150-Year Analysis: What Happens to Equities When Inflation Strikes

The quick rise in consumer prices following the pandemic disrupted decades of low inflation globally and sparked equity volatility that investors still struggle to navigate. While inflation has settled down, it has stubbornly stayed above central banks’ targets of around 2%. High inflation can cut out the bulk of a portfolio’s return, making it a paramount concern for investors.

To better understand how inflation impacts investors’ portfolios, we examined the sensitivity of equity returns to inflation over nearly 150 years, from 1875 to 2023. A rigorous analysis of inflation’s impact on investing requires this extensive history because periods of high inflation have been rare. Before the pandemic, global inflation had hovered around 2% for 50 years, never exceeding 4% from 1990 to 2020. In fact, there have only been a few periods of significant inflation in the past 150 years: the 1880s, after World War I, around World War II, the 1970s oil crisis, and most recently since the end of 2021.

To provide a more diverse view of options for investors’ portfolios beyond the broad stock market, we investigated the inflation sensitivity of common equity factors. These five equity factors — notable for their ability to outperform historically — are small caps, value, momentum, low volatility equities, and quality. We also combined these factors equally into a single multi-factor portfolio.

The Sensitivity of Performance to Inflation

Over the full period, equities returned 8.3% a year on average before inflation, with inflation averaging 3.3%. Notably, the five equity factors all delivered a performance premium (outperformed the broad market) with average annual returns ranging from 9.4% for small caps to 11.7% for momentum. The multi-factor portfolio yielded a robust annualized return of 10.6%.

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