The yield on the ten-year Treasury note recently rose above 1.6%, up from 0.9% at the start of the year.  Yields have spiked for two reasons, both of which are expected to result in higher inflation.  First, there are expectations of a strong re-opening of our economy sooner rather than later, and second, there is massive fiscal and monetary stimulus, including last week’s $1.9 trillion American Rescue Plan.  Can equities continue to rise with higher inflation?  Yes, we think so.
 
Let’s take a look at how stocks have performed at varying levels of inflation going back to 1948:

S&P 500 Performance Based on Yr/Yr CPI:  1948-2021

Yr/Yr CPI RANGE

ONE YEAR TIME HORIZON

 

MEDIAN GAIN %

% POSITIVE

<0%

21.6

90.0

0-1%

6.5

65.1

1-2%

12.9

80.9

2-3%

9.3

79.2

3-4%

9.0

70.3

4-5%

9.9

68.0

5-7%

5.1

62.1

7%+

9.8

71.1

 

 

 

ALL PERIODS

10.2

74.0

Source:  Bespoke Investment Group

The table shows that stocks perform best with either deflation (which is uncommon) or inflation in the 1-2% range (which is where we are now).  The table also shows that as inflation inches higher, equity returns still perform near the long-term average of 10.2%.  It is not until inflation runs hot (>5%) that median returns are significantly lower – and even then, returns are still positive.
 
Investors should not fear an uptick in inflation as history shows stocks are a good inflation hedge.  However, inflation does have a direct impact on market leadership.  Value stocks should continue to lead given higher anticipated inflation and interest rates.  Growth stocks are likely to struggle under this scenario.  We always hold a mix of growth and value stocks for clients, but our next purchases will continue to be value stocks.