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I downloaded Professor Robert Shiller’s historical stock market data to see how inflation has impacted stock returns. I had done this before with data from Ibbotson. Those numbers go back to 1925, but Professor Shiller’s numbers go back to 1871.

I wanted to see how the stock market performed at different rates of inflation. I took the after-inflation total return of each month from 1871 through 2010.

I found that the magic number is 5.3%. If the annualized inflation rate for the month is under 5.3%, the stock market has performed very well. But when inflation is above 5.3%, the market does poorly. It’s pretty amazing how well this relationship has held up over 140 years. Historically, monthly inflation has been above 5.3% about one-third of the time.

My calculations show that when inflation is below 5.3%, the stock market has had an annualized after-inflation gain of 9.59%. When inflation is above 5.3%, then stock market has had an annualized loss of 8.15%. Stretched out over 140 years, that’s a loss of nearly 98%.

(Click chart to expand)

Source: The Magic Inflation Rate: 5.3%