Stocks, bonds, T-bills and inflation hedging: From great moderation to great recession

• Stocks lack hedging ability from 1983 until the fall of Lehman Brothers late 2008.
• As of then, stocks in cyclical industries show significant hedging ability.
• Long positions in bonds turn out poor inflation hedges.
• T-bills have significant hedging ability; especially 3-month T-bills.
• T-bill indices involve significant costs of hedging.

Inflation hedging is an important issue for long-term investors, even during prolonged periods of relatively low inflation. This study analyzes the inflation-hedging properties of US stocks, bonds, and T-bills at the subindex level during the years 1983–2012. Our analysis provides only partial confirmation of the hypothesis that, during the post-1980 period, the returns of cyclical stocks exhibit a more positive long-run relation with inflation than the returns of non-cyclical stocks. Stocks in both cyclical and non-cyclical industries have virtually no hedging ability until the fall of Lehman Brothers in September 2008. From that moment on, equity subindices particularly in the cyclical industries start to develop statistically significant but economically modest hedging ability, even in the short run. In contrast to T-bills, long positions in bonds turn out poor inflation hedges during the entire sample period, regardless of maturity, issuer, risk rating and investment horizon. Only short positions in long-term bond indices including Treasury bonds (with maturities of 10 years and longer) may have some long-run inflation hedging capacity.