What if Inflation is Here to Stay?

What if Inflation is Here to Stay?

Heartland Advisors Value Investing S&P 600 Quintile Chart

Source: Ned Davis Research, Monthly data from 1/31/1919 - 10/31/2021. Copyright 2021 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

While consumers continue to face sticker shock when filling up their gas tanks, buying groceries or even paying rent, the debate among economists and investors continues to focus on whether recent spikes in prices are temporary. Judging by treasuries, where real yields on short- and long-term bills are stuck in negative territory, as shown in the chart, the consensus remains that the surge in prices is transitory.

But what if the predictive prowess of treasuries is missing the mark? It wouldn’t be without precedent. From roughly 1975 through 1979 consumer prices exploded while the treasury markets failed to keep pace with the stubborn nature of escalating costs. The result was negative inflation-adjusted yields for U.S. government-issued debt, while equities averaged double-digit annual gains. The most striking performance for stocks was in small cap value, which posted annualized returns of over 36% during the stretch, almost triple the returns for large growth stocks.* 

With value stocks, investors generally expect that earnings growth rates will be stable, while in periods of low inflation, investors exhibit a willingness to pay up for growth stocks on expectations of significant earnings expansion in the coming years. However, when inflation is high, future earnings are worth less in today’s dollars as purchasing power is eroded. 

Whether inflation is transitory or long-lived, we believe the current complex economic backdrop offers ample opportunities for individual companies to distinguish themselves in the eyes of investors. This dynamic should benefit active investors who focus on fundamentals and identifying catalysts for positive change. If cost pressures persist, the benefit could be even more pronounced among attractively valued businesses.

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Will Nasgovitz

CEO and Portfolio Manager


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*US Small Cap Value data is calculated using CRSP Data.

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