- When inflation is high, value stocks perform better, and when inflation is low, growth stocks perform better.
What is the impact of growing inflation on the stock market?
Read: Traders lift bets on a half-point Fed rate hike in March to as high as 83 percent due to ‘blowout’ inflation in the United States.
The data, on the other hand, does not lie. Consider what I discovered after examining the path of the 10-year Treasury yield TNX,+3.22 percent TMUBMUSD10Y,2.422 percent prior to the 17 bear markets that appear in Ned Davis Research’s bear-and-bull-market calendar since 1962. (I started there since it was the first year for which the US Treasury had historical data for the 10-year Treasury.) In ten of the 17 bear markets, the 10-year yield was lower on the day the bear market started than it had been three months before.
In the current situation, however, interest rates have risen significantly: the 10-year yield is now 2.01%, up from 1.56 percent three months ago.
I repeat that these findings do not imply that we are not in the early stages of a new bear market. After all, seven of the last 17 bear markets began at a period when the 10-year yield had climbed in the preceding three months, just as it is today. It’s plausible that a bear market started in early January, when the S&P 500 index SPX,-1.57 percent reached its all-time high. It is currently roughly 4% lower than its previous peak.
The correct conclusion is that interest-rate trends are a poor predictor of when bear markets will start. As a result, even if interest rates magically fell in the coming months, bulls shouldn’t expect to breathe a sigh of relief.
Many of you are astonished by my findings because you are suffering from “money illusion” or “inflation illusion,” as economists term it. I went into greater detail about these illusions earlier this month, but in a nutshell, they develop when you try to compare a nominal rate (one that hasn’t been adjusted for inflation) with a real rate (adjusted by inflation).
As a result, when inflation and interest rates rise, investors will update their stock market valuations inaccurately. They will, very appropriately, discount future years’ earnings at a higher rate, lowering the present value of those future earnings. However, that is only half of the story. They are oblivious to the fact that when inflation is strong, future wages grow quicker than they would otherwise.
These two effects of increasing inflation and interest rates cancel each other out to some extent. Although nominal earnings will be larger, they will need to be discounted at a higher rate to return to current value. The second of these two outcomes is recognized by inflation and money illusion, but not the first.
Does inflation affect stock prices?
When inflation rises, stocks may suffer a setback, but inflation often indicates that the economy is expanding and that stocks are rising in general. Stagflation occurs when a lengthy economic decline is accompanied by growing inflation. Stagflation is especially difficult for central bankers since many of the instruments they use to manage inflation rely on slowing down the economy.
What should you do if inflation occurs?
As a result, we sought advice from experts on how consumers should approach investing and saving during this period of rising inflation.
Invest wisely in your company’s retirement plan as well as a brokerage account.
How do you protect yourself from inflation?
If rising inflation persists, it will almost certainly lead to higher interest rates, therefore investors should think about how to effectively position their portfolios if this happens. Despite enormous budget deficits and cheap interest rates, the economy spent much of the 2010s without high sustained inflation.
If you expect inflation to continue, it may be a good time to borrow, as long as you can avoid being directly exposed to it. What is the explanation for this? You’re effectively repaying your loan with cheaper dollars in the future if you borrow at a fixed interest rate. It gets even better if you use certain types of debt to invest in assets like real estate that are anticipated to appreciate over time.
Here are some of the best inflation hedges you may use to reduce the impact of inflation.
TIPS
TIPS, or Treasury inflation-protected securities, are a good strategy to preserve your government bond investment if inflation is expected to accelerate. TIPS are U.S. government bonds that are indexed to inflation, which means that if inflation rises (or falls), so will the effective interest rate paid on them.
TIPS bonds are issued in maturities of 5, 10, and 30 years and pay interest every six months. They’re considered one of the safest investments in the world because they’re backed by the US federal government (just like other government debt).
Floating-rate bonds
Bonds typically have a fixed payment for the duration of the bond, making them vulnerable to inflation on the broad side. A floating rate bond, on the other hand, can help to reduce this effect by increasing the dividend in response to increases in interest rates induced by rising inflation.
ETFs or mutual funds, which often possess a diverse range of such bonds, are one way to purchase them. You’ll gain some diversity in addition to inflation protection, which means your portfolio may benefit from lower risk.
Is inflation beneficial to technology stocks?
High-growth equities have struggled throughout 2021 and this amazing start to 2022, owing to fears that the Fed may raise interest rates to battle inflation, putting pressure on their valuations. Professor Vittorio de Pedys criticizes all three pillars of the mainstream argument in this contribution based on his impact paper.
The Fed is unquestionably behind the curve when it comes to dealing with inflation. The M2 money supply indicator, which increased by 40% from 2019 to 2021, is a clear indicator of price pressure. Today’s supply chain bottlenecks are the outcome of economic limitations being countered with a significant shift in demand for products vs services, rather than a global economy unraveling. Companies are addressing this issue by re-engineering their supply chains and constructing factories (see Intel, Taiwan semiconductors). The IHS Markit PMI indices in emerging markets have all recently increased considerably, indicating that manufacturing capacity is improving. Money’s velocity is decreasing: because to productivity-enhancing technology, businesses are spending money less fast. Prices will continue to fall as a result of this secular trend. Finally, comparisons will be easier: inflation will be recorded in the second quarter of 2022 versus the substantially higher numbers witnessed throughout 2021. In 2022, tougher comps will inevitably hold down headline inflation. Market data backs up this assertion: the 5×5 years forward-forward in Libor/inflation swaps, a leading indication of market expectations, indicates that market dealers estimate inflation to be 2.5 percent in five years.
Fed funds rates will aim 2.5 percent in 2024 under the most extreme scenario. It’s hardly a frightening figure. Given the high quantity of business and student debt and its low quality, if the Fed hikes rates above the inflation peak, it risks halting the economic growth and unleashing a cascade of bankruptcies, resulting in an economic crisis. The cost of government debt servicing might soar, pushing out other, more vital public spending. On the other hand, if the Fed decides to maintain its current policy, its dovish posture will further fuel inflationary expectations. As a result, the inflate or die trap appears to be the best option. A strong US dollar will also assist in the long run. Because the real rate is minus 5.5 percent, the government can sit back and watch its mountain of debt (now at 136 percent of GDP) shrink. When looking at Fed Funds Future deliveries for the end of 2022 on the CBOT, the market is pricing a 0.874 percent O/N rate one year from now with three rate hikes. A similar message can be found in the EuroDollar Futures, with the expected 3-months rate for June 2024 trading at an unimpressive 1.37 percent. Chairman Jerome Powell is no Paul Volcker, so the Fed will put on a hawkish mask to gain time, then back down as inflation starts to fall in the second half of 2022.
According to Vittorio de Pedys, 2022 will be a stronger year than 2021 since rate hikes are beneficial to hypergrowth stocks. It’s the “roaring technological twenties”!
Since their all-time high in March 2021, high-growth technology stocks have been steadily declining. According to this logic, the higher the interest rate, the higher the discount rate employed in valuation models such as DCF and CAPM, and the lower the value of a growth stock. Higher inflation, on the other hand, has not historically sunk markets. Rates that are higher do. To destroy growth stocks, substantially higher rates than those proposed by the Fed will be required. Even if most people are unhappy, the economy is essentially in good shape. SPACs, Reddit investors, “meme” stocks, cryptocurrencies, and IPOs are all showing signs of froth. In terms of rates, the “danger” zone begins at 5%. According to studies, there has never been a recession with a rate of less than 4%. Over any 19-year period, US stocks have outpaced inflation 100% of the time, according to Goldman Sachs. The market is telling us that the Fed raised rates eight times between 2016 and 2018, and that growth companies prospered throughout that time: just look at Cathie Wood’s flagship ARK Innovation ETF (ARKK), which soared 90 percent during that time. Growth stocks are damaged by the worry of rising interest rates: the pain is limited to the prospect of higher rates. Once this occurs, these equities benefit because their greater growth potential is accurately valued above a minor multiple compression due to somewhat higher discount rates. The adoption of technology by a larger number of people is unstoppable. Hypergrowth stocks are at the heart of these factors, and they will gain from a strengthening economy.
Is inflation beneficial?
- Inflation, according to economists, occurs when the supply of money exceeds the demand for it.
- When inflation helps to raise consumer demand and consumption, which drives economic growth, it is considered as a positive.
- Some people believe inflation is necessary to prevent deflation, while others say it is a drag on the economy.
- Some inflation, according to John Maynard Keynes, helps to avoid the Paradox of Thrift, or postponed consumption.
What is the average duration of inflation?
NEW YORK (WABC) Inflation is at an all-time high, but this is hopefully the worst of it.
Consumer prices increased 6.8% in the year ended in November, a 39-year high. For a variety of factors, many economists forecast inflation to linger near this level for a few more months before moderateing through 2022. They also don’t expect a replay of the 1970s and early 1980s, when inflation soared beyond 10% for long periods of time.