The Monetary Approach to Stock Returns and Inflation

Earlier studies assumed that nominal stock returns and inflation were linked through the Fisher equation (i.e., nominal stock returns = real expected market returns + inflation expectations).  It was later found, however, that nominal stock returns might actually have an inverse relationship to inflation expectations.

The authors use a series of econometric equations relating money returns, stock returns, and gold returns in order to determine how each of the assets affects the other under different conditions.  Under a "money-neutral" condition (i.e., where the stock prices are not affected by the money supply), nominal stock returns will reflect expected changes in inflation.  In "non-neutrality" (i.e., when the real demand for stocks is more sensitive to the real return on stocks than inflation), an increase in expected inflation will increase the return of stocks.  Under a gold standard the relationship between inflation and stock returns may be positive or negative depending on the source of the innovations.

Canto, V. A., Findlay, M. C., & Reinganum, M. R. (1983). The Monetary Approach to Stock Returns and Inflation. Southern Economic Journal, 50(2), 396.