When Inflation is High, Buy High?

Posted by Vident Financial on 11/2/21 9:30 AM

The financial industry has various ways of classifying stocks. One is size, but there are also styles of investing, such as buying companies which are expensive (meaning the price is high relative to sales, or earnings or revenues or cash flow, or some other form of income). If stocks are expensive, it's like they are expected to have high earnings growth, otherwise why would investors pay more for them than for the "cheap" stocks?

The first kind are called "Growth," and the second kind are called "Value," and historically they don't respond the same way to high inflation environments.

(Source: Bloomberg, St. Louis Federal Reserve, Bowyer Research)

The chart above shows the performance of Growth versus Value indices during high inflation periods. Growth appears to us to be the superior historical inflation hedge, at least going by this set of examples. This might have been a direct effect of inflation, or it could have been relative to interest rates. The Federal Reserve expands the money supply by lowering interest rates, so this could have reflected the idea that low interest rates coming from easy money might have helped Growth stocks more than Value stocks. More research is needed to get to the bottom of why Growth has tended to be a better inflation hedge, but in the data set above, it appears to us that it was a better hedge, whatever the reasons.

Below, we added a comparison of high inflation environments (the top fifth in the data set) to low inflation environments (the bottom fifth):

(Source: Bloomberg, St. Louis Federal Reserve, Bowyer Research)

It appears that Growth stocks offered a relatively attractive trade-off in that they performed strongly during high inflation periods, but they still had positive (though much less positive) returns during low inflation environments. The charts above might also show some residual cap size trade-offs in that the Russell 2000® Growth Index Return is more a Mid and Small Cap index than a Large Cap one.

Next time, we’ll look at the global picture when it comes to historical performance during periods of high and low inflation.

The opinions expressed herein are those of Vident Financial at the time of publication and are subject to change. This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the information described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. Recipients should not rely on this material in making any future investment decision.

Investors cannot invest directly in an index. Indexes are not managed and do not reflect management fees and transaction costs that are associated with some investments. Past performance does not guarantee future results.