So far, 2022 hasn’t been a very good year for the stock market, as most of the stocks are having a hard time. Adding to that, inflation has been the highest in the last 40 years. Although experts believe that inflation is somehow associated with tumbling stocks, the relation between the two (inflation and stocks) is much more complicated.
Stocks don’t need to go down with the rise in inflation. However, investors react to new consumer price index reports on goods and services by the U.S. Bureau of Labor Statistics.
If the current inflation rate is considered, then it can be seen that it’s the highest since the 1980s. As inflation doesn’t directly impact the stock market, the question is: How can high inflation make stocks struggle?
Here are a few ways:
Inflation Creates Fears of Recession
The central bank is one of the bodies that react to inflation sooner than others. It increases short-term interest rates to control economic activity. These increased rates lead to expensive loans. In addition, businesses and consumers find it difficult to spend money.
The Fed increased the benchmark interest rate by 0.25% in April and 0.5% in May this year. Furthermore, it stated that there were plans to reduce the balance sheet, and the stock market fears that the Fed’s actions may lead to a slower economy, which may further lead to recession that affects stocks, and then investors will tend to spend less money.
Inflation Makes ‘Risky Assets’ Less Appealing
Over the last few years, when interest rates were nearly 0, investors paid attention to risky stocks. They had an idea to save those stocks for better results in the future. However, with the rise in interest rates, those risky stocks became less attractive to investors. Cryptocurrency is the right example of risky assets whose demand is decreasing with each passing day.
Inflation Impacts Investor Behavior
According to experts, how the Fed responds to inflation affects investors and their social network. However, there are many factors in the process.
The price of stocks depends on how much a company has been earning. If investors find that a company will experience profit, then its stock prices go up. Right now, not many companies are experiencing profitability. For example, Walmart reports that its profit has sunk by 25% in the last three months, compared to the same period last year.
Is Inflation ‘Really’ Bad for Stocks?
Inflation does affect the stock market, but it is not that bad for some stocks, especially ones that belong to companies with great pricing power. Here, pricing power means a company’s ability to provide a part of its profit to consumers. It happens especially when the prices are rising as there is a high demand for companies to pass pricing power.
According to experts’ analysis from The Leuthold Group, stocks tend to thrive and perform well during inflation and after the inflation rate peaks. it is necessary for investors to have a strong investment plan to do well during inflation.