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Are stocks going to continue their inflation-adjusted slide?



January 30, 2010 – Comments (1) | RELATED TICKERS: SLW , MVG.DL , JAGGD

All signs point to yes.

Sorry, folks. It just doesn't look good. Periods of huge quantitative easing have always (and necessarily) been followed by by periods of high inflation. And periods of high inflation are when stocks put out their worst inflation-adjusted returns. Check out moneychimp's historical stock market data with inflation calculator:

moneychimp's historical stock market data with inflation calculator

Now check out the period between 1973 and 1981, with and without inflation adjustment. For those too lazy (or too enrapt by my writing) to click on links, I'll tell you: 5.08% annualized return for stocks between Jan 1, 1973 and Dec 31, 1981. Without inflation, that is. Unfortunately, there is this rascally little thing about rising prices: you have to pay them or do without. So to get an idea of reality-based results, we have to figure in the inflation. Run it again with inflation baked in, and you get (ugh!) -3.79%! For every dollar you invested in stocks in 1973, your stock sales in 1981 would have been able to buy you 71 cents' worth of goods and services. Let's keep plugging in years to see when you would get to break even:

1982: 82c

1983: 98c

1984: 1.00 (but that's actually -0.02% CAGR, so let's wait another year, shall we?)

1985: 1.27 (yay!!)

So if you bought stocks to hold at market open in the first trading day of 1973, you lost 20% of your purchasing power in the first year, and you didn't get back to even until 1983, and if you only checked in on your stocks every New Year's Eve, you didn't show an inflation-adjusted profit until Dec. 31, 1985. Of course, if you had bought $10,000 of stock in 1973 and sold it in 1985, the IRS would have taxed you on your alleged $22,700 "capital gain." Let's say, for easy math, that the cap gains rate for you was 10%. That leaves you with $20,430 - or pretty much the same amount of purchasing power you had when you started thirteen years before.

Still, it could be worse: you could have invested in the overheated stock market in Jan 1929, and not seen a year-end, inflation-adjusted profit until 1943, fifteen years later. (Of course, the tax would have been lighter, after the deflation under Hoover and the exclusion rules for cap gains). 

Still, if you hold long enough, buying and holding stocks works in the long run, right? And there's no way you can predict the future, right? And stocks are still the best way to beat high inflation, right?

Well, no. If you had (illegally) bought gold on Jan. 4, 1973 for $64.90/oz, and sold it at 1985's lowest price, $284.25/oz, and paid 15% taxes on it (instead of 10% for the lesser gains on your stocks), you would have had an inflation-adjusted, after tax gain of more than $29/oz, aka ~45%, aka $4,485 more purchasing power for every $10,000 you plunked down on gold in 1973. (By the way, $284.25/oz is the lowest gold price in the entire decade of the 1980's.) Considering that the very smartest gold sellers got out of gold in 1980 for >$800/oz, you could have afforded to be a little late leaving the party. Like five years and a 66% drop too late. If you had waited until it was legal to buy gold, you would have paid over $100/oz and had to sell at something higher than the worst price of the 1980's to make your inflation-adjusted, after-tax, market-trouncing profit, but it still would have been better for you than buying stocks in the early to mid-1970's.

So the bad news is that, historically, stocks lose (or barely maintain) purchasing power and show taxable "gains" during periods of ludicrous quantitative easing. The good news is that it's legal to buy gold now, and gold not only maintains its purchasing power in times of inflation, but increases enough to pay your capital gains taxes on it and still have a little left over to invest in undervalued assets. (Like, for instance, stocks that have barely matched inflation for about fifteen years.) What is more, it doesn't take a genius market-timer to make money on gold during an inflation nightmare. It just takes knowing that an inflation nightmare is what is going on. And knowing that gold, not stocks, is the way to beat inflation. And now you know.

As an aside: if you had bought silver in Jan 1973 for a little more than $2/oz, and then sold it 66% off its 1980 high, you would have made about 170% inflation-adjusted, after-tax profit, but that was a much narrower window of opportunity, i.e months instead of the entire decade of the 1980's. Most silver trades from the early 70's to the early 80's would have been less like having owned gold and more like owning stocks. (If you want to indulge an avaricious fantasy, though, imagine buying 5000oz of silver for $2/oz [i.e. $10,000] in 1973 and selling it for $48/oz in 1980, for a before-tax notional profit of $280,000.)

Disclosure: I have some gold and silver for investment purposes, as well as Silver Wheaton (SLW) stock, positive interest with Mag Silver (MVG) stock by being short puts, and am short one put in Jaguar Mining (JAG).

1 Comments – Post Your Own

#1) On January 31, 2010 at 4:02 PM, Teacherman1 (< 20) wrote:

Your reference to illegally buying gold in 1973, should refer to bullion. Krugerrands, which were legal tender, were available from 1967, and it was legal for individuals in the U.S. to own them. I know because I did. They were even less than your starting price, so are up even more.

That's my fall back, but I still like stocks. Just not all of them.

Have a nice day. 

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