Despite investor concerns, rising inflation is not necessarily bad for stocks.
“We believe the popular investor focus on an earnings yield [being] less than [the] inflation rate is misplaced,” write Goldman Sachs strategists in their latest U.S. Weekly Kickstart report. “Equity earnings and the prices tied to them are nominal and typically rise with inflation.”
Moreover, most recent U.S. inflation reports “are biased by base effects and reopening dynamics,” according to the strategists, referring to the comparison of price data this year with the data last year when the economy was struggling with pandemic-induced lockdowns.
In addition, the gap between the earnings-per-share (EPS) yield and the 10-year U.S. Treasury yield, a common proxy for the excess return of stocks compared to risk-free Treasurys, remains above its long-term average, according to the Goldman Sachs analysts led by David Kostin, chief U.S. equity strategist.
“Overall, the stock market tends to perform better during periods of low inflation than when inflation is high,” according to the Goldman strategists. Since 1962, the median monthly U.S. equity market real return during periods of high inflation has been 9% on an annualized basis vs. 15% during periods of low inflation.
But certain sectors including health care, energy, real estate and consumer staples tend to outperform during periods of high inflation, and health and energy, along with value stocks, tend to do best when inflation is high and rising rather than high and falling, according to the Goldman report. Overall, however, most stocks will perform better in a high-inflation environment when inflation is headed downward rather than upward.
The median monthly market real return has been 15% annualized when inflation is high and falling versus 2% when inflation is high and rising, according to the report.
In mid-afternoon trading on Monday, the S&P 500 was down 0.3% at 4,217, the Dow Jones Industrial Average was down almost 0.5% at 34,591 and the Nasdaq was up 0.17% at 13,837.