History suggests that the period following a peak in inflation may be a good backdrop for equities. Brian Levitt examines U.S. stock performance after inflation peaks in 1974 and 1980.
Per the numerous questions I’m receiving, investors remember the 1970s well — and they’re concerned about the obvious parallels we see today: Elevated inflation,1 a U.S. Federal Reserve (Fed) that appears slow to respond, a global conflict that’s exacerbating the problem. On top of that, Paul McCartney, Elton John, and Bob Weir are on tour once again. Those tickets have hit my checking account as hard as $5.00/gallon gasoline has.
While investors may try to forget about their polyester leisure suits and their crocheted sweater vests, they can vividly recall the 34% decline in the S&P 500 Index from March 1973 (when the year-over-year inflation rate climbed above 4.5%) to December 1974 (when the rate of change in inflation peaked).2 The early 1980s wasn’t much better as inflation climbed to nearly 15%.3 That much is known. But what happened once inflation peaked?
The chart below illustrates how U.S. stocks performed after the inflation peaks of December 1974 and March 1980. In both instances, markets staged sound returns over the following 1-, 3-, 5-, and 10-year periods.4
U.S. stocks rebounded following peak inflation in the ’70s and ’80s
It’s not about ‘good’ or ‘bad’
As we know, markets don’t trade on whether conditions are good or bad, but rather on whether they are getting better or worse relative to expectations. As a result, peak inflation in 1974 and 1980 were times when things were “bad” but soon to get “better” and not the times to become long-term bears on stocks. Sure, markets didn’t move in a straight line. The U.S. economy even entered a recession in mid-1981,5 and there were many moments when it was feared that inflation was returning — but ultimately, long-term investors were rewarded.
Has inflation peaked?
That brings us to today. Has U.S. inflation peaked? It’s too soon to say. April was the first month of the past eight months in which the year-over-year percent change in the U.S. Consumer Price Index was below that of the prior month, albeit barely and it was still worse than expectations.6 Nonetheless it’s a start. In fact, I see a few reasons to take some solace: the U.S. bond market’s expectations of inflation have come down meaningfully in recent weeks,7 the Fed’s preferred measure of inflation (core personal consumption expenditure) have begun to roll over on a year-over-year basis,8 average hourly earnings have been slowing,9 M2 money supply growth has been plunging,10 and retailers have reported ballooning inventories.11 Admittedly, the risk to the peak inflation view is commodity prices, which continue to rise.
As I used to ask in the 1970s from the back of the wood-panel station wagon, “Are we there yet?” Not necessarily. “Are we getting closer?” It feels like it. It’s all about inflation now, and history suggests that signs of a peak in inflation can create a good backdrop for equities.
1 As represented by the U.S. Consumer Price Index. Source: U.S. Bureau of Labor Statistics, 4/30/22.
2 Source: Bloomberg.
3 As represented by the U.S. Consumer Price Index. Source: U.S. Bureau of Labor Statistics.
4 Source: Bloomberg. As represented by the S&P 500 Index.
5 Source: National Bureau of Economic Research
6 As represented by the U.S. Consumer Price Index. Source: U.S. Bureau of Labor Statistics, 4/30/22.
7 Source: Bloomberg. As represented by the 1-year, 3-year, and 5-year Treasury Inflation Protected Securities breakeven inflation rate. The breakeven inflation rate is calculated by subtracting the yield of an inflation-protected bond from the yield of a nominal bond of the same maturity.
8 Source: U.S. Bureau of Economic Analysis, 4/30/22.
9 Source: U.S. Bureau of Labor Statistics, 4/30/22.
10 Source: U.S. Federal Reserve, 4/30/22. M2 is a measure of the U.S. money stock that includes M1 (currency and coins held by the non-bank public, checkable deposits, and travelers’ checks) plus savings deposits (including money market deposit accounts), small time deposits under $100,000, and shares in retail money market mutual funds.
11 Source: U.S. Census Bureau, 4/30/22.