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Fund Spy

Stocks and Inflation: Who's Winning the Race?

We still think stocks are the best place to be over the long haul.

Looks like fund investors have had it with this market. As my colleague Karen Dolan detailed in a recent article, mutual fund outflows recorded their biggest monthly drains in September and October since Morningstar Market Intelligence data started tracking redemptions in January 2000. If past patterns of behavior are any indication, then there's a good chance investors are bailing at the worst possible time. Yet, one must say the angst is understandable. Since equities hit a new peak last October, a steady decline has turned into a rout the last couple of months. The sell-off is now deep enough to test the conviction of even the hardiest buy-and-hold investors. Even those who have been in stocks for a considerably long time now find their savings haven't kept pace with inflation.

This is a difficult time indeed to keep faith in stocks as an effective hedge against inflation. However, there is more to the relationship between stock returns and inflation than what we're seeing now. Let's look at the range of academic opinion on this subject, and evaluate the case for holding on to stocks for the long run from the standpoint of inflation.

The Lost Decade?
It's not over yet, but thus far the first decade of this century has proved very lean for stocks. As the following table shows, the Morningstar U.S. Market Index, which is a broad benchmark of domestic stocks, has declined at a 2% annualized clip since the start of 2000 through Nov. 3, 2008. Meanwhile, inflation, as tracked by the U.S. consumer price index (CPI), has paced a bit more than 3% annually in this decade. Forget about keeping up, stock investors have steadily lost ground to inflation. By comparison, competing asset classes such as bonds in general, inflation-protected Treasuries, and especially commodities have proved far superior. What happened? Weren't stocks supposed to be among the best stores of value in the long run?