The inflation story has gone worldwide, with food prices spiking in emerging markets, the UK’s CPI running well above the target rate, and the U.S. and eurozone now showing signs of a real pick up in prices.
Inflation, overall, is bad news for equity investors according to SocGen. This is because, as inflation rises, it becomes difficult for an equity portfolio to keep up with inflation, so profits that might otherwise seem large are hit by rising costs.
There are arguments that would suggest a portfolio of high yield or of high quality dividend paying stocks would survive and outperform in this environment. But looking at historical data, Societe Generale could find no evidence of that.
There’s simply no proof that the high quality dividend paying stock strategy works, from Societe Generale:
On a relative basis, with its lower beta and more cautious characteristics, equity income should outperform during weaker periods of equity performance. Coupled with a strategy of buying into higher quality, robust and cheaper-than-average dividend streams, this should allow equity investors to keep up with rising inflation without incurring the valuation downside risk associated with some of the racy and expensive areas of the equities market. So in theory, equity income is well placed, but can we prove it. Er … no, not really.
Further, there’s no historical data to show that high yield stocks have been able to deal with inflation and the knock on effect of higher interest rates.
So we ran some sensitivity analysis of high versus low dividend yield strategies in the US using data from 1950 onwards and 1974 in Europe. Again, the analysis is rather inconclusive. In the US, high yield stocks respond positively when interest rates are cut – we assume because the falling interest rates are a sign that the economy is slowing and high yield stocks in the US are typically less-cyclical. It is also worth noting that high yield investing in the US has also been less successful than in Europe. In Europe, our analysis shows that high versus low yield seems to outperform in all interest rate change conditions bar one, when rates are above average and still rising.
The only good news is for those individuals with fixed debts. A rise in inflation will allow them to pay that off faster, that is, if their real incomes rise simultaneously.
Photo: Societe Generale