How Inflation and Stock Market are Connected?

Inflation and stock market have a close connection. While inflation represents the increase in price for goods and services available to the population, it can decrease the purchasing value of a currency unit. It also means the change in stock market during inflation featuring growing input prices, increasing unemployment rate, and many other factors that may have both direct and indirect impacts on the stock price.

In this article, we will learn how inflation and stocks are connected. We will explore the influence of inflation on stock markets featuring some examples and steps to take to avoid potential losses.

Inflation and Stock Price

The last few years have been quite challenging for stock traders. A decade-long stretch of price growth has been replaced by heavy inflation that has stroke markets starting from 2021. It led to the rise of the consumer price index reaching 7% during the previous year. Experts say the trend will continue in 2022, which will result in enormous inflation. Who knows, it might be a good time to think over your future retirement plan.

The main factors to consider in regards to the stock market during inflation are as follows:

1. Whatever happens, you must develop an investment strategy considering inflation.
2. When banks lower the interest rate, it can lead to negative returns.
3. The inflation pressure in Europe will grow in the near future, as the oil and wheat price will go up taking into account the geopolitical situation.

So, should investors act in the face of growing inflation?

Inflation and Stocks

It appears that the stock market can actually be the tool to overcome inflation. What’s more, it can help investors build wealth in the long-term perspective. Inflation is the reason why we generally trade. We use the stock market as an instrument to prepare for the economy to make a bad move.

Example: average inflation in the United States has been around 3.5% over the last century. At the same time, the S&P index has been offering 10.49% of the annual return. In other words, long-term investors got a chance to not only keep up with inflation but also build solid wealth.

For many decades, experts have been exploring the connection between inflation and stock market price. The majority of them are sure inflation has a negative influence on the markets. On the other hand, none of them has managed to identify a direct correlation between these two forces.

If we have a brief look at the historical data, we will see that inflation growth affects the markets in different ways, keeping investors with both positive and negative returns. In addition, we keep in mind many other factors that can have a direct influence on the stock market performance. So, it is not just about inflation.

To understand how to behave during inflation, we need to consider the two main aspects:

• The way inflation affects the stock market – even the slightest inflation spile may result in increased market volatility. This is just what we are all looking for, aren’t we? Stock prices fluctuate during inflation, as the price of materials, inventory, and labor are growing. On the one hand, the returns here mainly depend on the company’s future earnings and expectations. On the other hand, it can trigger the situation known as a “sequence of returns”, where investors can still count on a positive outcome.
• The way inflation affects the bond yields and cash – another thing to consider is the day inflation influences cash and bonds. While the interest rate keeps lowering, people are not interested in keeping finds on saving accounts. Inflation will erode their savings, which will have a negative effect on their cash positions. The same applies to assets with a fixed income, for example, bonds. They generally show poor performance when inflation is high. This is where you need to consider “real return”. It represents the difference between the inflation rate and an interest rate you receive as an investor.

What History Says about Inflation and Stocks

While discussing inflation and stock market, we should take into account that inflation is quite rare in such countries as the United States. Us economy saw single time inflation went higher than 5% (a period between 1973 and 1982). Although the example shows an extended period of inflation taking place, they occur pretty seldom.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.