What Investors Can Learn From the History of Inflation – The Wall Street Journal

Inflation is on the rise, hitting some of the highest levels seen since the early 1980s. Back then, the Federal Reserves Paul Volcker killed off rampant price rises, hitting the economy hard initially, but ushering in decades of repeated rallies in stocks and bonds.

If todays post Covid-19 pandemic inflation proves sticky, will it be like the years before Volcker, or could it be more like the happier growth that followed World War II? These periods hold lessons about how financial markets might perform.

After World War II, stocks did well despite bouts of inflation. But that only lasted until the mid-1960s. Returns for stocks and Treasurys then struggled until after the 1970s inflation was crushed.

One reason why stocks did well in the 1950s was that money flowed into the market as pension funds and other institutions bought equities for the first time, according to Ian Harnett, chief investment strategist at Absolute Strategy Research. That helped push down the so-called equity-risk premium, which measures the extra returns stock investors demand over government bonds for the risk of losing their money.

In the 1970s, the risk premium rose again and stocks underperformed when inflation took hold. The clues to why this happened are elsewhere in the economic backdrop.

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What Investors Can Learn From the History of Inflation - The Wall Street Journal