Let's Talk About Inflation

So, if you’re like me, you’ve been hearing a lot lately about inflation. Some of the pundits and professionals say that it is only transitory (meaning not permanent) while others insist that it is here to stay due to the record spending that continues to be taking place since the start of the COVID pandemic early last year. Only time will tell which side will ultimately be right so let’s look at some current observations and then some historical perspective. 

CURRENT OBSERVATIONS: 

As of this writing, the current yield on the 10-year US treasury is 1.21% and the current yield on SPY (an index fund that you can invest in which tracks the S&P500) is 1.20%. For me, that is a very compelling argument to overweight equities in your investment portfolio for any long-term investor which I’ll define here as 5 years or more just to set the table (more on why this 5-year number to follow). What this yield comparison is telling you is that you can buy the “safe” investment of the 10-year Treasury Bond and earn an annual yield of 1.21% and get your original principal back at the end of 10 years. Conversely, you could invest the same principal amount into SPY and also earn a yield of around 1.20% but have the amazing opportunity to participate in the appreciation of your principal so that you get back more (sometimes substantially more) than your original investment. 

If inflation is here to stay, the equity market is one of the most efficient ways to hedge against it. The reason is intuitive if you think about it. What is any rational company going to do when the price of their inputs goes up? They are going to pass on that cost to you and me of course. Burger King will raise the price of a Whopper by a nickel, General Mills will raise the price of a box of Cheerios by 20 cents and Kimberly Clark will raise the price of Huggies diapers. So, without selling any more units of their products, efficient companies will have higher sales and earnings which will drive up their stock prices and our portfolio values. 

As great as that is it doesn’t even give you the whole story. The amazing thing about companies that pay dividends is that they regularly raise them. In fact, the average annual dividend growth rate of the S&P500 is 5.90% meaning that your dividend payout in dollars will have almost doubled over those 10 years. Pretty cool stuff!   

HISTORICAL PERSPECTIVE: 

In just the last 60 years the S&P 500 is up roughly 70 times, and its cash dividend is up 30 times while inflation (measured by CPI) is up a little more than 9 times. Historically mainstream equities have compounded at more than twice the rate the average bond index has, adjusted for inflation (7% verses 3%). So adjusting for inflation, $10,000 invested in the S&P 500 60 years ago would be worth $579,464 today while $10,000 invested into a bond index 60 years ago would be worth $58,916. Looking at those numbers, which investment carries the most risk to maintaining your dignity and independence throughout a multi-generational retirement? 

Ah, but I can hear some of you saying “That’s great Dave, but I don’t have 60 years to recover from the apocalypse du jour being propagated by the talking heads on T.V., in print or online”. Fair enough. Let’s look at some more historical numbers then. 

This chart represents the percentage of rolling periods with positive returns for the S&P 500, inclusive of reinvested dividends, since the beginning of 1926:

  Nick Murray, Nick Murray: Simple Wealth Inevitable Wealth 2020 

And at 15 years the positive percentage approaches near perfect: 958 out of 961 15-year periods for a positive percentage of 99.7%. I don’t know what your exact life expectancy is, but I do know that statically a 65-year-old married couple has a 90% chance of one of them living to 80 and a 49% chance of one of them living past 90 so the odds are in your favor.  

As we’ve discussed before, the only way to guarantee that we receive superior returns over the long-term and therefore position ourselves to reach, and even enhance, or long-term goals is to ride out the temporary declines in the pursuit of the permanent advances.  

I hope you’ve found this article informative and thought provoking. As always it is a pleasure and an honor to serve you. If you would like to discuss any of this information further, please reach out to us. Have a great day and talk with you soon! 

Cheers, 

David Henderson