Jeremy Schwartz: Why Stocks Are Good Inflation Hedges

Episode Summary

Executive Summary: Jeremy Schwartz argued that long-term investing should emphasize valuations, dividends, and quality while avoiding unnecessary risks like currency exposure. He defended WisdomTree’s indexing approach, highlighted stocks as strong inflation hedges, questioned some conventional factor premiums, and warned that China, private equity leverage, and bank profitability face evolving structural challenges.

Main Topics: Do-nothing investing and the power of holding winners (Priority: 5/5): Schwartz revisited research with Jeremy Siegel showing that simply holding the original S&P 500 constituents since 1957—despite industry decline and sector turnover—could match or even beat the index, underscoring the dangers of overtrading and the value of long holding periods. Valuation-based return expectations (Priority: 5/5): He said long-term expected equity returns can be estimated from earnings yield (the inverse of P/E), similar to how bond yields inform bond returns, and used current S&P 500 valuation levels to frame future return expectations. Dividends, quality, and inflation protection (Priority: 5/5): Schwartz made a strong case for high-quality dividend growers, linking dividends to real cash flows, sustainable reinvestment, and superior long-term inflation protection through earnings and dividend growth. Risk premiums, factors, and what investors are not paid for (Priority: 4/5): He questioned whether investors are compensated for taking international currency risk, suggested some factor premiums like small-cap outperformance may be regime-specific, and noted that momentum works even though it is widely known. Emerging markets, China, and idiosyncratic risk (Priority: 4/5): Schwartz discussed reducing China exposure in some strategies to lower geopolitical and policy risk, arguing that China’s weight in EM indexes has become too large for many investors’ comfort. ESG and private equity in a higher-rate world (Priority: 3/5): He presented ESG as partly demand-driven and regionally different, especially in Europe, while private equity faces tougher conditions because higher interest rates reduce leverage capacity and likely lower bid prices.

Key Arguments: Doing less can outperform doing more: the original S&P 500 stocks, tracked through mergers and spin-offs, held up surprisingly well versus the evolving index. Long-term equity return expectations should start with valuation; earnings yield is a practical proxy for forward real returns. High-dividend, high-quality businesses are attractive because they deliver real cash flows and tend to grow dividends sustainably through strong ROE and disciplined reinvestment. International investing often adds uncompensated currency risk; Schwartz argued investors are not reliably paid to bear it. Small-cap outperformance may have been concentrated in one historical window rather than representing a stable, persistent premium. Momentum is profitable despite being well known, but adding momentum to style indexes can create counterintuitive and sometimes undesirable allocations. Stocks are the best long-term inflation hedge because companies can raise prices, protect margins over time, and grow dividends above inflation. China exposure in EM benchmarks may not fully reflect geopolitical and policy risk, so active underweighting or ex-China approaches can be justified. ESG tends to raise investor demand and therefore valuations, but whether it improves returns depends on whether higher multiples are offset by stronger growth or lower risk. Private equity is not necessarily a bubble, but higher rates and leverage constraints likely compress returns and reduce purchase prices.

Data Points: S&P 500 long-run real return: about 6.5% to 7% - Referenced as the historical inflation-adjusted return of broad U.S. stocks S&P 500 real return estimate used by Siegel: 6.7% - Long-run stock return after inflation cited multiple times S&P 500 valuation: a little below 20x earnings - Used to estimate forward earnings yield and expected returns Earnings yield on S&P 500: about 5% to 6% - Approximate inverse of current P/E ratio Average historical S&P P/E: 15x - Used to explain why long-run returns have averaged around 6.7% High dividend index P/E: about 11x earnings - Used to argue for a valuation discount and higher earnings yield High dividend earnings yield: about 9% - Derived from roughly 11x earnings Currency movement: plus or minus 7% in a given year - Illustrated the volatility of currency risk S&P earnings growth when dollar rising vs falling: 0% vs roughly 6% forward six-month earnings growth - Long-term data used to support a weak-dollar earnings bias Recent dollar impact: 15% rise in the dollar six months ago - Linked to an almost 8% decline in earnings in the recent quarter Last 25 years dollar/earnings spread: almost 900 basis points - Difference in earnings outcomes when the dollar was rising vs falling Small-cap outperformance window: 1975 to 1983 - Most of the long-term U.S. small-cap premium came from this period Dividend growth since 1957: about 2% above 3.7% inflation - Used to show stocks’ real growth and inflation-hedging power Average dividend yield over long S&P history: roughly 2.5% to 3% - Part of the decomposition of long-run stock returns Return from fundamentals: about 8% to 9% - Approximate combined contribution of dividend yield and dividend growth 10-year Treasury inflation-protected securities (TIPS) yield: about 1.5% - Presented as a lower-risk alternative for inflation-sensitive retirees Energy sector valuation: about 10x earnings - Cited as a cheap sector that can help hedge inflation Emerging markets China weight two decades ago: less than 10% - Historical benchmark weight in EM indexes Emerging markets China weight at peak: almost 40% - Showed how dominant China became in EM benchmarks Current China weight in EM: about one-third - Used to justify ex-China considerations Emerging markets small-cap performance without dividend payers: -2% per year for 17 years - Lowest-quality non-payers underperformed materially Emerging markets small-cap high-yield quality performance: +8% per year for 17 years - Highest-yielding quality stocks strongly outperformed Quality dividend growth strategy age: 10 years - WisdomTree’s quality dividend growth family anniversary Large-cap dividend strategy age: 17 years - Example of a long-running WisdomTree product with a strong track record

Pivotal Quotes: "if you went back to 1957 and you held those original companies ... you beat the index" — Jeremy Schwartz: Describing the do-nothing strategy research on the original S&P 500 constituents "I think people are taking a lot of uncompensated risk when they invest internationally and take on currency risk, which I don't think you're paid to take." — Jeremy Schwartz: His core critique of unhedged foreign investing "stocks are really good long-term inflation hedges" — Jeremy Schwartz: Explaining why equities can preserve purchasing power over time

Implications: Listeners should think more carefully about valuation, currency exposure, and the hidden costs of benchmark-following. For firms, the conversation reinforces a shift toward quality, dividends, and selective active risk management in a world of higher rates, inflation uncertainty, and geopolitical fragmentation.