So, which industries actually do better and worse when inflation is rising? To answer this, I’ve looked at the performance of stock market sectors in the UK during the 'Great Inflation' of 1968-1980, and then during a much shorter and milder dose during the late 1980s-early 1990s.
Only two industries produced a positive total return during both of these episodes. Investors who bought into oil & gas and banks and reinvested dividends into them during the Great Inflation achieved 0.6 and 0.4 per cent annualised real returns respectively.
The performance of oil & gas should come as no surprise. Both the 1970s/80s and the 1980s/90s inflationary spike occurred against a backdrop of sharply higher energy prices. Interestingly, though, mining did strikingly badly during each episode. This is particularly curious for the 1970s, as there was a bull market in metals, as well as in energy.
Among those to achieve a positive performance in the 1970s and then only mildly negative returns in the 1990s are leisure goods, electronic and electrical equipment, and aerospace & defence.
But there are many more two-time losers than two-time winners: media, financials services, general industrials, healthcare equipment & services, auto & parts, industrial engineering and chemicals all figure on the list of victims.
Bond-fire of insanities
Ordinary bonds – which pay out a fixed amount of interest to their holder, plus a predetermined amount at maturity – get slaughtered by inflation. Both those interest payments and the capital repayment are diminished by the effect of rising prices. The higher the inflation, the worse is the effect.
Government bond prices have fallen in pretty much every episode of high inflation in the US since 1800, just as you would expect. The same is true of bonds issued by American companies, for which my records go back to 1831.
The loss of capital suffered by bondholders in the 1970s was devastating. The FT-Actuaries British Government All Stocks index lost more than 85 per cent of its real value during the worst of the inflation.
Should inflation take off, the last place you want to be is in bonds, therefore. For those who need an income but don't want to risk their capital, cash held in variable-rate savings accounts are clearly preferable to fixed-income securities during such episodes.
Gilts crash, shares struggle
Stuff that you can touch
According to popular wisdom, tangible assets such as commodities are the most likely winners during inflationary times. Materials that are actually used directly in everyday life – be it for nourishment, heating, building or manufacturing goods – are believed likely to hold their real value in times of generalised price increases.
History does not seem to support this notion in any general sense, however. During inflationary outbreaks in the US, copper has fallen almost every single time, even during the last one. And wheat's record is hardly impressive, either, having dropped more often than not and by substantial amounts in many cases.
Crude oil appears to be one exception here, although the figures do not go back as far as for some of these other assets. It gained in real terms during the price rises following the First World War and during the Great Inflation. So, we definitely would consider oil as a prime investment for the next time consumer prices take off.
Commodities in the 1970s
Gold and inflation
Gold is renowned for being a good defence against inflation. But, taking a long term view, this reputation is undeserved. Gold has failed to maintain its purchasing power in the face of rising inflation over the long term. Its adoring fans claim that it is still effective during temporary bursts of inflation. However, in almost every inflationary episode of the past couple of centuries, gold has failed to keep up with rising consumer prices.
That said, gold did more than keep up with general price rises during the latest – and to date – the biggest inflationary crisis. And the 1970s and early 1980s episode might be the most relevant one for judging how gold might perform in the future. Prior to the 1970s, gold served as – or at least was linked to – money itself. So, to say that gold lost its purchasing power during inflationary episodes is a tautology. Although the historical evidence is not as strong as the gold-bugs claim, our suspicion is that gold would do well in another bout of strong inflation.
The real deal?
Real estate – and especially residential property – is widely believed to be a great safeguard against rising prices over time. Even more so than basic materials, housing seems like a real good that you can actually lay your hands on, and is hence the sort of thing people might naturally turn to when confronted with a rocketing cost of living. A few academic studies have confirmed that real estate has some use as a hedge against inflation.
For the US, housing's record seems mixed at best. Residential real estate suffered during the flare-up in prices following the First World War. And it just about maintained its value during the 1970s.
From the late 1960s to the early 1980s, British housing gained 2.4 per cent a year in real terms, which is far better than stocks. However, this doesn’t tell the full story. During the period, there were two outright housing crashes and a further period of weakness. While someone who bought and held a property throughout would have seen their investment grow by around a third after inflation, it would have been a rollercoaster ride to say the least.
British bricks-and-mortar did much worse in the brief and relatively mild inflation of the late 1980s and early 1990s. Housing fell at an annualised rate of 7.6 per cent after inflation. As during the crashes of the 1970s, the much higher interest rates needed to combat upward price pressure were toxic for mortgage holders, many of whom had bought at high prices.
While property has the potential to prosper during inflation, valuation matters hugely. Those who bought when the average house was worth three times average salary would have done well in the 1970s. Those who bought when this ratio was nearer four or more would have done badly.