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Brian Levitt | June 2, 2022

Peak inflation and U.S. stock performance: Lessons from the 1970s

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

Source: Bureau of Labor Statistics. The S&P 500 Index is a market-capitalization-weighted index of the 500 largest domestic U.S. stocks. Indices cannot be purchased directly by investors. Past performance does not guarantee future results.

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.

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Some references are U.S. centric and may not apply to Canada.

Commissions, trailing commissions, management fees and expenses may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the simplified prospectus before investing. Copies are available from your advisor or from Invesco Canada Ltd.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.

All investing involves risk, including the risk of loss.

An investment cannot be made in an index.

Past performance is not a guarantee of future results.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

The U.S. Consumer Price Index (CPI) measures change in consumer prices as determined by the U.S. Bureau of Labor Statistics. Core CPI excludes food and energy prices while headline CPI includes them.

Personal consumption expenditures (PCE) measure price changes in consumer goods and services. Expenditures included in the index are actual U.S. household expenditures. Core PCE excludes food and energy.

M2 is a measure of the money supply that includes cash and checking deposits as well as savings deposits, money market securities, mutual funds and other time deposits.

The opinions referenced above are those of the author as of June 1, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.