What the 1970s Can Teach Us About Inflation, Stocks, Bonds and Gold

Inflation can be a strange thing for investors.

We often hear that stocks are a good hedge against inflation. We also hear that bonds provide safety. And in recent years, many investors have wondered whether gold belongs in a portfolio as protection against rising prices.

What Actually Happens When Inflation Gets Really Bad?

One of the best places to look is the United States in the 1970s and early 1980s. It was a period of persistent inflation, rising interest rates and considerable uncertainty—an unusually good real-world test of how different investments behave when the purchasing power of money is falling.

Imagine that you had $100 at the beginning of 1970 and invested it in one of several different ways.

Over the next 13 years, consumer prices rose dramatically. Something that cost $100 in 1970 cost approximately $259 by the end of 1982. In other words, you needed about $259 just to have the same purchasing power that $100 had in 1970.

Now compare that with what happened to different investments:

The results are surprising. Stocks barely stayed ahead of inflation. Treasury bonds actually lost purchasing power. Short-term Treasury bills roughly kept pace. And gold dramatically outpaced inflation.

Stocks Weren't Really an Inflation Hedge

Jeremy Siegel, the Wharton professor and author of Stocks for the Long Run, has made an important argument about stocks.

A stock represents an ownership interest in a business. If prices rise throughout the economy, businesses can generally raise the prices they charge. Their revenues, assets and potentially their earnings can rise along with the nominal economy.

A bond is different. If you buy a 10-year Treasury paying 5%, the government has promised you a fixed number of dollars. If inflation suddenly rises to 10%, you are still receiving the same dollars—but those dollars buy less.

That is the fundamental reason Siegel argues that stocks have a long-term advantage over fixed-rate bonds when it comes to inflation.

Stocks may participate in long-term economic growth, but that doesn't mean they are a good short-term inflation hedge. The 1970s offer a real-world example.

In fact, the 1970s were pretty painful for stock investors.

In 1973, the S&P 500 fell about 14%.

In 1974, it fell another 26%.

At the same time, inflation was accelerating.

So, an investor could experience both falling stock prices and falling purchasing power at the same time. That is not what most people would think of as an inflation hedge.

Bonds Had an Even Bigger Problem

Long-term Treasury bonds faced a different problem. When inflation rose, investors demanded higher interest rates to compensate for the loss of purchasing power. That caused the market value of existing bonds—with their lower fixed coupons—to fall.

Over the entire 1970–1982 period, a $100 investment in 10-year Treasury bonds grew to roughly $236. That sounds like a gain. But inflation required the $100 to be worth $259 to be able to purchase the same amount of goods and services.

So, the bond investor lost purchasing power. This is one of the most important things to understand about bonds:

A bond can return your original investment amount safely while still losing your purchasing power.

What About cash?

Short-term Treasury bills had a different experience. Because T-bill rates adjust relatively quickly, investors were able to earn increasingly higher interest rates as inflation and short-term interest rates rose. Over 1970–1982, $100 invested in T-bills grew to roughly $258—approximately enough to keep pace with inflation.

That sounds pretty good. But there was a cost. You essentially preserved purchasing power without creating much additional real wealth. And that illustrates an important distinction:

Short-term bonds can adapt to inflation better than long-term fixed-rate bonds, but they don't necessarily provide much real growth.

And Gold?

Gold was the extraordinary outlier. An investor who started with $100 in gold in 1970 ended up with roughly $1,100 by the end of 1982. Consumer prices had risen about 159%. Gold had risen more than tenfold. This was a spectacular period for gold. But there is an important warning here.

We shouldn't look at the 1970s and conclude that gold will always produce returns like that.

The 1970s were unusual. The United States was moving away from the Bretton Woods monetary system, gold prices were being liberalized, inflation was accelerating dramatically, and investors were becoming increasingly concerned about the value of paper money. Gold was repriced enormously for those reasons.

So, the 1970s demonstrate that gold can be a powerful inflation and monetary-stress asset, but they don't tell us what gold's normal long-term return should be.

What We Learned in the 1970s

The 1970s and early 1980s give us a more nuanced picture than the simple statement that "stocks hedge inflation." The lesson isn't that one asset is "the inflation hedge." Different assets protect against different risks.

Stocks:
Businesses can increase their prices and earnings over time, so stocks have the ability to participate in the growth of the nominal economy. But during a period of rapidly rising inflation, stocks can still perform poorly.

Long-term fixed-rate bonds:
They provide predictable payments, but those payments are fixed in dollars. Unexpected inflation can significantly reduce their purchasing power and cause their market value to fall.

Short-term Treasury bills:
Their interest rates adjust much more quickly, allowing them to respond to rising inflation and interest rates. They can preserve purchasing power better than long-term fixed-rate bonds, but they don't necessarily produce much real growth.

Gold:
Gold has no earnings or interest payments, but its price can rise dramatically when investors become concerned about inflation, currency values or monetary instability. Its performance can also be extremely volatile.

The 1970s are a powerful reminder that when inflation becomes the dominant economic problem, an investor should not assume that the asset that has historically been "safe" will necessarily protect purchasing power.

Was 2022 a Repeat of What We Learned in the 1970s?

2022 is a modern comparison with the 1970s, because inflation hurt stocks and bonds in both periods, but gold behaved very differently.

In the 1970s, gold was an extraordinary inflation hedge. In 2022, it wasn’t.

S&P 500, including dividends: −18.0%

10-year Treasury bonds: −17.8%

3-month Treasury bills: -1.5%

Gold: +0.6%

Inflation: 6.4%

Gold didn’t preserve purchasing power, but it did preserve nominal capital while both stocks and bonds were falling sharply.

Why did this happen?

The inflation environments were different.

1970s: inflation became persistent and repeatedly exceeded expectations. Inflation expectations took years to adjust.

2022: inflation jumped very rapidly, but the Federal Reserve responded aggressively by raising interest rates. The 10-year Treasury yield went from about 1.5% at the beginning of the year to about 3.9% by year-end. That caused an enormous bond-price decline.  

While 2022 was not an exact replica of the 1970s, it served as a reminder that adding gold to a portfolio can be helpful in inflationary environments.

How We Apply These Concepts to Portfolios Today

• We don’t own long dated bonds, and have low exposure to intermediate bonds.
• We are overweight cash which currently yields about 3.75% and is likely rising. Today, unlike the 1970s, cash is offering a real (inflation adjusted) return of about 1.35%.
• We own positions in physical gold ETFs.
• While we are staying invested in equities, our sector allocations offer protection against inflation. See our previous blog “Does Your Portfolio Need Bonds?” Both gold equities and energy stocks offer a potential hedge when bonds and equities sell-off together. We are overweight both market sectors.

Historical returns are not a guarantee of future results. The 1970–1982 period was unusual, particularly for gold, and should not be viewed as a forecast of future performance.