stocks and inflation (part 2 of 2)

22 Mar
(This is an update from yesterday’s discussion on inflation’s effect on markets.)
To augment the information presented in yesterday’s post, I wanted to add additional perspective with respect to earnings. Stock prices can be reduced to two components: (1) earnings and (2) a multiple against those earnings. Yesterday’s post dealt with the latter without much discussion of the former. So, I’ve added the chart below to address this oversight.

Readers will note that earnings (dark blue) more than kept pace with inflation over the twenty-five year period from 1964 through 1988. Certainly, if it were possible to invest in corporate earnings alone during this period, an investor would have fared quite well. This is the crux of the argument made by those who believe stocks will keep pace with inflation — that corporations will raise prices and earnings will largely keep pace. Unfortunately, it’s the ‘multiple’ component that hurts investors during inflation – if ending valuations are meaningfully lower than beginning, an investor may not fare well even if earnings grow nicely. And over this period, they certainly did — real earnings were 50% higher in 1988 than in 1964.

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