Sat. Jun 10th, 2023

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

MARCH 16, 2023 BY JONATHAN PING7 COMMENTSMy Money Blog has partnered with CardRatings and Credit-Land for selected credit cards and may receive a commission. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned.

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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