Stocks represent businesses that can raise prices as inflation rises, boosting revenues and earnings. Most bonds pay fixed coupons that lose value as inflation erodes purchasing power. You can think of stocks as rubber bands—their cash flows can stretch with inflation if the company has pricing power. Bonds are more like hard plastic—their cash flows are inflexible, so inflation erodes purchasing power.
Why Stocks Can Benefit
Pricing power matters: Firms with strong brands, scarce assets, or must-have services can increase prices. If costs are well-managed, this translates into higher revenue.
Asset values rise: When inflation increases replacement costs for assets, equity in these assets often gains value.
This is why, as a long-term hedge, historically, diversified stocks have often outpaced inflation over time. This helps protect and grow real wealth.
Why It’s Not Automatic
Not every company can reprice; price increases are especially challenging for companies with weak brands. High competition, regulatory constraints, or fixed contracts can also make it challenging.
Costs can rise first: Wages, materials, and financing costs may increase faster than selling prices, squeezing margins.
Valuation headwind: Rising inflation is often accompanied by higher interest rates, which can negatively impact valuation. Higher rates reduce present values and compress price-to-earnings ratios.
Stagflation risk: High inflation combined with slow growth can reduce sales volumes and increase costs—a challenging mix for many companies.
Short-Term vs Long-Term
In the short term, markets may show volatility as central banks raise rates. Investors reprice risk, compressing multiples and increasing volatility.
Over longer periods, however, businesses with pricing power and healthy balance sheets can adapt. They can grow nominal earnings and dividends.
Who Tends to Win (and lose)
Better-positioned sectors include commodities and energy (which move with inflation), strong consumer brands with pricing power, asset- or toll-like businesses (such as infrastructure with usage-linked fees), and certain real asset owners (REITs with escalator clauses).
Often more exposed:
More exposed are long-duration growth businesses, such as technology or biotech, which have future-oriented profits and are sensitive to discount rates. Regulated utilities with capped returns and contractors unable to pass on cost spikes also face risks.
Graham’s Nuance
Graham saw stocks as a ‘fair protection’ against inflation, not a guarantee. Stocks can lag when rates and costs rise more quickly than earnings.
Overall, inflation tends to favour equities over bonds, as many businesses can gradually raise prices and grow their cash flows, while bond coupons remain fixed. That advantage, however, depends on owning companies with genuine pricing power, reasonable valuations, and a balanced approach to risk.