During the 1966-1982 stagflationary period, the S&P 500 performed poorly in real terms. However, historical data from Fama and French shows that U.S. mid-cap value stocks successfully preserved their purchasing power. This suggests that in a similar environment of high inflation, these stocks may offer a relative safe haven.
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Contrary to popular belief, earnings growth has a very low correlation with decadal stock returns. The primary driver is the change in the valuation multiple (e.g., P/E ratio expansion or contraction). The correlation between 10-year real returns and 10-year valuation changes is a staggering 0.9, while it is tiny for earnings growth.
Holding cash is a losing strategy because governments consistently respond to economic crises by printing money. This devalues savings, effectively forcing individuals to invest in assets like stocks simply to protect their purchasing power against inflation.
Traditional analysis links real GDP growth to corporate profits. However, in an inflationary period, strong nominal growth can flow directly to revenues and boost profits even if real output contracts, especially if wage growth lags. This makes nominal figures a better indicator for equity markets.
Contrary to conventional wisdom, re-accelerating inflation can be a positive for stocks. It indicates that corporations have regained pricing power, which boosts earnings growth. This improved earnings outlook can justify a lower equity risk premium, allowing for higher stock valuations.
Having lived through hyperinflation where money became a meaningless number, the real store of value is owning productive assets. A portfolio of quality businesses that provide real goods and services offers tangible protection that fiat currency cannot, as these businesses can adapt and reprice.
During profound economic instability, the winning strategy isn't chasing the highest returns, but rather avoiding catastrophic loss. The greatest risks are not missed upside, but holding only cash as inflation erodes its value or relying solely on a paycheck.
While low rates and high nominal growth typically favor equities, financial repression introduces a counterintuitive risk. If institutions are forced to buy government bonds, they must sell liquid assets—primarily equities. This could lead to a slow, multi-year decline in the S&P 500, mirroring the 1966-1982 period, instead of a sudden crash.
Profitable companies act as a hedge against currency debasement. They issue long-term debt at low fixed rates, effectively shorting the currency. They then invest the proceeds into productive assets or their own stock, which tend to outperform inflation, benefiting shareholders.
Contrary to popular belief, the current upward inflationary pressure is a net positive for equities. It is not yet at a problematic level that weighs on growth, but it is high enough to prevent a more dangerous disinflationary growth scare scenario, which would trigger a full-blown "risk-off" cascade.
The argument against a market top is that high multiples are justified. In an era of sustained currency debasement, investors must hold assets like stocks to preserve purchasing power. This historical precedent suggests today's valuations might be a new, structurally higher baseline.
