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Equities and inflation


With global inflation rising, a new Credit Suisse report co-authored by Professor Elroy Dimson of Cambridge Judge Business School notes that while equities have beat inflation over history they have not hedged against inflation.

Panoramic view of The City of London cityscape skyline - Credit Suisse Investment Returns Yearbook 2022.

With inflation now rising around the world, a much-cited investment yearbook published by Credit Suisse cautioned today (24 February) that the widespread assumption that common stocks serve as a hedge against inflation is historically untrue. The report, co-authored by Professor Elroy Dimson of Cambridge Judge Business School, notes that while equities have beat inflation over a 122-year period, they have not served as a hedge against rising inflation.

Elroy Dimson
Professor Elroy Dimson

“The negative correlation between inflation and stock prices (has been) one of the most commonly accepted empirical facts in finance,” says a summary of the report, the Credit Suisse Global Investment Returns Yearbook 2022, noting that inflation rose last year to 7% in the US (the highest annual figure for 40 years), 5.4% in the UK (the highest for 30 years) and 5.3% in Germany (the highest in 40 years), and inflation has “continued to accelerate” in early 2022.

“Yet it is widely believed that common stocks must be a good hedge against inflation to the extent that they have had long-run returns that were ahead of inflation. But their high ex-post return is better explained as a large equity risk premium. The magnitude of the equity risk premium tells us nothing about the correlation between equity returns and inflation. It is important to distinguish between beating inflation and hedging against inflation.”

The Credit Suisse Global Investment Returns Yearbook 2022, published by Credit Suisse Research Institute, looks at returns over the period 1900 through 2021 for 35 countries. It is co-authored by financial historians Professor Elroy Dimson, chairman of the Centre for Endowment Asset Management at Cambridge Judge, Professor Paul Marsh of London Business School, and Dr Mike Staunton of London Business School.

The report finds that the average inflation rate among 21 Yearbook countries with financial histories since 1900 rose from 0.4% in 2020 (the lowest since the depths of the Great Depression in 1934) to 4.4% in 2021.

“It is often stated that equities are a hedge against inflation, and we examine this claim. In fact they are not, but over the long run, they have been an excellent inflation beater,” the report says. Looking over the 122-year period, the report found that during marked inflation periods equities gave a real return of −10.0%, greatly outperforming the bond return of −24.7%.

The Yearbook finds that over the last 122 years global equities have provided an annualised real US dollar return of 5.3%, compared to 2.0% for bonds and 0.7% for bills – and equities have outperformed bonds, bills and inflation in all 35 markets studied for the main asset categories.

The report also finds that the US has since 1900 been the best performing stock market with a real return of 6.7%, while the US share of global equities has “quadrupled to an astonishing 60%”.