Longtime readers of Businessweek will recall its Dewey-Defeats-Truman moment: A 1979 cover story that heralded “Death of Equities: How Inflation is Destroying the Stock Market.” Inflation was that bogeyman of the late ’70s and early ’80s – an oft-cursed scourge to the average family’s buying power. The problem with BusinessWeek’s headline declaration is it came shortly before the 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 ways.
“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’s fin de siècle high and factor in the growth since then 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 record you’re hearing so much about of late.
More conservatively defined – what does Washington really know about real-world inflation anyway? – inflation has walloped investors. According to the Leuthold Group, in hard-currency inflation-adjusted terms, U.S. markets are truly nowhere close to their highs. When denominated not in dollars but instead in the inflation-proofed Swiss Franc and gold, the S&P 500 is still down 48 percent and 84 percent, respectively, from the year-2000 high that it briefly surpassed in 2007.
It’s one thing to say your money hasn’t done anything in equities since the heady days of stockpicking 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.”
Of course, the best environment for investors is low, boring inflation. Not too hot or not too cold, as it were, and well removed from the quagmire that is deflation. You want just enough inflation to give companies pricing power and gainfully employed consumers purchasing power. But too much of it would call for the Fed to hike interest rates – an outcome anathema to the equity community in so many ways. For his part, Elfenbein calculated that inflation that crosses 5.3 percent a year is that good-to-bad inflection point.
The good news is 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 puts it (seraphically, is it?): “It only took 13 years to make a real profit. A very, very, very, very small (but real) profit.”
