Tutorial on the Historical Relationship between Stock Prices and Inflation

 or, Another Saturday Afternoon Adventure on the Internet 2-7-2004

Robert Thibadeau, Ph.D.

With the U.S. deficit so high, what happens to stock prices during high inflation?  After all, the expected  pay back of trillions of debt dollars is first by the dollar slipping against other currencies (already happening), and as that fails, hyperinflation (not happening, yet).   So, here's the history of inflation going back to 1914...note what happens after the expensive wars like WWI, II, Korea, Vietnam...

Ever wonder what inflation already did to your investments?  Click Here to calculate the effect of inflation on any investment.  

But, back to the task at hand.  What is the relationship between inflation and stock price?

Let's take one stock, General Motors. The raw, uncorrected for splits and dividends, price of the stock seems most informative. The GM data only goes back to 1962.  You can see clearly that when inflation goes up, stock price comes down.  The huge down in the late 1980s was a 3 for 1 split.  Low inflation was really watching the stock rise.  

Now, to get interesting, here is the relationship between GM average monthly stock price and monthly inflation rate...

It sure looks like there is an inverse relationship between stock price and inflation.  Another way to put it is that high prices and low inflation seem to go together.  However, when the price is low, inflation can be huge.  For the techies...

This negative relationship is huge and accounts for 30% of the variation in stock price.

So, maybe that's just GM.  What about GE? Here you can see the many splits clearly.  

Same story that the price gets high when inflation is low. The graph below shows this too (the lines connect contiguous months). When inflation is high, the stock don't go nowhere (and, because of inflation, you are losing there too).  When inflation goes up, the stock loses.  Bad inflation.

What about DOW Chemical (since 1977)? Yup. Same story.

Here's IBM.. the splits tend to mask the effects but they are still visible:

What about gold and inflation.  Barrick Gold (ABX) tracks gold pretty well.  So here's the historical price...

 

Since this was just 1985, it is probably hard to say if the story is much different than other stocks, but it looks like there is a bit more tendency for this stock to follow inflation.  But here is the historical price of gold compared to inflation.  Clearly gold price follows inflation up and down.  In the earlier years gold price was fixed and held nearly constant.  Once the price fixing stopped, gold followed inflation for awhile (maybe not in the 90s). 

What about banks?  Banks get interesting:

If one didn't know any better, he would say buy bank stocks right after inflation comes down to a previous level. The stock price does not seem to accelerate upward as the inflation is coming down.  This is unlike other stocks that seem to increase substantially during all the inflationary fall.  However, like other stocks, the time the stock prices are most variable (a good thing for making money) is during times of low inflation.  When inflation is high, the price is depressed and not particularly variable.

A note to those who think we should use more powerful tools than these simple plots: Originally I did use more powerful statistical tools, but they turned out to mask what I was really interested in knowing: what is the relationship between stock price and inflation (not stock value, for instance).  Here is a chart using stock data corrected for splits and dividends to more accurately reflect value and then doing a best linear fit of the stock prices to the inflation.  It shows the negative overall relationship between stock price and inflation, but this trend has enough confoundings to kill a horse.  The stupid old raw price data was, in this case, the easiest data I have found so far to understand.

Here's my raw data and graphs.  

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