One needs to choose investments options that have the potential of giving a much higher returns to offset inflationary decrease in purchasing power and hence savings.
To understand this, let’s have a look at what Inflation means, and how it’s linkage to equity markets.
Warren Buffet described Inflation best as, “gravity on asset values – The higher the rate, the greater the downward pull”.
In layman’s terms, Inflation is the economic principle behind increasing product prices, and thus, reduced purchasing power. Remember when Onions went up to Rs. 120+/Kg or Zimbabwe currency was used as confetti –> Now you know why.
As can be seen above, for any of your investment goals to materialize in the future, it is important, that sum invested out-performs inflation rate at the time.
How have the Indian Markets fared against the country’s inflation rates?
Indian markets, in their entire history have out-shined inflation. The graph below shows the same:
As can been seen above, in 80’s and 90’s, before India became the investment avenue for the world, it was overwhelming it’s counterpart inflation rate at the time, and in some fashion! Well, the narrative has not changed even today, as equity markets continue matching and delivering investor expectations.
Average inflation in the last 4 decades comes in at 7.9% vs the returns from indices coming in at 15.7% –> Nearly 2X!!
Closing Comment
In principle, equities always act as inflation hedge! Albeit, with different margins, sometime cushioned, and, sometimes tough. Increasing inflation rates means increasing interest rates, which leads to higher borrowing costs for businesses. This naturally puts downward pressure on product margins, affecting company cash flows.
It is in these interim times, Howard Marks’s quote come to mind: “Everything is cyclical. Nothing goes in one direction forever”.
As the interest rate cycle changes, business pick up again, and the same sentiment is reflected in the equity markets.
With RBI’s target inflation range of between (4 +/- 2)%, and India acting as a promise land for global and local borders, Indian equities can draw comfort from this unparalleled confidence!
The difference between an intelligent and a foolish investor is the perception of inflation in their investment decisions.
