The New Normal And Asset Class Cycles

November 20, 2009


Figure 2 groups economic factors in the top half of the table (blue highlight), and the investment performance of stocks and bonds in the bottom half of the table (green highlight). Median measures are employed for economic factors, while annual compound total returns and income yields are shown for investments.

Economic and investment samples employ 120 continuous years from 1890 through October 2009 to establish baseline standards for comparisons to our Stagflation Period Sample (28 chained calendar years, Figure 2, column 3). Our sample includes 28 calendar years out of the 120 years since 1890, which were stagflation years (a 23.3 percent frequency).

Investment performance chains 10 discontinuous stagflation periods into a single 28-year continuous holding period to arrive at total returns (Appendix, Figure A). Yields represent the averaged yields during the 28-year sample period.



Figure 3 displays performance results obtained from chaining the investment returns of stocks, gold and three bond categories. For example, $1,000 was invested into each investment at the start of 1909 through 1911, the first stagflation episode. By the end of 1911, there was $1,158, $1,000, $1,088, $1,122 and $1,092 invested in stocks (S&P 500 Index), gold, U.S. 10-Year Treasury Notes (10 Yr TSY), AAA-rated corporate bonds (Corp Bonds) and state municipal bonds (Muni Bonds), respectively. These sums were reinvested back into each category at the start of 1919. They remained invested until the end of 1921, the end of our second stagflation episode. This process was repeated for the remaining eight episodes.

There were wide variances in the duration and severity of each stagflation period. Gold and corporate bonds performed best. Equities were last and at their worst when inflation exceeded 6 percent. Bonds did best after stagflation gave way to inflations below 2 percent. Gold performed fairly well in all episodes, with the exception being the 1948 deflation period. Gold prices were fixed prior to April 1933, when our nation revalued its dollar/gold exchange value.



For the most part, gold bested stocks/bonds during past stagflations. All episodes begin with high inflation and end with declining inflation, leading to good corporate bond performance. Corporate bonds did best when inflation declined because the resulting rise in RGDP mitigated default risks. Treasury returns beat all assets when declines in inflation rates and CPI deflations are associated with debt and asset deflations.

Municipal bonds were the worst performers because stagflation causes state tax revenues to decline. The laden default risks inherent in munis are exposed (Figure 4). Past stagflation periods raised investor concerns about each state’s inability to honor its debts (unlike the federal government, which can print money to avoid default); consequently, munis were repriced for higher default risk.



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