Inflation and equities: A worry or a boon?


John Leonard

  • Senior Managing Director, Global Head of Equities
  • Read bio

Inflation, and the fact that it has ratcheted up in recent months, would ordinarily be a source of worry for equity investors. Generally speaking, high inflation is often seen as a negative for stocks, in part because some investors believe that lower expected earnings growth can put downward pressure on stock prices.

However, this era of COVID-19 is no ordinary time. In our view, the pandemic is largely responsible for many of the current economic conditions and problems ranging from the global supply chain to the US labor markets to inflation. So, like the Federal Reserve, we see the recent uptick in both headline and core inflation as transitory and not permanent. And, although the US Consumer Price Index (CPI) reached 5.4% in both June and July 2021 after averaging below 2% for the last two years (source: US Bureau of Labor Statistics), we believe talk of a return to the high, 8%-10% inflation of the 1970s and 1980s is overblown.

Headline and core inflation since the 1960s

Source: US Bureau of Labor Statistics.

Higher prices may offer opportunities

Still, just because something is unlikely doesn’t mean that it can’t influence the thinking of equity market participants. If a substantial minority of investors believe that inflation is likely to become more of a problem in the future, they may start bidding up the prices of stocks that are expected to be less sensitive to inflationary pressures – in other words, whatever they view as potential hedges against inflation. These may include commodity producers and associated industries, as well as banks and homebuilders. Conversely, some companies, such as consumer discretionary or technology, may be expected to do badly in inflationary conditions – those prices may go down.

This can create an opportunity for momentum investors in the first instance of inflation-hedged sectors, and for value investors in the second. For investment teams that are either growth or value, that means, in theory, both can do well if they make the right sector choices. Either way, active equity managers may be able to take advantage of this.

Active management and inflation hedges

Active equity managers have the potential to outperform in a wide range of market contexts. Conditions of rising inflation may present opportunities for active managers who have the ability to make strategic choices, such as focusing on sectors that may react favorably or poorly to inflationary conditions.

In recent months, some market participants have been looking back at conditions in the 1970s and 1980s to see how different sectors behaved during that era. We think that the world has changed so much in the past four decades that such efforts are likely to be of rather limited usefulness. Instead, we prefer to look at how equities have behaved during the period when inflation rates have generally been low in numerical terms, but when inflation has sometimes been rising and sometimes falling. As the graph above shows, since the start of 1990 inflation rates have rarely gone above 3% for a sustained period. Focusing on these later decades, in our view, is more likely to reflect how financial markets have rewarded or punished different sectors as inflationary conditions have evolved.

Moreover, we think that dividing the world into “rising inflation” and “falling inflation” is too simplistic. Rather, we consider that investors are smart enough to distinguish between inflation that is rising, flat, or falling. We believe that if trailing 12-month inflation is not more than 0.3% above or below its level from a year ago, then investors will consider that inflation is roughly “flat” in the sense that prices are neither accelerating nor decelerating.

Over the period from January 1990 onward, using these definitions, inflation was “flat” in about 43% of months, “falling” in 31% of months, and with the remaining 26% of months considered “rising.” Splitting up the historical experience in this way should help to clarify how markets reward or punish different sectors according to prevailing economic conditions. The following chart summarizes our findings for the Russell 3000® Index, and reports the median monthly active total return for each sector, based on core inflation data from the Bureau of Labor Statistics as of September 2021. The analysis incorporates a one-month lag to reduce the likelihood that look-ahead bias is affecting the analysis. We would note that this is solely an examination of past reaction to relative inflationary conditions and not a predictor of future performance.

Equity sectors (Russell 3000 Index) performance in various inflationary periods

Sources: inflation data from US Bureau of Labor Statistics; Russell 3000 sector data from FTSE Russell via FactSet.

The sector responses to different inflation conditions contain a few surprises. Moderate increases in inflation are often associated with an expanding economy, which would presumably make consumers feel more confident about the near-term outlook, and could explain why the consumer discretionary and consumer staples sectors have been relatively strong performers. Similarly, economic expansion is likely to be favorable for credit providers, and this could explain why the financials sector has also been among the beneficiaries from such conditions. Conversely, rising inflation seems to have been viewed negatively for information technology (IT), at least compared to this sector’s significantly strong performance when inflation has been roughly flat. Finally, it seems clear that both energy and materials have not been very effective hedges against inflation, although both sectors have also generally delivered disappointing returns when inflation has been approximately flat.

Inflation not necessarily bad for all

If higher inflation or the threat of it materializes, many equity prices could react unfavorably. But it does not necessarily mean bad outcomes for all. By focusing on certain sectors, some investors who are more oriented to short-term outperformance have the potential to benefit by jumping on the bandwagon. Meanwhile, those investors seeking long-term gains may be able to pick up bargains. For both groups, paying attention to inflation may potentially create investment opportunities, with active management the potential catalyst.


This market commentary has been prepared for general informational purposes by the author, who is part of Macquarie Asset Management (MAM), the asset management business of Macquarie Group (Macquarie), and is not a product of the Macquarie Research Department. This market commentary reflects the views of the author and statements in it may differ from the views of others in MAM or of other Macquarie divisions or groups, including Macquarie Research. This market commentary has not been prepared to comply with requirements designed to promote the independence of investment research and is accordingly not subject to any prohibition on dealing ahead of the dissemination of investment research.

Nothing in this market commentary shall be construed as a solicitation to buy or sell any security or other product, or to engage in or refrain from engaging in any transaction. Macquarie conducts a global full-service, integrated investment banking, asset management, and brokerage business. Macquarie may do, and seek to do, business with any of the companies covered in this market commentary. Macquarie has investment banking and other business relationships with a significant number of companies, which may include companies that are discussed in this commentary, and may have positions in financial instruments or other financial interests in the subject matter of this market commentary. As a result, investors should be aware that Macquarie may have a conflict of interest that could affect the objectivity of this market commentary. In preparing this market commentary, we did not take into account the investment objectives, financial situation or needs of any particular client. You should not make an investment decision on the basis of this market commentary. Before making an investment decision you need to consider, with or without the assistance of an adviser, whether the investment is appropriate in light of your particular investment needs, objectives, and financial circumstances.

Macquarie salespeople, traders, and other professionals may provide oral or written market commentary, analysis, trading strategies, or research products to Macquarie’s clients that reflect opinions which are different from or contrary to the opinions expressed in this market commentary. Macquarie’s asset management business (including MAM), principal trading desks, and investing businesses may make investment decisions that are inconsistent with the views expressed in this commentary. There are risks involved in investing. The price of securities and other financial products can and does fluctuate, and an individual security or financial product may even become valueless. International investors are reminded of the additional risks inherent in international investments, such as currency fluctuations and international or local financial, market, economic, tax, or regulatory conditions, which may adversely affect the value of the investment. This market commentary is based on information obtained from sources believed to be reliable, but we do not make any representation or warranty that it is accurate, complete, or up to date. We accept no obligation to correct or update the information or opinions in this market commentary. Opinions, information, and data in this market commentary are as of the date indicated on the cover and subject to change without notice. No member of the Macquarie Group accepts any liability whatsoever for any direct, indirect, consequential, or other loss arising from any use of this market commentary and/or further communication in relation to this market commentary. Some of the data in this market commentary may be sourced from information and materials published by government or industry bodies or agencies; however, this market commentary is neither endorsed nor certified by any such bodies or agencies. This market commentary does not constitute legal, tax accounting, or investment advice.

Recipients should independently evaluate any specific investment in consultation with their legal, tax, accounting, and investment advisors. Past performance is not indicative of future results.

This market commentary may include forward-looking statements, forecasts, estimates, projections, opinions, and investment theses, which may be identified by the use of terminology such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “can,” “plan,” “will,” “would,” “should,” “seek,” “project,” “continue,” “target,” and similar expressions. No representation is made or will be made that any forward-looking statements will be achieved or will prove to be correct or that any assumptions on which such statements may be based are reasonable. A number of factors could cause actual future results and operations to vary materially and adversely from the forward-looking statements. Qualitative statements regarding political, regulatory, market and economic environments and opportunities are based on the author’s opinion, belief, and judgment.


Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.

Diversification may not protect against market risk.

Equity securities are subject to price fluctuation and possible loss of principal. Investments in small and/or medium-sized companies typically exhibit greater risk and higher volatility than larger, more established companies. International investments entail risks including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations. Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility, lower trading volume, and higher risk of market closures. In many emerging markets, there is substantially less publicly available information and the available information may be incomplete or misleading. Legal claims are generally more difficult to pursue.

A sector is a segment of the economy that includes companies providing the same types of products or services. Although companies within a sector tend to be reasonably consistent in their fundamentals, these fundamentals may differ substantially from one sector to another. For example, some sectors are cyclical, rising and falling with changes in the economy while others are defensive, maintaining their strength despite economic ups and downs.

Inflation is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.

The disruptions caused by natural disasters, pandemics, or similar events could prevent the strategies from executing advantageous investment decisions in a timely manner and could negatively impact the strategies’ ability to achieve its investment objective and the value of the strategies’ investments.

The US Consumer Price Index (CPI) is a measure of inflation that is calculated by the US Department of Labor, representing changes in prices of all goods and services purchased for consumption by urban households.

The Russell 3000 Index measures the performance of the largest 3,000 US companies, representing approximately 98% of the investable US equity market.

Frank Russell Company is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company.

Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.

All charts are for illustrative purposes only. Charts have been prepared by Macquarie Asset Management unless otherwise noted.

Economic trend information is sourced from Bloomberg unless otherwise noted.