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Mark Hulbert
Feb. 1, 2011, 12:01 a.m. EST
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By Mark Hulbert, MarketWatch
CHAPEL HILL, N.C. (MarketWatch) "” Stocks are poised to outperform gold going forward.
That is the surprising new prediction from none other than Richard Russell, editor of Dow Theory Letters. But what makes his forecast surprising is not its content; it's that he was the one making it. That's because, for many months now, Russell has been bearish on the stock market and "buy-and-hold" bullish on gold.
What made Russell change his mind: His belief that dividend-paying blue-chip stocks are themselves good inflation hedges. And while he remains bullish on gold too, because it also is such a good inflation hedge, he thinks there is the distinct possibility that blue-chip stocks will do even better in coming weeks and months.
Russell's argument about stocks as a good inflation-hedge prompted me to review the historical record, since most investors would disagree with him.
But it turns out that Russell is right: Over the last century, corporate earnings have tended to increase during periods of rising inflation and fall when inflation is declining. (Click here to read an academic study reviewing the historical record in this regard.)
This is not as counter-intuitive as you might think. When inflation is high, companies are able to raise prices and hence fatten their bottom line. By the same token, when inflation is low, firms' pricing power is correspondingly low.
Another way of summarizing the historical record: Real (inflation-adjusted) corporate earnings tend to be relatively stable, while nominal earnings tend to be relatively volatile.
The mistake that investors systematically make is believing that nominal earnings are immune to inflationary pressures, on both the upside and the downside. Economists refer to this mistake as money illusion.
Note carefully that this historical record to which I refer is based on the average earnings of publicly traded stocks in general. Russell, in contrast, is focusing on just the bluest of the blue chips. So he is not recommending broad index funds, but instead the Dow Diamonds /quotes/comstock/13*!dia/quotes/nls/dia (DIA 120.06, +1.46, +1.23%)
Russell also places a stop-loss on his new recommendation of 11,500 on the Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed (DJIA 12,033, +140.96, +1.19%) . "Below 11,500, ... I'd think that the Dow was in trouble, and if that occurs, I would be OUT of the diamonds," he writes.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now.
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