You Cannot Run Away from Inflation
Back in 1980s the Sensex generated returned 21.6 per cent every year. This is despite the average inflation during that period being at 8.97 per cent. Well in the 2010s, inflation averaged at 6.34 per cent per year but the stock market was up by a mere 8.8 per cent on an annualised basis, which barely beat the average inflation by 2.5 per cent. Between 1980 and 2020, there were 16 years when the stock market generated negative real returns adjusting for headline inflation. What do these numbers about the impact of inflation on the stock market indicate? Is higher inflation good or bad for the stock market?
The stock market is a great long-term hedge against inflation but sometimes it doesn’t work so well in the short term. Now let us see the returns provided by the bond yields through different decades. We will assume yields to be representative of returns. We see that in the last 23 years there were eight incidences when inflation was higher than the government bond yields. Unfortunately, bonds too cannot hedge you against high inflation consistently. Gold was a great hedge against inflation and was assumed to protect you from higher inflation.The stock market is a great long-term hedge against inflation but sometimes it doesn’t work so well in the short term. Now let us see the returns provided by the bond yields through different decades. We will assume yields to be representative of returns. We see that in the last 23 years there were eight incidences when inflation was higher than the government bond yields. Unfortunately, bonds too cannot hedge you against high inflation consistently. Gold was a great hedge against inflation and was assumed to protect you from higher inflation.
However, since the start of 2020, globally we have had the highest inflation rate in four decades and gold is flat. The point here is that there are no perfect assets. Nothing hedges you against inflation at all times. Investing involves uncertainty. You cannot predict how certain investments are going to react to every situation. The good news is that once you realise there are no perfect assets, you can begin to create a portfolio that takes into account the fact that nothing works always and forever in the markets. Our cover story this time gives you a glimpse of how to make such a portfolio.
SHASHIKANT