Common Stock Performance and Inflation: An International Comparison

Abstract

Several recent studies have questioned the long-held view that stocks are a good inflation hedge.' First, Alchian and Kessel2 found that corporations which were net monetary debtors3 experienced an increase in their equity value greater than that of net monetary creditors. Thus, debtor companies provide better inflation protection than do creditor companies. In a second study, Reilly, Johnson, and Smith4 considered market performance during five periods of rapid inflation. They found that the average real return on stock (using several well-known stock indexes) was negative or below the long-term average return in each of the five periods. Two of the periods, however, began during expansions and ended during recessions; two began during peacetime and ended during war; and one straddled the 1967 credit crunch. Thus, noninflationary factors may have caused the poor performance. In a third study, Keran5 found that inflationary expectations depressed stock prices (as measured by Standard and Poor's 500). If stocks were considered a complete inflation hedge, inflationary expectations would not depress their prices. In fact, an attempt to shift from assets which provided less inflation protection might cause an increase in stock prices. Thus, Keran's study indicates that the stockholders do not react as if they thought stocks were a good inflation hedge. Finally, Oudet conducted a study in which he concluded that inflation exerted a negative influence on returns.6 While each of these studies suggests that stocks are not a complete inflation hedge, none of them indicates to what extent, if at all, stocks may be a partial hedge. In order to answer this question and to provide a check on the previous results, all of which are based on U.S. timeseries data, it is useful to consider international data.

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