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Individual Common Stocks as Inflation Hedges*

Published online by Cambridge University Press:  19 October 2009

Glenn L. Johnson ,
Frank K. Reilly  and
Ralph E. Smith
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Extract

The results of this study indicate that the individual common stocks in the Dow-Jones. Industrial Average were not consistent inflation hedges. Assuming an 8.2 percent normal required rate of return, none of the common stocks was a complete inflation hedge during all three recent inflationary periods tested. Even assuming a zero normal required rate of return á la traditional investment theory, only six (20 percent) of the thirty common stocks sampled were inflation hedges during all three inflationary periods.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 6 , Issue 3 , June 1971 , pp. 1015 - 1024
Copyright
Copyright © School of Business Administration, University of Washington 1971

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References

1 For example, see “Common Stocks Can Hedge Inflation—If You Pick Right,” Business Week (February 24, 1951), pp. 114–115; Graham, Benjamin, Dodd, David L., and Cottle, Sidney, Security Analysis, 4th ed. (New York: McGraw-Hill Book Company, Inc., 1962), pp. 4–8Google Scholar; Hayes, Douglas A., Investments: Analysis and Management, 2nd ed. (New York: MacMillan Company, 1966), pp. 440–445Google Scholar; Dougall, Herbert E., Investments, 8th ed. (Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 1968), pp. 345–347Google Scholar; and Clendenin, John C., Introduction to Investments, 4th ed. (New York: McGraw-Hill Book Company, Inc., 1964), pp. 96–98Google Scholar.

2 Johnson, Glenn L., “A Critical Analysis of Common Stocks as Inflation Hedges,” Mississippi Valley Journal of Business and Economics, III (Spring 1968), pp. 50–62Google Scholar.

3 For a recent study of stock market averages that does consider the normal required return and classifies periods of inflation, see Reilly, Frank K., Johnson, Glenn L., and Smith, Ralph E., “Inflation, Inflation Hedges and Common Stocks,” Financial Analysts Journal, XXVI (January–February 1970), pp. 104–110CrossRefGoogle Scholar.

4 For a formulation of these rates, see Johnson, Glenn L., “Professor Johnson's Hedges: A Reply.” Mississippi Valley Journal of Business and Economics, V (Fall 1969), pp. 85–89Google Scholar.

5 Because the common stock data on the Standard & Poor's COMPUSTAT Tapes were only available over the 1949–1968 time period, the analysis of inflationary periods was limited to the same overall time period.

6 For example, in an interview in the U.S. News & World Report (April 28, 1969), p. 48, Paul W. McCracken, Chairman of President Nixon's Council of Economic Advisors, states that a 1.25 percent increase in the price level is “probably not much more than the unmeasured improvement in the quality of products” and such a rate of increase “was really a fairly stable price.”

7 For a specification of inflationary and noninflationary periods! for the period September 30, 1937, through December 31, 1968, see Reilly, Johnson, and Smith, “Inflation, Inflation Hedges, and … ”

8 The actual rates were calculated by using a computer algorithm developed by Professor Fisher and subsequently modified by Professor Kaplan. See Fisher, Lawrence, “An Algorithm for Finding Exact Rates of Return,” Journal of Business, XXXIX (January Supplement, 1966), pp. 111–118Google Scholar, and Kaplan, Seymour, “Computer Algorithms for Finding Exact Rates of Return,” Journal of Business, XL (October 1967), pp. 389–392Google Scholar.

9 Fisher, Lawrence, “Outcomes for ‘Random’ Investments in Common Stocks Listed on the New York Stock Exchange,” Journal of Business, XXXVIII (April 1965), p. 153Google Scholar.

10 Cohen, Jerome B. and Zinbarg, Edward D., Investment Analysis and Portfolio Management (Homewood, Illinois: Richard D. Irwin, Inc., 1967), pp. 231–232.Google Scholar