect stocks to go up when inflation does hit. However, we depend on businesses as a whole to continuously adapt (raising prices, lowering input costs, switching to alternative products, etc), so our best choice is to hold stocks and hope they continue to adapt through capitalism. If we only hold cash, we can only expect to break even after inflation at best, and usually go negative after taxes.

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  1. I disagree. I think they are credited as an inflation hedge because companies can charge more for their products, the value of their land inflates, etc.

  2. The most important sentence I read was “During the decade ending in 2021, the United States Treasury received about $32.3 trillion in taxes while it spent $43.9 trillion.”
    One day the piper must be paid.

  3. Objective Ace says

    I dont think this is correct. There’s high inflation and there’s inflation growth. It’s important to distinguish between the two. I believe Credit Suise’s graphic is looking at inflation growth not high inflation.

    Stocks were up in the 1980s, a time period we had double digit inflation.

  4. I disagree also. If a company’s input costs grow 10% from inflation, and companies raise their prices 10% to offset that, then their earnings will also grow 10% (you can check the math). So in this sense, yes, stocks most certainly are inflation hedges.

    However, the ability of consumers to absorb those price increases comes into play – first, is inflation translating to higher wages, and second, whether those price increases are shifting consumer buying behavior toward lower priced alternatives. This is where the impact to a single company’s bottom line and their ability to adapt earnings to an inflationary environment can vary widely.

    But if talking about a wide collection of companies (think index funds) rather than an individual one, there’s no reason that stocks shouldn’t serve as good inflation hedges. And if you look at countries that have experienced not just high inflation but rather runaway hyperinflation, this becomes very evident. Zimbabwe’s stock market reportedly produced a return of over 1,000% in the year 2020, buoyed by runaway inflation. The real gains after inflation probably weren’t great, and were perhaps still losses, but the stock market still served to significantly protect assets from inflation even in that nightmarish environment.

  5. canoeguy1 says

    I believe that stocks are an inflation hedge. Simplified example: A company has a valuation of $1 billion, and 10 million shares outstanding. That’s $100/share. After 10% inflation, assuming all other factors remain the same (and the value of the underlying assets doesn’t change), the company has a valuation of $1.1 billion, and the 10 million shares are each worth $110. It’s no different to gold, or any other assets. On average, in the long term, inflation will be baked into the price.

  6. I believe a good inflation hedge is real estate/rental. If inflation goes up, rents will go up as well. Just make sure to avoid cities with heavy rent control. Those are a pain to deal with.

  7. In inflation general stocks may not do well but commodity & gold stocks have a better chance at gains.

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