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This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License
Article
Author(s)
Michael Clemens
Full-Text PDF
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DOI:10.17265/2328-2185/2019.02.004
Affiliation(s)
BankInvest Group, Copenhagen, Denmark
ABSTRACT
While the
literature on inflation and stock prices is plentiful, there is little
literature on deflation and stock prices. This paper explores the empirical
data and makes a theoretical analysis of the likely impact on stock prices when
expectations change from inflation to deflation. Deflation has a bad name among
some economists and most investors. However, from a stock market perspective,
deflations’ bad name may not be well-deserved. Several observations
support this: 1) The 1930s was a statistical outlier and not representative for
a deflationary period and deflation does not seem to create recessions,
causality goes the other way; 2) real
stock returns are positive and around average in the periods leading up to and
following the onset of deflation; 3) when moving from low inflation to
mild deflation, P/E ratios are virtually unchanged; and 4) peak P/E ratios seem to be reached
at inflation rates close to zero. The author proposes three possible explanations for
the seemingly disconnect between the empirical data and the “default” ex ante
belief of most economists and investors: availability heurist, deflation
illusion, and tax related issues in connection
with the tax hypothesis.
KEYWORDS
deflation, stock prices, price-to-earnings ratio, availability heuristic, deflation illusion, tax hypothesis
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