Stocks Are Our Inflation-Fighting Warriors

As the pandemic has wound down, businesses open back up, and the economy heats up, it seems we have found a new enemy in inflation.  Indeed, the Bureau of Labor Statistics reports that the Consumer Price Index (CPI) rose 0.9% in the month of June and is up 5.4% over the last 12 months.  Some of this gain is due to increases in food and energy, but even the core inflation rate, which removes food and energy, is up 4.5% over the past 12 months, the largest gain since 1991.  This large jump in consumer prices is quite dramatic compared to what we have seen this century. 

Economists are split on whether this phenomenon is a short-term disruption or the start of a long-term trend.  The massive fiscal stimulus packages from Congress, and the very accommodative monetary policies of the Federal Reserve, have pumped the system full of dollars.  Meanwhile, the usual international supply chains are much slower to come back online as the developing world is getting access to the vaccine at a much slower pace than here in the US.

The argument for inflation as a short-term adjustment is that these causes are temporary in nature; therefore, the effect should be temporary too.  The stimulus packages seem to be done, and eventually, the supply chains should come back online.  On the other hand, the size of both the stimulus packages and the Federal Reserve’s efforts are truly unprecedented.  Some predict that it would take several years of high inflation to reach equilibrium again.

As long-term investors, it is not our job to outguess the market and make investing riskier than it needs to be by timing it.  However, it is our job to have a diversified portfolio that is ready for all different markets.  So how do we prepare for the possibility of higher inflation? By holding stocks.

If the prices of goods and services go up, the seller of those products are often publicly traded companies.  As they pass on their higher costs to their customers, their profits and thereby their stock price will also increase. The effect on stock values may not be immediate, but it does come.  The weighty evidence of history confirms this.

For example, the index value of the S&P 500 in June of 1971 was 100.  It ended June 2021 just shy of 4,300.  That’s an increase of 43 times over 50 years.  The dividend of the S&P 500 was $3.10 in 1971 compared to $57.87 in 2021, an increase of 18 times.  Meanwhile the Consumer Price Index increased of 6.6 times.  Most long-term periods will have similar results.  Stocks outpace inflation by multiples over long time periods.

Whether the inflation wave stays for the long-term, retreats in a few months, or does something in between, having a healthy dose of stocks is essential to meeting most long-term goals.  Stocks come with extra risk when it comes to short-term volatility, but they reward patient and disciplined long-term investors with inflation-adjusted gains.