Inflation is one of the few problems the economy hasn't encountered in recent years, but it could be making a comeback. This makes it worth a look at what you might expect from some major investment classes if inflation does perk up.
Inflation: a recent and longer-term history
In the past 20 years, there has been only one calendar year in which inflation exceeded 4 percent. But in the 20 years before that, it was a completely different story. Inflation was above 4 percent for 13 of those years, with a high of 13.3 percent in 1979.
What could trigger a return of inflation? The price of oil is always a prime suspect. It was a driving force behind June's inflation rising to 0.5 percent (which would project to an annual rate of more than 6 percent), and oil prices continued to surge in the first weeks of July.
With the possibility of a return to higher inflation, investors may want to familiarize themselves with the history of how different asset classes have performed under inflationary conditions.
Searching for safe havens
Below is a look at how some asset classes have performed over the past 40 years when inflation has been above 4 percent for the calendar year. This has happened 14 times, for a compound average annual inflation rate of 7.58 percent during those years. Since history does not usually repeat itself in a precise and orderly manner, this history is accompanied by some cautions on why things might be different going forward:
- Gold. Gold has a reputation as an inflation hedge, and indeed, of the asset classes discussed here, it has the best historical returns in high-inflation years with an annualized average of 16.18 percent. However, it isn't the most reliable inflation hedge. Overall, in 14 years when inflation exceeded 4 percent, the price of gold beat the inflation rate in 8 of them, but had a negative return in 6. Also, the first decade of this century saw a steep rise in the price of gold in a non-inflationary environment, which makes it debatable how much near-term potential gold prices have left in them.
- Deposit accounts. Sometimes slow and steady is the way to go. According to Federal Reserve data, one-month CD rates beat the Consumer Price Index (CPI) in nine of the 14 high-inflation years, and beat inflation overall with a compound average annual return of 8.59 percent during those 14 years. One caution though: Those CD rates are close to zero today, so they have some catching up to do to get past inflation.
- Bonds. Bonds were the worst performers of this group in high inflation years, with an annualized return of just 4.45 percent. They beat inflation in just 6 of the 14 high-inflation years.
- Stocks. Despite beating the CPI in eight of the 14 high-inflation years, stocks trailed inflation overall during those years with an annualized return of 7.04 percent. Stocks have been a major beneficiary of low interest rates in recent years, so they may struggle if inflation pushes those rates higher.