Research Themes
Jun 2021

Inflation, equities and the ghost of the 1970s

Inflation is on the rise almost everywhere. US CPI hit its highest level since 2008 in April driven in part by economic reopening and supply chain disruptions. Some are even raising the specter of the 1970s and 1980s when inflation averaged 8%-12% across the globe. Against this backdrop, Citi’s Robert Buckland poses an interesting question: Do equities offer a hedge against inflation?
Citi Global Insights

So are equities a good inflation hedge? History suggests the answer is yes. For example, US EPS growth has generally matched inflation, even in the 70s and 80s.

US CPI Inflation YoY (%)

Inflation By Decade



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Source: Citi Research, Datastream

Source: Citi Research, Global Financial Data


The one time US EPS lagged was in the lower inflation 2000s as seen in the next chart.

US EPS Growth And Inflation By Decade


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Source: Citi Research, Global Financial Data, MSCI


That’s not to say equity returns have always kept up with inflation. The next chart shows real returns (nominal minus inflation) by decade for major stock markets. They were negative in the 1970s and 2000s but for very different reasons. In the 1970s high inflation was the problem. In the 2000s, valuations were already high at the start of the decade. This combined with the global financial crisis towards the end of the decade proved fatal, despite lower inflation.

   Real Stock Market Returns (Annualized, Nominal minus Inflation)

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Source: Citi Research, Global Financial Data, MSCI


So it’s clear that at times in the past, equities have been a decent hedge against inflation. They are a real asset class, where corporate revenues offer positive exposure to rising consumer prices. But double-digit inflation and interest rates, as seen in the 1970s, proved too much to beat.

But Robert and team wonder if that’s an overly simplistic interpretation. What about the role of other factors like valuation, monetary policy and balance sheet in driving future returns?


Rates are different 

If history is any guide, absolute equity returns over the rest of the 2020s will be more a function of current valuation than future inflation. One problem with relying on what happened in the past as a guide to what happens next, in this case, is you can’t assume interest rates will track inflation higher like they did in the past. Equities performed poorly in the 1970s because higher inflation led to higher rates and an associated de-rating of stocks. In addition, tight monetary policy tipped economies into recession, which hit corporate profitability. Given this combination, it is not entirely surprising equities struggled.

It might be different this time though. Even as inflation expectations are rising, rates are not following- partly because central banks are largely suggesting they won’t hike even if inflation picks up further.

Central bank dovishness in part reflects a belief that the current inflationary upturn is temporary but also a willingness to let economies run hotter than in the past.

What does that mean for equities? Bulls have drawn parallels with the 1950s, when real rates were kept low even as inflation and economies picked up. This helped reduce high debt/GDP rations built up in WW2. Alternatively, much of that could be put down to cheap starting valuations.

In summary, the key issue for equities might not be rising inflation, but more what central banks choose to do about it. Right now, they are choosing to do nothing.


High debt

Debt levels look higher than in previous inflation cycles. Citi’s Matt King recently highlighted that US borrowing is back at WW2 levels and even higher in Japan. That makes economies even more sensitive to rate increases, further explaining the reluctance of central banks to tighten, even if inflation picks up further.


US Debt (as % of GDP)

Japan Debt (as % of GDP)



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Source: Citi Research, BIS

Source: Citi Research, BIS

Perhaps counterintuitively, current record high US and Japanese debt levels have been accompanied by record lows in rates. By contrast, the highest levels of US interest rates (in the early 80s) came when US debt/GDP levels were around their post-war lows.

Sectors and styles

Consensus views suggest commodity stocks provide the best hedge against higher inflation. This is heavily influenced by the 1970s, when regular oil crises drew the markets down and energy stocks up. The latest upturn in inflation has also been accompanied by higher oil process. But the natural inflation hedging qualities of oil stocks have been constrained by ESG concerns.

Whatever your view on whether 70s style inflation is coming back, it looks inevitable that inflation will be one of the primary factors driving global sentiment for some time to come. For more on this subject see the full report here Global Equity Strategy - Are Equities An Inflation Hedge?

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.

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