Unexpected Inflation and Real Stock Returns

Abstract

We review the relationship between inflation and real stock returns. Stocks tend to outperform inflation over long horizons, and recent data show a weakened correlation between inflation and real returns. However, controlling for monetary shocks in the post 2008 period, expected real stock returns are significantly lower during periods of higher than average inflation. We find that a one standard deviation increase in unexpected inflation can lower expected returns by about 1% per year over a 5 year horizon. Investors concerned with inflation should consider the potential for lower expected stock returns in their plans.

Keywords: Unexpected inflation, real stock returns

JEL Classification: G11, G12, E44