S&P 500 Held Gains After 3.7% Inflation Reading in Historical Data

Historical data suggests that selling an S&P 500 index fund following a 3.7% inflation reading is not supported by long-term market performance. The Bureau of Labor Statistics reported on Wednesday, Oct. 14, that the consumer price index rose 3.7% in the 12 months through September, up from a 3.4% pace for August. The S&P 500 index slid about 1.1% on that day, finishing near 7,719.

The increase was driven largely by energy costs, with gasoline prices climbing 9.1% in September alone, accounting for over half of the month's total increase. Excluding food and energy, prices rose a more modest 2.6% from a year earlier. Despite the headline figure, the index has generally continued to rise after similar readings, though at a slower pace than when inflation was lower.

An analysis of seasonally adjusted consumer price index data from 1950 paired with S&P 500 price changes over the following 12 months provides context for this relationship. The study examined 908 months with complete one-year results. In the 337 months where inflation was at 3.5% or above, the S&P 500 rose in about 69% of cases, with an average gain of roughly 7%. By comparison, in the 480 months where inflation was below 3%, the index closed higher about 79% of the time, with an average gain of about 11%. Across all 908 months, the index rose about 75% of the time, averaging roughly a 9% gain.

The specific range of September's reading offers little difference in outcomes. When limited to months with inflation between 3.5% and 5%, approximately 70% of the 149 instances saw the index finish the next year higher, with an average gain of about 7%. This indicates that high inflation has historically correlated with somewhat worse odds and smaller average gains rather than a falling index.

However, these historical patterns are heavily influenced by timing within inflationary cycles. About six in ten of the high-inflation months occurred in the 1970s and 1980s, a period when inflation peaked above 14% in early 1980. The position of a reading within an inflation surge matters significantly. During the initial phase of the current surge, beginning in spring 2021, the S&P 500 ended every month from April 2021 through February 2022 lower than it had been a year prior. Conversely, readings around the June 2022 peak of about 9% were followed by an 11% gain over the next year.

Higher inflation can keep interest rates elevated, which may pressure stock valuations by causing price-to-earnings ratios to fall as investors pay less for company earnings when bonds offer higher returns. For long-term holders, the record does not support liquidating an index fund over a 3.7% reading, as the index was higher about two-thirds of the time a year later in hot months. However, investors should not expect gains as large as those seen when inflation was below 3%, as average gains in high-inflation periods have historically been around 7% rather than 11%.