The Ultimate Inflation Hedge: Stocks?

Alexander Green
by Alexander Green, Chief Investment Strategist

The Ultimate Inflation Hedge: Stocks?

by Alexander Green, Chairman, Investment U

Investment Director, The Oxford Club

Monday, June 23, 2008: Issue # 811

Investors looking for the ultimate inflation hedge have few attractive choices right now...

  • Real estate is fine under ordinary circumstances. But the housing market is in a death spiral right now. And we're still a good ways from the bottom, in my view.
  • The barbarous relic - gold - is another good choice, usually. But gold has already appreciated from just over $300 an ounce six years ago to almost $900 today. It could be a little late.
  • And inflation-adjusted Treasuries have moved up so much over the past year that they're currently yielding less than 1%. That's an awfully steep price to pay for inflation protection.

So where can an investor put money to work today to hedge against the risk of higher inflation?

Stocks - The Ultimate Inflation Hedge

In stocks.

This may seem counter-intuitive at first. After all, inflation devalues corporate earnings, the major driver of stock prices. But the mere presence of inflation also indicates that many companies are successfully passing along price increases to customers. This allows stocks to rise even when inflation is climbing.

In 1980, for example, the Consumer Price Index rose by more than 12%. Yet the stock market rose 32%. And while the average rate of inflation throughout the 1980s was an uncomfortable 5.6%, it still turned out to be a great decade for stocks: the S&P 500 rose by an average of 12.6% a year.

A recent analysis by Ibbotson & Associates found that in inflationary periods - as measured from troughs to peaks - going back to August 1972, some 6 of 10 market sectors in the S&P 500 actually gained ground.

So don't let anyone persuade you that you should bail out of stocks and into precious metals, commodities, and real estate investments. Sure, these asset classes should make up a portion of your portfolio, but certainly not the bulk of it.

Asset Returns For The Last 100 Years

Dr. Jeremy Siegel, a professor of finance at The Wharton School of the University of Pennsylvania and author of Stocks for the Long Run, has done a thorough historical study of the returns of different types of assets over the past couple hundred years.

What he discovered is dramatic:

  • $1 invested in gold in 1802 would have been worth $32.84 at the end of 2006.
  • The same dollar invested in T-Bills, with interest reinvested, would have grown to $5,061.
  • $1 invested in bonds would be worth $18,235.
  • And $1 invested in common stocks with dividends reinvested - drum roll, please - is now worth more than $12.7 million.

The Ultimate Inflation Hedge - Stocks

The odds are good, of course, that you weren't around a couple hundred years ago. And, unless something truly exciting happens soon in the field of cryogenics, you won't be around 200 years from now, either.

It's not necessary to think that long term, however...

Remarkably Consistent Stock Returns Over Decades

Start whenever you want and you'll find that when measured in decades the investment opportunities and returns for different asset classes are remarkably consistent. Stocks are the big winner. Since 1926, the stock market has generated a positive return in 59 out of 82 calendar years - or nearly three out of every four years.

President Harry Truman once observed that, "The only thing new in the world is the history you don't know."

For the past 200 years, nothing has come close to matching the long-term compounded returns of common stocks. It's hard to imagine that anything ever will.

Good investing,

Alex

Alexander Green's recommendations have beaten the Wilshire 5000 Total Market Index by more than 3 to 1 over the past five years. To get access to a steady stream of the companies he expects to outperform this year, consider joining The Oxford Club, our premium service. You'll get immediate access to all of Alex's growth-stock recommendations.

Today's Investment U Crib Sheet

There's no shortage of news coming from Wall Street this week. Here are a few of the highlights...

  • In this week's meeting, the Federal Reserve board is expected to leave rates unchanged. However, tough language on inflation-fighting is anticipated. Alex Green recently showed us why inflation is the biggest risk you face as an investor, and how to defend your portfolio against it.
  • Gas prices have reached a record $4.10 a gallon, and crude oil flirted with highs of $139 a barrel. The debate rages on whether 'the price of oil is the mother of all bubbles,' or if we are seeing the result of a global economy hooked on oil.
  • The Dow Jones Industrial Average closed below 12,000, at levels not testing since October of last year. Lacking any positive economic news could steer the market lower this week. But for Floyd Brown and contrarian investors, the negative banking stock headlines could reveal the 'Buys of the Decade.'

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