Equities and Inflation: Inflation Hedging Capabilities of Individual Equities

Abstract

Inflation is once again an incredibly important factor for investors, following the energy crisis and extensive increase of the money supply in the US during COVID-19, which resulted in inflation levels not seen in decades. The thesis considers the problem of inflation hedging faced by investors, by examining how to hedge inflation, namely with the use of individual equities from the S&P 500. The analysis consists of an in-sample and out-of-sample analysis, in which quintile portfolios are constructed based on the inflation beta of individual equities in the period 1990-2022. The methodology is extended to include an insight into the portfolios in different inflationary states. Empirical findings show that the equity market on aggregate is a poor inflation hedge, contradicting the Fisher Effect, but conversely it finds that some individual equities exhibit a positive relationship with inflation. The findings of the thesis show that while it is possible on an ex post basis to construct portfolios of individual equities that hedges inflation, it is harder to predict which equities will be good inflation hedging in the future and therefore harder to construct portfolios of individual equities that hedges inflation, on an ex ante basis. The results are improved when only including significant inflation betas and alternative estimation methods can be argued to yield more robust results. Additionally, the Energy and Information Technology sector are found to have good inflation hedging capabilities, albeit the inflation hedging capabilities of the Information Technology sector seem to have shifted since they have performed poorly in the inflationary period 2021-2022, most likely due to structural changes within the sector. Growth equities are found to have a positive relationship with inflation which is argued to be due to their pricing power.