Inflation and Stock Returns at B3/Inflacao e Retornos de Acoes na B3.

AutorChaves, Carlos
CargoTexto en ingles - Ensayo
  1. Introduction

    We study the empirical relation between inflation and stock returns at B3, the Brazilian stock exchange. We use weekly real returns for Ibovespa (the stock market index), the Brazil 5-year CDS, the Bloomberg Ibovespa target for the next 12 months, Ibovespa earnings per share forecasts, the VIX index and, from the Focus survey, forecasts for the next 12 months of CPI (IPCA) inflation, industrial production growth and GDP growth (1).

    We find robust evidence of a negative relation between expected inflation on stock returns. From July 2005 to December 2016, in our main specification (regression 3, in Table 2), a 1 percentage point increase in expected inflation for the next 12 months from the Focus survey is associated with a 0.57 percentage point decline in the weekly real returns for Ibovespa. We control for country risk, the VIX index, industrial production forecasts and other variables. The coefficient on expected inflation is statistically significant at the 1 percent level. With a value of 0.57, it is also economically significant.

    We also observe a negative relation between expected industrial production growth and stock returns. An increase of 1 percentage point in the industrial production growth forecasts is associated to decrease of real stock returns of 0.23 percentage points. Moreover, we find that the Ibovespa returns react negatively to changes of the 5-year CDS and the VIX index.

    The negative relation between inflation and stock returns has been related to a decrease in future earnings per share (Sharpe, 2002). However, we do not find any statistically significant relation between inflation and earnings forecasts for Ibovespa.

    Figure 1 shows cumulated nominal and real returns for Ibovespa and cumulated inflation measured by the CPI (IPCA) from January 2000 to December 2016. Cumulated inflation during the period is equal to 182.8 percent. Cumulated Ibovespa returns are 252.4 percent. An investor who invested in the Ibovespa portfolio earned cumulated real returns of only 17.2 percent during the whole period, approximately 1 percent per year.

    Fama and Schwert (1977) pointed out the negative correlation between inflation and returns of financial assets, including real stock returns. According to Feldstein (1980), in an early explanation, the negative correlation between inflation and stock returns is due to the nominal capital gains generated by inflation, which results in higher tax rates.

    Fama (1981) stated that the negative correlation between inflation and real stock returns is a result of the negative correlation between inflation and real activity. The negative correlation between inflation and real activity, together with a positive correlation between real activity and real stock returns, implies the negative correlation between inflation and real stock returns. (2) Related to the negative correlation between inflation and real activity, Piazzesi and Schneider (2007) state that inflation is negatively correlated with future consumption growth. Piazzesi and Schneider (2012) show that inflation can explain an increase in housing prices together with a decrease in the stock market, as inflation implies portfolio changes from stocks to real estate. (3)

    For Brazil, Nunes et al. (2005) study the relation between Ibovespa returns and different macroeconomic variables. Nunes et al. find a negative relation between inflation and real stock returns, in accordance with our results. However, our study differs from Nunes et al. in different dimensions. In particular, we focus on the relation between inflation and real stock returns, and we relate our findings with investment strategies of fund managers. Moreover, we use the Focus survey for data on inflation expectations and we consider additional variables such as earnings forecasts and proxies for sovereign risk and market volatility. (4) Given these differences, we find a stronger and more robust negative relation between inflation and real stock returns. (5)

    For Treasury bonds, there are studies on the term structure, inflation expectations and the inflation premium for Brazil. Among others, Vicente and Guillen (2013) analyze the relation between the breakeven inflation rate for indexed and nominal Treasury bonds in Brazil with future rates of inflation. Doi et al. (2017) study the relation between the level of disagreement of inflation expectations across investors and the term structure of inflation risk premium of Brazilian Treasury bonds. (6) For the best of our knowledge, our paper is the first to focus on inflation and stock returns for Brazil. (7)

    The relation between real stock returns and expected inflation is especially relevant for the Brazilian market. Brazil has a long history of high and volatile inflation. Given the high magnitudes and volatility of inflation, taking into account changes in inflation for portfolio management could result in considerable gains. Establishing a consistent negative correlation between inflation and stock returns for Brazil, therefore, is important to set guidelines for portfolio managers.

    According to our findings, inflation expectations help to forecast stock returns. As a result, an investor or portfolio manager can optimize the gains of an investment strategy by observing the evolution of expected inflation.

  2. Data

    Ibovespa is the most frequently used stock index in Brazil. We use weekly returns since November 2001. Real Ibovespa returns are obtained with the nominal returns deflated with the consumer price index (CPI). We use the IPCA for the CPI. We obtain Ibovespa and the IPCA from Economatica.

    We also use the Ibovespa target, the forecast of Ibovespa earnings per share (EPS), and the median of inflation, industrial production growth, and GDP growth forecasts for the next 12 months. We include the Brazil 5-year CDS (Credit Default Swap) to capture expectations of financial agents with respect to the risk in financial markets in Brazil, and the VIX index to capture the overall risk expectations in financial markets.

    Inflation expectations are obtained from the Focus survey (Market Expectations System of the Central Bank of Brazil). The system was created in 1999 to support the implementation of the inflation targeting regime, established in the same year. The system collects market expectations from banks, asset managers, brokers and other institutions about future inflation, GDP, and other economic indicators. The data are collected online continuously from each institution and consolidated daily. The forecast of each institution is identified with a specific login ID. To encourage participation and improve the quality of forecasts, the central bank ranks institutions by the accuracy of forecasts on a set of indicators and makes public the top 5 institutions. Participation on the survey is open to accredited institutions by the central bank and requires the existence of a specialized team on macroeconomic forecasts. The system also requires the regular update of forecasts. According to Gaglianone et al. (2017), the format of the Focus survey, especially with the ranking of institutions, contributes to the frequency of updating and accuracy of estimates. (8)

    We use the median of inflation forecasts for the next 12 months since November 2003. Figure 2 shows cumulated inflation for the last 12 months and the inflation forecast for the same month made 12 months before. The Focus survey also provides the standard deviations of inflation forecasts. Figure 3 shows the standard deviations together with the squared error of the projections, calculated as the square of the difference between cumulated inflation of the last 12 months and the forecast for the same month made 12 months earlier. The largest standard deviations and errors of the projections are concentrated in the initial period of the Focus survey.

    Data on expectations about industrial production growth for the next 12 months were also obtained from the Focus survey. Industrial production is used as a proxy for aggregate demand because of the lack of availability of a weekly series suitable for economic activity as a whole. Figure 4 shows the percentage actual industrial production growth with respect to the same month of the previous year together with the growth forecast for the same month made 12 months before. Market forecasts do not capture large variations in industrial production. Figure 5 shows the standard deviations of the forecasts along with squared errors.

    There is a substantial difference between the...

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