Click on any of the asset images above to see the effect of utilizing Fear as an investment criterion.
|
Inflation may be bad news for Equities, but it is even worse news for Fixed Income. This relationship is much more straightforward.
All else equal, positive Inflation is detrimental to Bonds because it erodes the real value of Bonds’ fixed payments (Ang 2014).
|
Some researchers have contended that Equities serve as an Inflation hedge since the 70’s - Bodic (1976), Fama and Schwert (1977). The argument holds up logically. Equities are a real asset, so if an investor holds a share in a stock and Inflation sets in, the nominal value of his/her asset will be likely higher in the future than it was when he/she bought it.
But this relationship is not empirically true in the short-term. The ‘Theory of Sticky Prices’ helps explain why not (Mankiw 2002). In order to serve as a short-term Inflation hedge, companies would need to immediately increase the prices of their products (and subsequently their profits) as Inflation manifests itself. In reality, there is a considerable lag between Inflation and increased prices, which causes margins, and thus performance, to fall.
In addition, because higher Inflation creates higher uncertainty about future Inflation, companies are hesitant to make investments knowing that further Inflation could be detrimental to margins and ROI.
Long story short, Inflation is not great news for Equities in the short-term.
|
Positive Inflation is correlated with positive Commodity performance for two primary reasons.
First, the Consumer Price Indices (CPI’s) are a major component of Inflation measurement, and all CPI’s are composed of real assets like Commodities and Real Estate. So the mere statement that Inflation is positive is to say, in part, that Commodity prices are rising.
Second, Commodities can be thought of as a synthetic asset where the real part is the physical Commodity and the nominal part is the dollar. By buying Crude Oil, for example, an investor buys the physical asset and sells the dollar. If Inflation is positive, the price of his/her Crude Oil goes up, and the value of the dollar he/she sold goes down.
Commodities are the true, reliable hedge to Inflation.
|
|