Permanent Value

Week in Review (5/1/14)

Bruce Doole
May 1st, 2014

Analysis: How Inflation Affects a Portfolio

In the years since 1970, the median annual rate of inflation, as measured by the Consumer Price Index, has been 3.37%; the average rate over the past 44 years has been 4.27%. (The linkage between the federal discount rate and the Consumer Price Index is fairly distinct, with about a 70% correlation between the two since 1970.) The average is higher than the median in this case because of three particular years — 1974, 1979 and 1980 — in which inflation exceeded 12%, skewing the average upward but with virtually no impact on the median.

Comparing Performance

Large-cap U.S. stocks, as represented by the S&P 500, had much better performance during periods of lower inflation. The median annual return for the S&P 500 during years of low inflation was 15.89%. When inflation was higher — that is, in the years when the inflation rate was above the median, U.S. large-cap stocks had a median return of 6.41%.

We see the same basic pattern for U.S. small-cap stock (measured by the Russell 2000 Index) and non-U.S. developed stock (MSCI EAFE index): better performance during periods of low inflation. Bonds (as measured by the Barclays Capital Aggregate Bond index) had slightly better performance during periods of high inflation — at least when measuring performance in gross terms. Cash (defined as three-month T-bills) was clearly advantaged during times of higher inflation — again, on a gross returns basis.

The median returns for real estate (using Dow Jones U.S. Select REIT index) were essentially the same across periods of high and low inflation. The one other asset class that showed a huge differential in performance during years of high and low inflation was commodities (S&P Goldman Sachs Commodity index), where the median return was 3.25% during years with low inflation but 24.66% during years with high inflation.


This Week’s Economic Data

Existing home sales contracted for the seventh time in eight months, reporting -0.2% change for March for an annual rate of 4.59 million.

New home sales fell 14.5% in March to 384,000, sharply below the low-end estimate of 440,000.

Jobless claims jumped 24,000 to 329,000 in the April 19 week.

Consumer sentiment was up in mid-April to 82.6 from the 80.0 end of March reading.


Source: Financial Planning/ Ivy Funds