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Inflation and market performance
Old 07-07-2006, 12:31 PM   #1
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Inflation and market performance

Do stocks generally do better as inflation increases? I presumed this is so given how many times we hear that the only way to keep up with inflation is to keep some equities.

If true, I wonder if FC has any correction for stock yields as the inflation rate you select increases. That is, the historic yields given a fixed 3% inflation rate may model one way. If I choose to enter a 5% inflation rate, is it accurate to assume that my returns would be the same as under 3% inflation?

I noticed what a powerful effect inflation has on failure rates, but at the same time I wonder if it is underestimating returns relative to the IR as they rise ahead of CPI, etc.
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Re: Inflation and market performance
Old 07-07-2006, 02:38 PM   #2
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Re: Inflation and market performance

[img width=750 height=351]http://www.martincapital.com/chts-econ/ch_infst.gif[/img]
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Re: Inflation and market performance
Old 07-07-2006, 05:34 PM   #3
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Re: Inflation and market performance

Quote:
Originally Posted by Rich_in_Tampa
If true, I wonder if FC has any correction for stock yields as the inflation rate you select increases. That is, the historic yields given a fixed 3% inflation rate may model one way. If I choose to enter a 5% inflation rate, is it accurate to assume that my returns would be the same as under 3% inflation?
FC uses the same inflation rate for the yields as are affecting the spending that year.

I don't recommend overriding the inflation rate with a fixed percentage, and only added that capability under protest for those who wanted to test something.
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Re: Inflation and market performance
Old 07-07-2006, 08:06 PM   #4
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Re: Inflation and market performance

RiT,

- wab's chart pretty much tells the story. I've read that equities do a good job of keepingup with moderate inflation, but they don't do well when the inflation is so high that it disrupts financial markets (e.g. interest rates have to go through the roof so people will put money in the bank, thereby driving up the cost of capital, etc).

- I think having equities helps you keep up with inflation for two reasons:
-- Stocks do tend to track inflation when it is moderate
-- The overall return on stocks, over decades, has historically been higher than inflation. That doesn't necessarily mean that they have risen at the same time.
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Re: Inflation and market performance
Old 07-07-2006, 08:11 PM   #5
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Re: Inflation and market performance

Perhaps there may be confusion over the cause and effect. Perhaps the equity markets do well because the companies/economy is doing well, which results in the higher inflation. The subsequent higher rates imposed to cool the economy produces weaker returns in equities as borrowing becomes more expensive.

Otherwise, as Sam notes, almost nothing except equities exceeds inflation by enough to matter. Anything else is just playing to not lose too badly, but in fact to lose.
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Re: Inflation and market performance
Old 07-07-2006, 10:10 PM   #6
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Re: Inflation and market performance

Quote:
Originally Posted by dory36
FC uses the same inflation rate for the yields as are affecting the spending that year.

I don't recommend overriding the inflation rate with a fixed percentage, and only added that capability under protest for those who wanted to test something.
Then, it relies on the same historic database for inflation that it relies of for the yields, following in the same sequence in which they unfolded for each historic cycle (assuming you don't override the inflation number)?

Guess that's as good as one can expect. It certainly underscores how there are lots of scenarios out there which history might not reflect (both good and not good).

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Re: Inflation and market performance
Old 07-08-2006, 06:56 AM   #7
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Re: Inflation and market performance

Quote:
Originally Posted by Rich_in_Tampa
Then, it relies on the same historic database for inflation that it relies of for the yields, following in the same sequence in which they unfolded for each historic cycle (assuming you don't override the inflation number)?
Yep
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