Monday, May 14, 2012

Stock Market as a Hedge Against Inflation

Two competing theories going on in my mind.

1.   The market is overvalued because of trillions of retirement dollars hitting the market over the past 40 years and the younger generations not having the purchasing power to continue to inflate that bubble.


2.  The market derives its value from future cash flows and profits.  These future cash flows generated by the assets of these companies will be priced in "future dollars" as the company will naturally increase prices to keep up with inflation and maintain profitability.  Additionally, a higher and higher percentage of sales are coming from foreign countries to offset the craptastic business prospects here in the US, providing an additional hedge against inflation.

Discuss and resolve!


Mk said...

Both are true to some extent although I think factor #1 will be much more a factor over next 10-15 yrs.
In my finance classes back in college I never felt adequate explanation was given about short term irrationality and how it can lead the market into crazy places. Instead it was always extreme market's are efficient drivel.

Anonymous said...

I suspect the latter, if only because the boomers will try to protect their retirement by keeping cash in play.

Jim said...

Don't look at where the market sits price/point wise. Look at the volume and compare it to the past. The market now moves on relatively light volume compared to what it used to. This is for all intents and purposes a bear market even though the indexes are reaching new highs. Not good at all.

This is the Dow Jones:^I\DJI&period=1&freq=0

Elusive Wapiti said...

OT: Cappy, do you have an ePUB or PDF version of your book available? Would like to read and review your book, but I'm a Nook dude, not Kindle.

lelnet said...

Wouldn't bet on it being a particularly _good_ hedge against inflation, but I for one am definitely thinking it's more about inflation than about boomers buying stock funds.

It's probably overvalued anyway, but when one remembers that we're talking nominal dollars instead of constant dollars, it looks a lot less insane.

Captain Capitalism said...


Shoot me an e-mail with your mailng address and I'll drop a physical copy in the mail.

I've a bit reluctant to ship out digital copies.

Anonymous said...

Both are true and #2 compounds #1.

Also a reversal of the "age pyramid" means fewer future consumers to support the enterprises that comprise "the market"; thus their stock prices will have to fall because future cash flows will be falling.


FSK said...

The stock market underperforms true inflation. Compare the stock market to gold and silver, over the past 10-15 years. It isn't close.

An idiot says "Hooray! The stock market went up 20%!", ignoring that inflation was 30%, making it a real loss of 10%.

An idiot says "Stocks get earnings and a dividend!" However, you also have all the waste and theft and corruption associated with a large bureaucracy.

For example, consider the way that the CEO of Chesapeake Energy robbed his shareholders, with the "Founder Well Participation" program.

The stock market is a losing proposition. It underperforms true inflation.

It was a shock to realize that the stock market is one big scam. It's a losing proposition for non-insiders. The stock market is a negative-sum game. That was like discovering that Santa Claus doesn't exist.

Can I trade in my Cappy points for some links?

Anonymous said...

The Boomer's parents were the big savers, not the Boomers themselves. One could argue that much of thier money has already left the market. With regards to the Boomer's money (the few that did save), deinvestment will happen over the balance of their lives (30+ years).

With regards to savings, what are the alternatives and what would be better? Real Estate? Bonds? I'm guessing not.

Anonymous said...

Yeah, not really a dilemma when you don't have options. Bonds, CD Real Estate, Gold - I can't liquidate my 401k and buy assets my balls aren't that big. I may lose in the stock market but if it really takes a shit everyone else will be in the same boat. My hedge is learning to brew my own beer, martial arts,and growing my own food. Inflations comes I'll have an inflated 401k. Market tanks - it was all funny money to begin with . . .

Anonymous said...

Both, and not completely neither.

The best performing "market" over the last few years, in terms of price rise, was Zimbabwe's (yes, they have one), and we sse that the market there was driven soley by inflationary pressure.

As for the lack of GenY participation, there isn't enough "asset cash" (savings) under control of most of them to support a market sustainment/increase. Most of their cash is spent on consumption "expenses" (food, iPads, protest signs, etc). This leaves a general decline in the market as Boomers sell off the market to stay afloat.

Notice, however, this is going to affect the market as a whole. Individual businesses may do very well, and once you have your metals (Au, Ag, Cu, Pb, and Fe specifically), seeds and producive land squared away as a core portfolio, you can look at individual companies for other places to stash cash if you want o be "in the market".

Personally, I'm looking at GlaxoSmithKline (Geritol), Kimberly Clark (adult diapers) and Diageo (Rumpie!) for potential long term holdings.

Ryan Fuller said...

I think foreign investors are more likely to look at developing countries in Asia more than they do now. We can't expect them to prop up our stock market forever.

"The stock market underperforms true inflation. Compare the stock market to gold and silver, over the past 10-15 years. It isn't close."

Gold and silver are commodities, not an absolute measure of value. People who expect economic disaster invest in gold, and probably stuck up on canned food and ammunition while they're at it.

The price of gold isn't a measure of inflation any more than any other good is. If anything, it's just an indicator of how likely people think it is that the economy is going to collapse.

Gold is not magical. People need to stop pretending that it is.

Dick Slater said...

Go to for an analysis of how Rhodesians used stocks as a hedge against the hyperinflation generated by Robert Mugabe's government.

Short version: during the inflation Rhodesians used stock in Old Mutual, a bank whose shares were traded on the London as well as the Salisbury ("Harare") stock exchange, as a store of value and as a way of tracking Rhodesian inflation after the Mugabe government stopped reporting price data, which by 2008 was impossible to make look good. The inflation ended when Mugabe realized that simply not reporting price data wasn't concealing the inflation, and decreed new regulations that forced the stock exchange to close. No longer able to calculate what a "Zimbabwe" dollar was worth, Rhodesians responded by completely rejecting the "Zim" and the economy dollarized spontaneously.

If the USA's dollar-store Mugabe allows capital markets to keep functioning at all, stocks should be a reasonably good store of value in the face of even the worst inflation, backed as they are by the net worth of their firms.

That, of course, is a big if. Do, by all means, keep some physical gold in a safe place, just in case.

Rachel & Robert said...

I think you are spot on about #1 in that, most people who are into investing think more about capital gains than dividends, so there probably is something of a bubble. I just think that when you place point #2 against that, it means we may be looking at a protracted period where long term returns for stocks are closer to 5% ("new normal"). After all, businesses are making money, profit margins are just lower.

I do think there is another piece to this. The boomers have to sell. Even if they had sufficient cash reserves, at 70 & 1/2 the IRS will come knocking for RMD's. Could deflate the bubble slowly, allowing younger people to buy shares at a more reasonable (less outrageous?) price.

Steve said...

I think it's both. Like a rental property there is an underlying cash flow that provide a baseline for the valuation.

If you will it's like an radio frequency signal. The main wave is the starting point from the future cash flow. On top of this various other signals that are superimposed. The expected inflation rate, the taxation rates, total national or global growth rates, return from other assets, or available cash looking for a home.

At different times different factors become large enough to move the dial. Then they fade away again to be replaced by others or to see the core valuation more clearly. Lots of factors suggest the valuations are high but there are still lots of unknowns. Will the rise of a global middle class make up for the decline in US boomers looking to fund retirement?

Great blog btw.

Hot Sam said...

No, debt and equities perform poorly against inflation. Some commodities (precious metals) do well as a hedge while others do not (Agriculture). Derivatives can be an inflation hedge, but they're too complicated for most people. TIPS have built in inflation protection.

The commodity hedge can be undermined if the price is bid up as a hedge to volatility.

Anonymous said...

Eh? The S and P is on track to rack up more than 100 points of profit this year. When you look at profit over inflation/treasuries (ie, why 1970's p/e ratios are full of crap), the market is in fact VERY CHEAP.

Gold, college, real estate madness, Obamacare, and automobile addiction are not real measures of inflation.

In the real world, the cost of women is the real inflation rate for economically literate men. :)

The greatest fallacy here is confusing the S and P with the USA. These are multinational corporations! Most of humanity is moving in the right direction!


No, markets are absolutely not efficient. Not now, not ever. Just because technical analysis is a load of crap doesn't mean markets are efficient!


Options are becoming a lot more popular. Volume is secretly increasing. Plus, volume is measured in shares traded, not their price, so it can remain healthy overall. Look at it as total money, not as raw number of shares, which is vulgar and arbitrary.


Buybacks are superior to dividends for tax reasons. Boomers sell and companies repurchase the artificially cheap stock with buybacks, coming from profits. In the long run, this partially smooths out much of the bumps in the road.

Also, when boomers sell stock and start demanding more services in retirement with their fresh money, this means more liquidity and inflation to ease debt for new firms, and more jobs for the next generation. It's largely a self correcting problem, if left alone.

Problems are almost always political in nature, NOT a consequence of the economy. You guys have the right hearts, but there are lots of misconceptions here...

Wiccapundit said...

You must first set up an equation with the two factors and solve.

The answer is: Blue

Anonymous said...

Re #1 and #2, both are in play - to what degree depends on a large number of individual and institutional investors.

Given that equities adjust in varying degrees to inflation, but not at 100% and cash doesn't at all, we're looking at which is the lesser of two evils. High-quality stocks will likely lose less than cash or bonds.

The real question becomes in what do you invest and in what proportions?

Unless you want to play currency arbitrage like George Soros - I'm not smart enough to play that game.

Rachel & Robert said...

Something else to think about. "Inflation" can be rather nebulous. The "official" measure of inflation leaves out the only things that really inflate, like food and energy. After all, a can of beans is a can of beans no matter what I pay for it. On the other hand, most of the items in the CPI are tech items. And once you factor in the technology price curve, there is no inflation for people who don't need to be on the bleeding edge (i.e. in 1990 a personal cd player cost over $200, an item that is now worthless, and not nearly as useful as a $20 generic mp3 player). The economy model of today is always superior to the cutting edge of yesterday (at least when applied to tech items like electronics, cars, and home appliances).