Longtime readers of BusinessWeek (now Bloomberg Businessweek) will recall its Dewey-Defeats-Truman moment: A 1979 cover story that heralded the “Death of Equities: How Inflation is Destroying the Stock Market.” Inflation was the bogeyman of the late 1970s and early ’80s, an oft-cursed scourge to the average family’s buying power. The problem with BusinessWeek’s headline declaration is that it came shortly before the Paul Volcker Federal Reserve vanquished runaway inflation, setting up an 18-year bull market.
Since that bull maxed out 13 years ago, the market has pretty much gone to hell and back, twice. While inflation has been consistently in the low single digits, it hasn’t been as irrelevant as many investors imagine. Indeed, like termites coring out a wooden house, rising prices have already set them back a long way.
“Inflation,” says Crossing Wall Street‘s Eddy Elfenbein, “is a tax on capital and it slowly eats away at your portfolio. Even a low rate of inflation—say, 3 percent per year—compounds to 50 percent in less than 14 years. It’s proverbial running to stand still.”
In simple terms, if you were to take the Standard & Poor’s 500-stock index’s fin de siècle high and factor in the subsequent growth in the consumer price index, the market is 27 percent below its inflation (as the government defines it)-adjusted high. So much for the few percent we need to hit that market record you’re hearing so much about of late.
More conservatively defined—how much does Washington know about real-world inflation anyway?—inflation has walloped investors. According to the Leuthold Group, U.S. markets are nowhere close to their highs in hard-currency, inflation-adjusted terms. When denominated, not in dollars, but in the inflation-proofed Swiss Franc and gold values, the S&P 500 is down 48 percent and 84 percent, respectively, from the year-2000 high it briefly surpassed in 2007.
It’s one thing to say your money hasn’t done anything in equities since the heady days of stock-picking cabbies and Superbowl sock puppets. It’s a whole other sobriety to realize how much you have lost in true, inflation-adjusted terms. “We suppress a seraphic grin whenever we hear an analyst express wonder that free money from the Fed ‘hasn’t yet led to currency debasement,’” wrote the Leutholders. “The market says it has, regardless of the Consumer Price Index.”
The best environment for investors is unquestionably low, boring inflation: not too hot and not too cold, as it were, and well removed from the quagmire that is deflation. You want just enough inflation to give pricing power to companies and purchasing power to gainfully employed consumers. Too much inflation would call for the Fed to hike interest rates—an outcome anathema in so many ways to the equity community. For his part, Elfenbein has calculated that inflation crosses that good-to-bad inflection point when it surpasses 5.3 percent a year.
The good news is that, when measured on a total-return basis, with reinvested dividends included, the broad market just managed to visit an all-time, inflation-included high—however marginally.
As Elfenbein says (seraphically?): “It only took 13 years to make a real profit. A very, very, very, very small—but real—profit.”