A recent CFA Institute article debates the case for equities as an inflation hedge.

“Since operating businesses can increase their prices at will, the theory holds, they can mitigate the negative effects of high inflation by simply raising their prices along with it,” the article notes, a theory that CFA Institute tested by creating four inflation regimes spanning the period from 1947 to 2021 (using data from the St. Louis federal Reserve and stock market data from the Kenneth French data library). The results are illustrated in the following graph:

“The lowest returns,” the article reports, “occurred during periods of deflation, which usually coincide with economic recessions. However, inflation above 10% did not seem to have a negative impact on stock market returns.”

But when these returns were adjusted for inflation, the picture appeared quite different:

The sectors that suffered the most during higher inflation regimes, the article reports, were those “that dealt directly with consumers” including auto and retail. “Despite their ability to adjust their prices at will, these businesses seem to struggle to pass the increases to their customers.”

And although a survey by JPMorgan showed that most respondents (47%) viewed commodities as the most effective inflation hedge (versus 27% for equities) the article says the argument in favor of commodities as a hedge is “a tenuous one,” noting that “a bet on commodities is a bet against human progress: It is probably a losing long-term proposition.”

Instead, it suggests investing in “trend-following, commodities-focused funds or commodity trading advisors (CTAs),” explaining, “If gold prices rise due to higher inflation, these funds will jump on the trend sooner or later. If prices decrease amid falling inflation, investors can short these asset classes.” Although such a strategy isn’t foolproof, the article concludes, “it may be a more elegant way of hedging against both inflation and deflation.”