Equities as a hedge against inflation

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Ron Scott
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Equities as a hedge against inflation

Post by Ron Scott » Tue Sep 25, 2018 12:37 pm

This obviously falls into a category like speculation, belief, or dogma, as we don’t know for sure. I buy into it because without being able to return at least at the inflation rate corporations would not attract capital. So this becomes primal for them.

I have also read that since corporations are providing the products which are increasing in price to produce inflation they are able to increase in value in proportion to the price increases. I understand this in principle, but I don’t buy into it for the total market.

Others claim that history is the determining factor and so far equities have been able to keep pace with the repeat inflation and therefore will continue to do so into the future. This I do not buy at all.

What do you think?
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siamond
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Re: Equities as a hedge against inflation

Post by siamond » Tue Sep 25, 2018 12:44 pm

Maybe you should explain WHY you "don't buy into" something... It would then be much easier to discuss the point.

And then let me suggest you check this thread, which is basically the same discussion:
viewtopic.php?f=10&t=259538

alex_686
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Re: Equities as a hedge against inflation

Post by alex_686 » Tue Sep 25, 2018 12:45 pm

Let us review. In theory equities should provided a hedge against inflation and this is born out empirically. You don't believe either. O.K., why?

I am not trying to be snide, but this is a fairly robust position. What parts of this huge granite edifice do you want to start at? The hedge is not perfect. We can look at extreme circumstances, such as supply shocks. Or we can talk about secular shifts. But I need a place to start.

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Re: Equities as a hedge against inflation

Post by Leesbro63 » Tue Sep 25, 2018 12:47 pm

I think equities generally work well as an inflation hedge over long periods of time. But in the short run, maybe not so much. In Weimar Germany's hyperinflation, equities did the best to preserve buying power. In the 1970s, inflation ran ahead of equities. But in the 1980s stocks caught up and then some. But if you're already 75 years old, you might not have 20 years to even things up.

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Re: Equities as a hedge against inflation

Post by JBTX » Tue Sep 25, 2018 12:50 pm

I am somewhat skeptical of the equities = inflation hedge argument.

Inflation generally brings higher discount rate, and thus lower PE's - yes the earnings growth rate should go up too, but I suspect that actually lags - especially in a global market.

Late 70's inflation, and subsequent interest rate adjustments killed equities.

Tamalak
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Re: Equities as a hedge against inflation

Post by Tamalak » Tue Sep 25, 2018 12:52 pm

A stock is a share of a company.. a company is made up of a lot of things, inventory, land, buildings, employees, IP, cash, debt etc.

Of all that, only the cash and debt get eaten by inflation, and you WANT debt to get eaten. So it seems like equities are a good protection to me.
Last edited by Tamalak on Tue Sep 25, 2018 1:05 pm, edited 1 time in total.

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Re: Equities as a hedge against inflation

Post by nisiprius » Tue Sep 25, 2018 12:56 pm

The question about whether something is "a hedge against inflation" tends to turn on several very different questions.
  1. In the long run, let's say periods of thirty years or more, has it more-or-less tended to hold real value?
  2. In the intermediate and short term, say 1-10 years, has it reliably held real value during periods of high inflation?
  3. Has it just plain made so darn much money that you don't really care whether it has any actual link to inflation or not?
  4. During periods of high inflation, has reliably spiked dramatically, so reliably and so much that a small, 5-10% holding can act like an insurance policy, not only holding real value, but compensating for the loss of real value in the rest of the portfolio?
I would say that stocks have met criterion 1, but not 2, 3, or 4.

With regard to criterion #2, I would quote Benjamin Graham, In The Intelligent Investor, 4th ed., 1973, p. 20:
On this point we can be categorical. There is no close time connection between inflationary (or deflationary) conditions and the movement of common-stock earnings and prices. The obvious example is the recent period 1966-1970. The rise in the cost of living was 22%... but both stock earnings and stock prices have declined since 1965. There are similar contradictions in both directions in the record of previous five-year periods.
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Re: Equities as a hedge against inflation

Post by Ketawa » Tue Sep 25, 2018 1:01 pm

We need to be more precise in our terms. People can mean a couple different things when discussing a hedge against inflation.

Historically, equities have outpaced inflation. They should because as inflation happens, companies are able to raise prices. Bonds also hedge against inflation in this manner since inflation expectations are baked into nominal interest rates. So sure, equities are a hedge against expected inflation, but so are other investments. There's nothing particularly special about equities.

Equities have not been good hedges against unexpected inflation. If there is an inflation shock, the economy and stock market will suffer. How did equities do in the 70s?

I think the only really good hedges against unexpected inflation are TIPS and maybe short bonds. The best is probably the G Fund in the TSP. A mortgage can be a hedge since it is a large negative bond (if buying long bonds exposes you to inflation risk, selling them reduces it), but it can be a costly hedge.

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Re: Equities as a hedge against inflation

Post by vineviz » Tue Sep 25, 2018 1:24 pm

Typically, equities have offered good protection from inflation over periods of 5+ years. Less so over shorter time periods.

https://www.washingtonpost.com/business ... 25f810ee59

Portfolios with some characteristics are better than others (small stocks and foreign stocks tend to help more than large cap US stocks, for instance).
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Ron Scott
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Re: Equities as a hedge against inflation

Post by Ron Scott » Tue Sep 25, 2018 4:21 pm

siamond wrote:
Tue Sep 25, 2018 12:44 pm
Maybe you should explain WHY you "don't buy into" something... It would then be much easier to discuss the point.
alex_686 wrote:
Tue Sep 25, 2018 12:45 pm
Let us review. In theory equities should provided a hedge against inflation and this is born out empirically. You don't believe either. O.K., why?
Well I feel more than a little put upon since it is usually not the nonbeliever who is required to provide the proof, but I will comply for the sake of the board:

1. I doubt I’d be convinced with 10 times the amount of data we have, but we don’t have a lot of data. And the data we do have is biased. We use about 80 or so years of 20th century US data (biased because it comes from precisely the period in our history that we became the dominant world power) to predict a specific 30-year retirement period (yours). To me, using such data belongs in the you’ve-got-to-be-kidding-me category.

2. Since the 1950s the social sciences—psychology, political science, sociology, ECONOMICS et al—have bet the house on becoming “scientific”, using tools successfully employed by their STEM cousins. They have attempted to advance their fields through the analysis of observations and experience instead of theory and logic and this has been an embarrassing failure for them. The social empiricist’s chest of accomplishments is fairly barren. I don’t want any of us to gamble our retirement as they have gambled their careers.

3. Finally, some will tell you to use historical data as a guide (Firecalc or some Monte Carlo sims for example) because you get the benefit of both the averages and what they call the "worst case scenario". What they don't tell you is before that worst case happened no one believed it would happen and no one planned for it. AND THE NEXT WORST CASE SCENARIO HASN'T BEEN THOUGHT OF AND IS NOT IN PEOPLE'S PLANNING. No one knows what the worse case is or even if we will enter a period of very low returns for a couple decades.

I will leave you with the story of the empiricist turkeys, a sect that lived years ago and are no longer. Each day, for literally hundreds of days, these turkeys observed the behaviors of men to ensure they would be well fed. They “learned” that when the little gate in back of the big house opened they could file in and the men would give them all the food they wanted. Given so many confirmatory observations they treated the routine as a natural phenomena, taught it to their kids and never thought to question it. Then came the Friday before Thanksgiving… (Stuff we don’t think will happen happens.)

Some people tell us we have usable historical data that contains the universe of likely outcomes that we can use for planning purposes. We do not.
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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siamond
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Re: Equities as a hedge against inflation

Post by siamond » Tue Sep 25, 2018 5:14 pm

Ron Scott wrote:
Tue Sep 25, 2018 4:21 pm
Well I feel more than a little put upon since it is usually not the nonbeliever who is required to provide the proof, but I will comply for the sake of the board [...]
Ok, so you don't believe in learning lessons from history. Now I remember, you made that very clear in another thread. I do understand some level of skepticism against backtesting, but in this case the evidence is quite compelling. If I am not mistaken, a hard fact is that stocks exceeded inflation in the long run in every single country in known history (except those few countries which closed their stock market for decades, admittedly). You can choose to ignore such powerful fact, but I don't know, this screams 'denial' to me... But I am not going to change your mind, so be it.
Ron Scott wrote:
Tue Sep 25, 2018 12:37 pm
I have also read that since corporations are providing the products which are increasing in price to produce inflation they are able to increase in value in proportion to the price increases. I understand this in principle, but I don’t buy into it for the total market.
You didn't explain why this (quite obvious imho) point would apply to individual companies and yet wouldn't apply to the total market? This line of thinking has nothing to do with backtesting, so what's the source of your non-belief here? Just trying to understand.

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galeno
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Re: Equities as a hedge against inflation

Post by galeno » Tue Sep 25, 2018 5:23 pm

Most people I talk to think investing in the stock market is akin to gambling in a casino. You can take a horse to water but...……..
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Re: Equities as a hedge against inflation

Post by nisiprius » Tue Sep 25, 2018 5:31 pm

Sounds like you've been reading Nassim Nicholas Taleb. I really liked Fooled by Randomness and The Black Swan. I detested The Bed of Procrustes: Philosophical and Practical Aphorisms and posted a parody which apparently went completely unnoticed. I started Antifragile but couldn't get into it.

If I've guessed right about Taleb, and if you haven't yet read The Misbehavior of Markets: A Fractal View of Financial Turbulence, by Benoit Mandelbrot and Richard L. Hudson, you will probably like it, too.

If I've guessed wrong about Taleb, then the story of the empiricist turkey must be more widespread than I realized.
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Re: Equities as a hedge against inflation

Post by JoMoney » Tue Sep 25, 2018 5:50 pm

I don't believe equities perfectly hedge against inflation, there are variety of factors that go into a companies valuation, and in the securities market in general. Inflation hurts some businesses more than others. It can raise the balance sheet value in some areas, decrease margins in another. Some businesses can adjust there prices quicker than others. Rising interest rates can hurt some more than others.... but it is a claim on real assets
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JoeRetire
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Re: Equities as a hedge against inflation

Post by JoeRetire » Tue Sep 25, 2018 5:59 pm

Ron Scott wrote:
Tue Sep 25, 2018 4:21 pm
1. I doubt I’d be convinced with 10 times the amount of data we have, but we don’t have a lot of data. And the data we do have is biased. We use about 80 or so years of 20th century US data (biased because it comes from precisely the period in our history that we became the dominant world power) to predict a specific 30-year retirement period (yours). To me, using such data belongs in the you’ve-got-to-be-kidding-me category.

2. Since the 1950s the social sciences—psychology, political science, sociology, ECONOMICS et al—have bet the house on becoming “scientific”, using tools successfully employed by their STEM cousins. They have attempted to advance their fields through the analysis of observations and experience instead of theory and logic and this has been an embarrassing failure for them. The social empiricist’s chest of accomplishments is fairly barren. I don’t want any of us to gamble our retirement as they have gambled their careers.

3. Finally, some will tell you to use historical data as a guide (Firecalc or some Monte Carlo sims for example) because you get the benefit of both the averages and what they call the "worst case scenario". What they don't tell you is before that worst case happened no one believed it would happen and no one planned for it. AND THE NEXT WORST CASE SCENARIO HASN'T BEEN THOUGHT OF AND IS NOT IN PEOPLE'S PLANNING. No one knows what the worse case is or even if we will enter a period of very low returns for a couple decades.
Thus, there are no hedges against inflation?

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Re: Equities as a hedge against inflation

Post by marcopolo » Tue Sep 25, 2018 6:31 pm

Ron Scott wrote:
Tue Sep 25, 2018 12:37 pm
This obviously falls into a category like speculation, belief, or dogma, as we don’t know for sure. I buy into it because without being able to return at least at the inflation rate corporations would not attract capital. So this becomes primal for them.

I have also read that since corporations are providing the products which are increasing in price to produce inflation they are able to increase in value in proportion to the price increases. I understand this in principle, but I don’t buy into it for the total market.

Others claim that history is the determining factor and so far equities have been able to keep pace with the repeat inflation and therefore will continue to do so into the future. This I do not buy at all.

What do you think?
I am a bit confused by this.

In other threads (e.g., viewtopic.php?f=10&t=257672&p=4093384&h ... t#p4093384),
You have made it very clear that you do not believe in using past data to make plans.
When asked what you assume for equity returns in your planning, you said you use 0% real for planning.
When asked why you believe that other than it has been historically the case, you replied that you are very confident "that in democratic, capitalist countries equities and bonds are highly likely to at least keep pace with inflation" You seemed pretty certain that this was a fundamental principle, and not useless historical data.

Do you no longer believe that to be the case, or do you think the US is no longer such a democratic, capitalist country?
Once in a while you get shown the light, in the strangest of places if you look at it right.

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Re: Equities as a hedge against inflation

Post by Ron Scott » Tue Sep 25, 2018 7:50 pm

marcopolo wrote:
Tue Sep 25, 2018 6:31 pm
Ron Scott wrote:
Tue Sep 25, 2018 12:37 pm
This obviously falls into a category like speculation, belief, or dogma, as we don’t know for sure. I buy into it because without being able to return at least at the inflation rate corporations would not attract capital. So this becomes primal for them.

I have also read that since corporations are providing the products which are increasing in price to produce inflation they are able to increase in value in proportion to the price increases. I understand this in principle, but I don’t buy into it for the total market.

Others claim that history is the determining factor and so far equities have been able to keep pace with the repeat inflation and therefore will continue to do so into the future. This I do not buy at all.

What do you think?
I am a bit confused by this.

In other threads (e.g., viewtopic.php?f=10&t=257672&p=4093384&h ... t#p4093384),
You have made it very clear that you do not believe in using past data to make plans.
When asked what you assume for equity returns in your planning, you said you use 0% real for planning.
When asked why you believe that other than it has been historically the case, you replied that you are very confident "that in democratic, capitalist countries equities and bonds are highly likely to at least keep pace with inflation" You seemed pretty certain that this was a fundamental principle, and not useless historical data.

Do you no longer believe that to be the case, or do you think the US is no longer such a democratic, capitalist country?
Yes, I wrote above I buy into it because without being able to return at least at the inflation rate corporations would not attract capital. I believe this is almost always true in democratic, capitalist countries, and spotty in countries where the governments engage in winner-picking and other significant control.

I do use 0% real in my personal planning (assuming my investments keep pace with inflation).

I do believe the use of historical data is not helpful in planning for retirement. We cannot predict future return rates.
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Equities as a hedge against inflation

Post by Ron Scott » Tue Sep 25, 2018 7:55 pm

JoeRetire wrote:
Tue Sep 25, 2018 5:59 pm
Ron Scott wrote:
Tue Sep 25, 2018 4:21 pm
1. I doubt I’d be convinced with 10 times the amount of data we have, but we don’t have a lot of data. And the data we do have is biased. We use about 80 or so years of 20th century US data (biased because it comes from precisely the period in our history that we became the dominant world power) to predict a specific 30-year retirement period (yours). To me, using such data belongs in the you’ve-got-to-be-kidding-me category.

2. Since the 1950s the social sciences—psychology, political science, sociology, ECONOMICS et al—have bet the house on becoming “scientific”, using tools successfully employed by their STEM cousins. They have attempted to advance their fields through the analysis of observations and experience instead of theory and logic and this has been an embarrassing failure for them. The social empiricist’s chest of accomplishments is fairly barren. I don’t want any of us to gamble our retirement as they have gambled their careers.

3. Finally, some will tell you to use historical data as a guide (Firecalc or some Monte Carlo sims for example) because you get the benefit of both the averages and what they call the "worst case scenario". What they don't tell you is before that worst case happened no one believed it would happen and no one planned for it. AND THE NEXT WORST CASE SCENARIO HASN'T BEEN THOUGHT OF AND IS NOT IN PEOPLE'S PLANNING. No one knows what the worse case is or even if we will enter a period of very low returns for a couple decades.
Thus, there are no hedges against inflation?
I believe equities, like a TSM fund, is a reasonable hedge. But it is just a belief based on theory, not data analysis, and I would not bet my life on it.
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Equities as a hedge against inflation

Post by Ron Scott » Tue Sep 25, 2018 8:10 pm

siamond wrote:
Tue Sep 25, 2018 5:14 pm
Ron Scott wrote:
Tue Sep 25, 2018 4:21 pm
Well I feel more than a little put upon since it is usually not the nonbeliever who is required to provide the proof, but I will comply for the sake of the board [...]
A
Ok, so you don't believe in learning lessons from history. Now I remember, you made that very clear in another thread. I do understand some level of skepticism against backtesting, but in this case the evidence is quite compelling. If I am not mistaken, a hard fact is that stocks exceeded inflation in the long run in every single country in known history (except those few countries which closed their stock market for decades, admittedly). You can choose to ignore such powerful fact, but I don't know, this screams 'denial' to me... But I am not going to change your mind, so be it.
Ron Scott wrote:
Tue Sep 25, 2018 12:37 pm
I have also read that since corporations are providing the products which are increasing in price to produce inflation they are able to increase in value in proportion to the price increases. I understand this in principle, but I don’t buy into it for the total market.
B
You didn't explain why this (quite obvious imho) point would apply to individual companies and yet wouldn't apply to the total market? This line of thinking has nothing to do with backtesting, so what's the source of your non-belief here? Just trying to understand.
A. Perhaps you're mistaking me for the guy who shot your dog? (Just kiddin') I am not aware of your hard fact, powerful or not, or the caveats you put around it. Tell us more.

B. In principal the argument makes sense to me, but drawing a line between inflation and market returns is too simplistic and I don't think inflation would actually affect the entire market at once. Here's an overview: https://www.investopedia.com/articles/ ... turns.asp
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Equities as a hedge against inflation

Post by rnitz » Tue Sep 25, 2018 8:47 pm

I'd be interested in the distinction between stocks performance under moderate inflation (0-4%) vs. high inflation (>5%). My understanding is that stocks are a great inflation hedge when inflation is modest (when you don't care) and is not so good when you have high inflation (aka the 70's type of inflation, when both stocks and bonds got hammered). My knowledge/google-foo is limited, so I'd love input from those who have much better knowledge than I.

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Re: Equities as a hedge against inflation

Post by siamond » Tue Sep 25, 2018 10:06 pm

Ron Scott wrote:
Tue Sep 25, 2018 8:10 pm
A. Perhaps you're mistaking me for the guy who shot your dog? (Just kiddin') I am not aware of your hard fact, powerful or not, or the caveats you put around it. Tell us more.
Well, those of us who think that history can teach us many lessons really enjoyed reading the "Triumph of the Optimists" book that was issued in 2002, as a groundbreaking study documenting stocks, bonds, bills and inflation over 101 years across sixteen countries. This allowed to get out of the overly narrow study of the US history, and to test various hypotheses out of sample (i.e. in other countries). For each country, there is a table documenting real (inflation-adjusted) annualized returns per decade, 1900-1909, 1910-1919, etc. The quasi-totality of those numbers are positive. Some ARE negative, so stock returns didn't exceed inflation over a decade. It is clear that the stock market can go through severe convulsions at times, fairly independently from inflation bursts, so this isn't entirely surprising. Now do we find longer periods of time (say 20 years), where stocks did not catch up with inflation?

I checked again, not wanting to let my memory distort facts. I did find several cases where we had two negative numbers in a row. Those are all European countries, and the timeframe is directly related to the extreme devastation brought by WW-I or WW-II. Then, yeah, all bets are off and much more. Post WW-II, I didn't find a sequence of 20 years where a negative number isn't counter-balanced by a bigger positive number, with... two exceptions (Italy and Spain each had such a sequence around the oil crisis).

Conclusion: besides the extreme devastation brought by WW-I and WW-II, the hypothesis that stocks catch up to inflation in less than 10 years (in the great majority of cases) and less than 20 years (for a few cases) seems to hold pretty good. Yet, admittedly, there were two exceptions. Across 16 countries and so many years, knowing that stock returns are the sum of MANY distinct forces, this seems pretty compelling empirical evidence to me. Albeit not as black & white as I thought.

This being said, I am always skeptical about empirical evidence if this is all there is. But then, it seems really clear to me that the basic mechanics of pricing would make stock returns catch up with inflation in the absence of other factors (e.g. speculative mania and subsequent crash, etc), which is your 2nd point. If we accept this non-empirical hypothesis (I know, you're skeptical too), then the strength of the empirical confirmation should convince most people...

Note that if we look at bonds instead of stocks, here the case is extremely clear, regular government bonds stayed under water for multiple decades in a row, and this means more than two! Starting by the US after WW-II, four decades in the red...
Ron Scott wrote:
Tue Sep 25, 2018 8:10 pm
B. In principal the argument makes sense to me, but drawing a line between inflation and market returns is too simplistic and I don't think inflation would actually affect the entire market at once. Here's an overview: https://www.investopedia.com/articles/ ... turns.asp
I didn't see anything in the Investopia article that relates to discussing inflation as applied to an individual enterprise vs. the total-market. I do take your point that inflation would affect the entire market in an uneven manner. It seems quite a stretch to conclude that the dynamics applying to enterprises wouldn't apply to an entire market though. But at least, I see your point a tad better now. I am not aware of studies related to this precise point.

PS. I like dogs, you got that right. :wink:

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Re: Equities as a hedge against inflation

Post by Ron Scott » Tue Sep 25, 2018 11:42 pm

siamond wrote:
Tue Sep 25, 2018 10:06 pm
Ron Scott wrote:
Tue Sep 25, 2018 8:10 pm
A. Perhaps you're mistaking me for the guy who shot your dog? (Just kiddin') I am not aware of your hard fact, powerful or not, or the caveats you put around it. Tell us more.
Well, those of us who think that history can teach us many lessons really enjoyed reading the "Triumph of the Optimists" book that was issued in 2002, as a groundbreaking study documenting stocks, bonds, bills and inflation over 101 years across sixteen countries. This allowed to get out of the overly narrow study of the US history, and to test various hypotheses out of sample (i.e. in other countries). For each country, there is a table documenting real (inflation-adjusted) annualized returns per decade, 1900-1909, 1910-1919, etc. The quasi-totality of those numbers are positive. Some ARE negative, so stock returns didn't exceed inflation over a decade. It is clear that the stock market can go through severe convulsions at times, fairly independently from inflation bursts, so this isn't entirely surprising. Now do we find longer periods of time (say 20 years), where stocks did not catch up with inflation?

I checked again, not wanting to let my memory distort facts. I did find several cases where we had two negative numbers in a row. Those are all European countries, and the timeframe is directly related to the extreme devastation brought by WW-I or WW-II. Then, yeah, all bets are off and much more. Post WW-II, I didn't find a sequence of 20 years where a negative number isn't counter-balanced by a bigger positive number, with... two exceptions (Italy and Spain each had such a sequence around the oil crisis).

Conclusion: besides the extreme devastation brought by WW-I and WW-II, the hypothesis that stocks catch up to inflation in less than 10 years (in the great majority of cases) and less than 20 years (for a few cases) seems to hold pretty good. Yet, admittedly, there were two exceptions. Across 16 countries and so many years, knowing that stock returns are the sum of MANY distinct forces, this seems pretty compelling empirical evidence to me. Albeit not as black & white as I thought.

This being said, I am always skeptical about empirical evidence if this is all there is. But then, it seems really clear to me that the basic mechanics of pricing would make stock returns catch up with inflation in the absence of other factors (e.g. speculative mania and subsequent crash, etc), which is your 2nd point. If we accept this non-empirical hypothesis (I know, you're skeptical too), then the strength of the empirical confirmation should convince most people...

Note that if we look at bonds instead of stocks, here the case is extremely clear, regular government bonds stayed under water for multiple decades in a row, and this means more than two! Starting by the US after WW-II, four decades in the red...
Ron Scott wrote:
Tue Sep 25, 2018 8:10 pm
B. In principal the argument makes sense to me, but drawing a line between inflation and market returns is too simplistic and I don't think inflation would actually affect the entire market at once. Here's an overview: https://www.investopedia.com/articles/ ... turns.asp
I didn't see anything in the Investopia article that relates to discussing inflation as applied to an individual enterprise vs. the total-market. I do take your point that inflation would affect the entire market in an uneven manner. It seems quite a stretch to conclude that the dynamics applying to enterprises wouldn't apply to an entire market though. But at least, I see your point a tad better now. I am not aware of studies related to this precise point.

PS. I like dogs, you got that right. :wink:
OK, good. So you have learned a lot by studying the history of the 20th century. For the benefit of those in the final stages of their retirement planning, we should be able to ask what history tells them about the probability any of the following will happen:

1. Several difficult global challenges [global banking failures, limited wars involving top world powers, protracted trade wars), happening 5 to 7 years apart and upsetting investment returns for 20 years.
2. 15 more or less consecutive years of 0% real returns caused in part by high government and corporate debt and incompetence in handling the complexities.
3. Increasing globalization of labor—much of it virtual—that raises the standard of living in relatively poor countries at the expense of employees in the richer countries.

The answer is so obvious we don’t need the debate: A. Any or a combination of these occurrences could produce historically aberrant investment returns. B. The history of the 20th century you reference cannot possibly predict any of this or any other less dramatic circumstances that can impact the behavior of markets.

Now, realize that we do not need to predict specific challenges to manage our portfolioss conservatively, so that they are far more robust that an analysis of 20th century returns would require. We can save more, spend less and work longer.

Rather than trusting history to set a cap on market losses we can prepare better. This is where our differences lie.

62 years old; about 50 lived with a dog...
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Re: Equities as a hedge against inflation

Post by Valuethinker » Wed Sep 26, 2018 2:30 am

Ron Scott wrote:
Tue Sep 25, 2018 12:37 pm
This obviously falls into a category like speculation, belief, or dogma, as we don’t know for sure. I buy into it because without being able to return at least at the inflation rate corporations would not attract capital. So this becomes primal for them.

I have also read that since corporations are providing the products which are increasing in price to produce inflation they are able to increase in value in proportion to the price increases. I understand this in principle, but I don’t buy into it for the total market.

Others claim that history is the determining factor and so far equities have been able to keep pace with the repeat inflation and therefore will continue to do so into the future. This I do not buy at all.

What do you think?
https://research-doc.credit-suisse.com/ ... 3R5kq7g%3D

p 15 "don't confuse inflation beating with inflation hedging"

It's a very important point re stocks. They pay high, and highly volatile returns. The reward for that volatility is high real returns.

In terms of companies:

- they have volume growth, and they have price growth price x volume = sales

- so inflation benefits price and thus sales

However

- profits = revenues - costs

costs also rise with inflation. Depending on how competitive a market they operate in, they may or may not be able to raise prices as fast as costs rise.

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Re: Equities as a hedge against inflation

Post by Valuethinker » Wed Sep 26, 2018 5:42 am

rnitz wrote:
Tue Sep 25, 2018 8:47 pm
I'd be interested in the distinction between stocks performance under moderate inflation (0-4%) vs. high inflation (>5%). My understanding is that stocks are a great inflation hedge when inflation is modest (when you don't care) and is not so good when you have high inflation (aka the 70's type of inflation, when both stocks and bonds got hammered). My knowledge/google-foo is limited, so I'd love input from those who have much better knowledge than I.
There's some more information in the Dimson Marsh "Triumph of the Optimists" presentation I reference above.

I suspect that *rising* inflation is generally bad for stocks. Companies find it hard to pass on price increases to customers as fast as their own input prices rise (labour, raw materials etc.). I have not seen proof of my hypothesis, though.

In addition Central Banks tend to respond with higher interest rates and higher real interest rates. That's generally bad for stocks as it is bad for bonds.

Of countries that experienced very high inflation in the 1970s (but not hyperinflation) like the UK and Italy equities did very poorly but the same factors that caused high inflation (wage-price spiral with strong trade unions) also were not good for business.

I think there is at least some evidence that the Italian stock markets have suffered from "crowding out" due to very high government borrowing-- the stock market listed part of the Italian corporate world is stunted, compared to its Anglo Saxon peers. Italy has something similar to the UK GDP (within 20%) but a stock market capitalized at (less than?) half the size.

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Re: Equities as a hedge against inflation

Post by nisiprius » Wed Sep 26, 2018 6:03 am

I just had a weird thought and I wonder if anybody has any actual data on it. When I've bloviated about this in the past, one of my observations is that most investments have had positive real returns in the past, over long periods of time, including bank accounts. The only obvious exceptions seem to be a) intermediate and long-term nominal bonds, and only when the holding period ends in a period of high inflation, and b) and literal currency. Thus, almost any investment can be, and has been promoted as "a hedge against inflation," just as almost any investment can be, and has been promoted as "diversification."

But now I'm wondering about literal currency.

Assume a random sample of, let's say, $100,000 or more in physical cash, such as you might get from a bank, in mixed denominations and including coins. My point is: a random sample of what's really circulating, not an existing numismatic "collection" of rarities. If held for 100 years, what are the chances that such a collection will include enough items of high enough numismatic value to falsify the idea that physical currency actually has zero return?

Just wondering. I'm pretty sure it wouldn't have kept up with inflation or even close to it, but the return would not quite be zero.

We know that an amazing amount of "the return of the stock market" is actually attributable to an amazingly small portion of the stocks in the market, conceivably the same thing could be true of currency.

(I suspect numismatic dealers and websites are not a good place to seek unbiassed information about this, however).

(Please do not think for one microsecond that I am advocating any kind of "investment" in any kind of collectible).
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Re: Equities as a hedge against inflation

Post by Valuethinker » Wed Sep 26, 2018 6:16 am

nisiprius wrote:
Wed Sep 26, 2018 6:03 am
I just had a weird thought and I wonder if anybody has any actual data on it. When I've bloviated about this in the past, one of my observations is that most investments have had positive real returns in the past, over long periods of time, including bank accounts. The only obvious exceptions seem to be a) intermediate and long-term nominal bonds, and only when the holding period ends in a period of high inflation, and b) and literal currency. Thus, almost any investment can be, and has been promoted as "a hedge against inflation," just as almost any investment can be, and has been promoted as "diversification."

But now I'm wondering about literal currency.

Assume a random sample of, let's say, $100,000 or more in physical cash, such as you might get from a bank, in mixed denominations and including coins. My point is: a random sample of what's really circulating, not an existing numismatic "collection" of rarities. If held for 100 years, what are the chances that such a collection will include enough items of high enough numismatic value to falsify the idea that physical currency actually has zero return?

Just wondering. I'm pretty sure it wouldn't have kept up with inflation or even close to it, but the return would not quite be zero.

We know that an amazing amount of "the return of the stock market" is actually attributable to an amazingly small portion of the stocks in the market, conceivably the same thing could be true of currency.

(I suspect numismatic dealers and websites are not a good place to seek unbiassed information about this, however).

(Please do not think for one microsecond that I am advocating any kind of "investment" in any kind of collectible).
There are "Alternative Asset" indices for cars, fine wine, coins & other collectibles. I don't have time to look them up, now, but, yes, there are such indices. Paper money is very rarely worth even as much as its face value when issued.

I have a scepticism on the data. Christie's and Sotheby's, for example, charge something like 25% of gross auction value (plus various other fees, no doubt) and I do not believe that is included in the indices.

The usual argument is low or uncorrelated returns v. stocks & bonds. My guess is that is an artefact of the data (as it is with Real Estate, and that's widely understood). i.e. that for example the fine art market tracks financial profits-- Japan in the late 1980s, Far East & hedge funds now. It is just that the actual index lags because it is based on actual sale events rather than appraised values. Art also changes in fashion - in 1990 it was Impressionists, now it is (or was) modern art, etc.

I don't know if the index creators properly allow for that lag in valuation change (or how). If they don't, then you get low correlations which are not, in fact, correct.

City of London or New York office buildings were worth a lot less in 2009 than 2008. But since you couldn't sell them, or only at a very distressed price (say: bank repossession), the index was pretty sparse. Buildings had say -50% in value top to bottom, but it would not have been obvious in the data for some time, probably when things were past their worst (and buyers reemerged).

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Re: Equities as a hedge against inflation

Post by siamond » Wed Sep 26, 2018 8:36 am

Ron Scott wrote:
Tue Sep 25, 2018 11:42 pm
siamond wrote:
Tue Sep 25, 2018 10:06 pm
[...] This being said, I am always skeptical about empirical evidence if this is all there is. But then, it seems really clear to me that the basic mechanics of pricing would make stock returns catch up with inflation in the absence of other factors (e.g. speculative mania and subsequent crash, etc), which is your 2nd point. If we accept this non-empirical hypothesis (I know, you're skeptical too), then the strength of the empirical confirmation should convince most people... [...]
OK, good. So you have learned a lot by studying the history of the 20th century. For the benefit of those in the final stages of their retirement planning, we should be able to ask what history tells them about the probability any of the following will happen: [...]
You may have missed the point I made in the middle of my historical discussion. Backtesting alone has to be taken with a lot of suspicion, this is obvious, everybody should know that. Backtesting confirming a perfectly reasonable and intuitive hypothesis, an hypothesis that has no reason to change in the future, now that is something that cannot be discarded so easily.

Now the funny thing is that you didn't hone on the two exceptions I listed (Italy and Spain, oil crisis), while this troubled me last night when double-checking my facts. The oil crisis was squarely an inflation crisis, this wasn't about speculative mania, or world war, or anything like that. And yet stocks took 20+ years to catch up in those two economies. This is troubling for the core hypothesis. And I'm sure we can find smaller economies in South America where inflation went so berserk that the 20 years barrier was reached. For me, the lesson is that the hypothesis ("stocks auto-adjust over the long run") probably needs to be refined to only apply to well diversified economies. Which certainly makes a lot of sense at the non-empirical level. Still, the example of Italy and Spain remain troubling (I remember running the SWR numbers for them based on MSCI data, and man, this is sobering), and squarely speaks in favor of extra diversification (e.g. non-domestic).

PS. I'd be careful if I were you. Domesticated dogs always displayed incredible love for human beings. This doesn't prove they might not revolt one day and put you on a leash, threatening to eat you alive if you don't fetch whatever they throw... Never happened in the past, but... :wink:

EDIT: refining a bit my thinking... Inflation risk is related to the basket of goods one is consuming (directly or indirectly, e.g. manufacturing process). If one's exposure to equities misses a big component of such goods (e.g. Italian companies not having much of a stake in oil products), then the OP's point B might apply, the market-level inflation feedback loop might not be good enough. In other words, one needs to diversify enough to ensure proper coverage of one's basket of goods. That's an interesting point.
Last edited by siamond on Wed Sep 26, 2018 10:49 am, edited 1 time in total.

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Re: Equities as a hedge against inflation

Post by siamond » Wed Sep 26, 2018 8:46 am

Valuethinker wrote:
Wed Sep 26, 2018 2:30 am
https://research-doc.credit-suisse.com/ ... 3R5kq7g%3D

p 15 "don't confuse inflation beating with inflation hedging"
I came back to the 2017 credit suisse investment report itself (instead of the slideset illustrating it that you quoted). There is actually very little analysis of inflation vs. stock returns in this document. I found this quote though:

However, a full examination of inflationary periods in the Yearbook provides a reminder that the term "inflation hedge" can be something of a misnomer. If the term "hedge" is used to portray a price moving in the opposite direction to another, equities do not necessarily fit this bill in a progressively higher inflation world.

I think this is a crucial point. Stock returns are not strongly correlated with inflation. Which means that stock returns do not react quickly to inflation bursts (or sudden deflation) - contrary to TIPS. The feedback loop one can expect will probably take multiple years. And can be drowned in extraneous factors (e.g. speculative mania). This doesn't mean the signal doesn't exist. It means that there is quite some noise around it.

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Re: Equities as a hedge against inflation

Post by Boglegrappler » Wed Sep 26, 2018 12:28 pm

Read Buffetts letter from 2011, pages 17-19

http://www.berkshirehathaway.com/letters/2011ltr.pdf

From the letter, and an important point:
Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.
Those several pages are full of wisdom, imo.

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Re: Equities as a hedge against inflation

Post by hdas » Wed Sep 26, 2018 1:30 pm


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Re: Equities as a hedge against inflation

Post by JoeRetire » Wed Sep 26, 2018 2:10 pm

Ron Scott wrote:
Tue Sep 25, 2018 7:55 pm
I believe equities, like a TSM fund, is a reasonable hedge. But it is just a belief based on theory, not data analysis, and I would not bet my life on it.
So in spite of the three reasons you posted for why you aren't convinced, you still believe equities are a hedge against inflation "based on theory". Uhm, okay.

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Re: Equities as a hedge against inflation

Post by Ron Scott » Wed Sep 26, 2018 3:44 pm

JoeRetire wrote:
Wed Sep 26, 2018 2:10 pm
Ron Scott wrote:
Tue Sep 25, 2018 7:55 pm
I believe equities, like a TSM fund, is a reasonable hedge. But it is just a belief based on theory, not data analysis, and I would not bet my life on it.
So in spite of the three reasons you posted for why you aren't convinced, you still believe equities are a hedge against inflation "based on theory". Uhm, okay.
That's right Joe, and there's no inconsistency if that's what you're implying.

It seems to me that in relatively open economies that aren't burdened with excessing government interference--mostly democratic capitalist economies--corporations are extremely driven to produce returns that at least match inflation in order to attract capital; sort of a primal instinct with them. So I'm betting on the collective drive of businesses to thrive.

That's my theory and as I said it does not rely on data analysis and I would not bet my life on it. I use this theory as a tool to set AA. And I believe in low cost index investing.

Joe, each of us needs to make investment decisions to drive our future retirement years. I do not rely on historical data for the reasons I've stated. Instead of treating the estimation of future returns as an empirical problem I try to approach it with logic and caution, preferring to invest in preparation instead of predictions. As a result I use 0% real to estimate future returns. And I end up with a lower SWR and a higher multiple of expenses for retirement than is typical on this board.

Okay?
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Re: Equities as a hedge against inflation

Post by ThrustVectoring » Wed Sep 26, 2018 3:49 pm

rnitz wrote:
Tue Sep 25, 2018 8:47 pm
I'd be interested in the distinction between stocks performance under moderate inflation (0-4%) vs. high inflation (>5%). My understanding is that stocks are a great inflation hedge when inflation is modest (when you don't care) and is not so good when you have high inflation (aka the 70's type of inflation, when both stocks and bonds got hammered). My knowledge/google-foo is limited, so I'd love input from those who have much better knowledge than I.
I think it's important to pull apart the effect of the supply shocks in the 70's from inflation per se. What happened in the 70's was a massive oil shortage, causing there to be less stuff, so the relatively constant amount of dollars didn't buy as much stuff. In other words, stocks got hammered because the real US economy shrank, which also happened to cause inflation. Of course the US stock market fairs poorly when the US economy suddenly becomes much less productive.

What would this mean in an inflationary period not caused by a supply shock? I don't really know because there isn't a good reason for unexpected inflation in the absence of a supply shock. Maybe the fed doing something really silly, like the failures of Japan's central banking system in their Lost Decade. I don't really know. Equities represent a tiny fraction of the publicly held real economy, so if the real economy is doing okay during an inflationary period then they should be fine. But again, why would there be unexpected inflation if the real economy is doing fine and the central bank isn't printing a ton of money for no reason?

I think the takeaway is to have sufficient exposure to international stocks? Global real economic collapse is less likely than American. At the end of the day, though, if the society you wind up with at retirement is less wealthy in real terms, your fair share of societal wealth is going to be smaller. There's not really a good hedge for that.
Current portfolio: 60% VTI / 40% VXUS

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Re: Equities as a hedge against inflation

Post by JoeRetire » Wed Sep 26, 2018 6:14 pm

Ron Scott wrote:
Wed Sep 26, 2018 3:44 pm
That's right Joe, and there's no inconsistency if that's what you're implying.

It seems to me that in relatively open economies that aren't burdened with excessing government interference--mostly democratic capitalist economies--corporations are extremely driven to produce returns that at least match inflation in order to attract capital; sort of a primal instinct with them. So I'm betting on the collective drive of businesses to thrive.
I understand your primal instinct and collective drive theory.
That's my theory and as I said it does not rely on data analysis and I would not bet my life on it. I use this theory as a tool to set AA. And I believe in low cost index investing.
Got it. You've got your theory and you'll reject any data.
Joe, each of us needs to make investment decisions to drive our future retirement years. I do not rely on historical data for the reasons I've stated. Instead of treating the estimation of future returns as an empirical problem I try to approach it with logic and caution, preferring to invest in preparation instead of predictions. As a result I use 0% real to estimate future returns. And I end up with a lower SWR and a higher multiple of expenses for retirement than is typical on this board.
Got it. Logic and caution. Invest in preparation (whatever that is) and not in predictions. 0% real returns estimate.
Okay?
Of course it's okay. It doesn't have to make sense to me. We are all free to use whatever theories suit our personal instincts.

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Re: Equities as a hedge against inflation

Post by Ron Scott » Wed Sep 26, 2018 7:05 pm

You're getting there!

See my CLARIFICATIONS IN BOLD BELOW
JoeRetire wrote:
Wed Sep 26, 2018 6:14 pm
Ron Scott wrote:
Wed Sep 26, 2018 3:44 pm
That's right Joe, and there's no inconsistency if that's what you're implying.

It seems to me that in relatively open economies that aren't burdened with excessing government interference--mostly democratic capitalist economies--corporations are extremely driven to produce returns that at least match inflation in order to attract capital; sort of a primal instinct with them. So I'm betting on the collective drive of businesses to thrive.
I understand your primal instinct and collective drive theory.
That's my theory and as I said it does not rely on data analysis and I would not bet my life on it. I use this theory as a tool to set AA. And I believe in low cost index investing.
Got it. You've got your theory and you'll reject any data.
I REJECT USING THE ANNUAL RETURNS AND WORST CASE SCENARIOS IN AVAILABLE 20TH CENTURY US HISTORICAL DATA FOR THE PURPOSE OF PREDICTING FUTURE MARKET RETURNS DURING A SPECIFIC 30 YEAR RETIREMENT HORIZON IN THE 21ST CENTURY.
Joe, each of us needs to make investment decisions to drive our future retirement years. I do not rely on historical data for the reasons I've stated. Instead of treating the estimation of future returns as an empirical problem I try to approach it with logic and caution, preferring to invest in preparation instead of predictions. As a result I use 0% real to estimate future returns. And I end up with a lower SWR and a higher multiple of expenses for retirement than is typical on this board.
Got it. Logic and caution. Invest in preparation (whatever that is).
"INVESTING IN PREPARATION" MEANS TAKING ACTIVE AND CONSERVATIVE MEASURES, LIKE SAVING MORE AND PLANNING TO SPEND LESS. MAKING YOUR PORTFOLIO LESS VULNERABLE TO FAILURE AND MORE ROBUST.
Retirement is a game best played by those prepared for more volatility in the future than has been seen in the past. The solution is not to predict investment losses but to prepare for them.

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Re: Equities as a hedge against inflation

Post by Valuethinker » Thu Sep 27, 2018 9:03 am

ThrustVectoring wrote:
Wed Sep 26, 2018 3:49 pm
rnitz wrote:
Tue Sep 25, 2018 8:47 pm
I'd be interested in the distinction between stocks performance under moderate inflation (0-4%) vs. high inflation (>5%). My understanding is that stocks are a great inflation hedge when inflation is modest (when you don't care) and is not so good when you have high inflation (aka the 70's type of inflation, when both stocks and bonds got hammered). My knowledge/google-foo is limited, so I'd love input from those who have much better knowledge than I.
I think it's important to pull apart the effect of the supply shocks in the 70's from inflation per se. What happened in the 70's was a massive oil shortage, causing there to be less stuff, so the relatively constant amount of dollars didn't buy as much stuff. In other words, stocks got hammered because the real US economy shrank, which also happened to cause inflation. Of course the US stock market fairs poorly when the US economy suddenly becomes much less productive.
However you could have had that shock without inflation. What would have happened is that the relative price of oil and gas would have risen, and other prices would have fallen as consumers spent more on their energy needs, and less on other stuff.

So I agree there was a supply shock. But it was in the context of the highest peacetime inflation the US had ever experienced, I believe.

The supply price shock got the inflationary spiral going, but it was the combination of overly loose monetary policy and the wage-price spiral which then caused inflation to be sustained.
What would this mean in an inflationary period not caused by a supply shock? I don't really know because there isn't a good reason for unexpected inflation in the absence of a supply shock. Maybe the fed doing something really silly, like the failures of Japan's central banking system in their Lost Decade. I don't really know. Equities represent a tiny fraction of the publicly held real economy, so if the real economy is doing okay during an inflationary period then they should be fine. But again, why would there be unexpected inflation if the real economy is doing fine and the central bank isn't printing a ton of money for no reason?

I think the takeaway is to have sufficient exposure to international stocks? Global real economic collapse is less likely than American. At the end of the day, though, if the society you wind up with at retirement is less wealthy in real terms, your fair share of societal wealth is going to be smaller. There's not really a good hedge for that.
Unfortunately an American collapse is highly likely to take down the rest of the world economy / financial system with it. If China collapsed now it would probably mostly just affect growth - the financial consequences should be firewalled (they might not be, and it wouldn't feel like they were if you live in Toronto or Vancouver, but they should be).

But America? The Rest of the World is too interlinked with the world's largest or second largest economy and definitely its largest financial system.

The argument for an American holding the global equity portfolio is simply that it diversifies her risk across more companies, more economies (to an extent) and more sectors. Why hold P&G but not Nestle and Unilever? Why hold Exxon but not BP and Shell? If you want to hold mining companies then you want London (where 3 of the world's top mining companies are listed), Canada, Australia and South Africa (and Brasil, for Vale).

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Re: Equities as a hedge against inflation

Post by JoeRetire » Sat Sep 29, 2018 12:43 pm

Ron Scott wrote:
Wed Sep 26, 2018 7:05 pm
"INVESTING IN PREPARATION" MEANS TAKING ACTIVE AND CONSERVATIVE MEASURES, LIKE SAVING MORE AND PLANNING TO SPEND LESS. MAKING YOUR PORTFOLIO LESS VULNERABLE TO FAILURE AND MORE ROBUST.
OKAY WHATEVER. GOOD LUCK.

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