6/1/2022 12:00:00 AM

How have markets historically performed in high-inflationary environments?


With inflation on the rise, what does this mean for markets? CEO + Founder Mike Taylor takes a look back.

Stock markets are sensitive beasts and they are happiest when economic growth and inflation are kept at a nice even pace of 2-3%. Call it the “goldilocks” scenario - not too hot and not too cold. In 2008, for example, we had deflation and negative economic growth. During Covid-19 in 2020, investors had the same concerns. 

Today however, the concern is about high inflation in the West, leading to slower economic growth, or even a recession. Let’s put economic growth to one side and focus on inflation. During periods of high inflation, stock market valuations or multiples generally fall because the cost of equity goes up. This is why tech companies have fallen the most, because their earnings are long-dated and as such valuations are vulnerable to changes in interest rates. So it’s fair to say that when inflation is above 3% and rising, this is bad news for stocks. However, once inflation peaks, even if we are in the middle of a recession, this usually marks the turning point for stocks and is a buy signal. (See chart below). 

But a common misconception is that the stock market, specifically falling stock prices, is a good predictor of future recessions. There is a saying that the stock market has predicted 9 of the last 5 recessions. i.e. it’s hopeless at predicting recessions, proving no better than a coin toss.

In summary, stocks have proven to be the best hedge against inflation over the long run, historically they have outperformed all other asset classes, including commodities and property. But the corollary to that is you have to accept higher volatility. You can of course use that volatility to your advantage. Simply, an equity market sell-off should be viewed from an unemotional perspective as an opportunity to increase your allocation to what I think is the best performing asset class that is available to investors. 

Buying stocks by averaging your way in over a period of months after inflation has peaked is likely to be our strategy at Pie Funds, ceteris paribus. 

Information is current as at June 2022. Pie Funds Management Limited is the manager of the funds in the Pie Funds Management Scheme. Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Pie Funds Management Scheme investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a reliable indicator of future returns. Returns can be negative as well as positive and returns over different periods may vary.