Effect of Inflation on the Stock Market

During the era of the 1920s, 1950s and the 1980s which were characterized by massive economic performances, the stock prices also spiraled up. It was thus believed that an environment of strong economic growth coupled with low inflation will make the stock market breath easy. But the point is, well, ‘Inflation’! Investment and market analysts are always suspicious of incredibly high economic growth and fabulous job reports. They are stricken with fear and apprehension because this artificial recovery or the inflationary boom of the economy is aided by the ‘easy credit’ policy of the government. It creates huge federal deposits and substantially expands money supply. During inflation, this economic growth is unsustainable and the stock markets face an inevitable crash since the federal agencies will have to tighten the rope sooner or later.

Majority of the investors do not actually enjoy an investment profile which involves high interest rates and the companies raising prices. Stocks are considered to be a great hedge against inflation since the respective company’s revenue and earning grow at the same rate as that of the inflation.

Companies react to inflation by raising their prices usually there are others who find it difficult to stay in the global market and compete with the foreign producers who do not raise their prices. The rising prices fuelled by inflation rob the investors since there is no corresponding increase in value. This has a corresponding implication too. The company’s financials get over-stated as a result of inflation, since the revenue and earnings also rise in the same rate as the inflation and this in combination with additional value which is generated by the company.

Now, when there is a decline in the inflation, the previously inflated earnings and revenues likewise gets deflated. When a lot of money is chasing after goods that are fewer in supply, it happens to be a classic case of inflation. Then the option is to make money more expensive to borrow. The excess capital gets removed and the cycle of price increase is slowed down.

As an investor, a substantial portion of the portfolio ought to be in fixed income securities. Since the inflation erodes the purchasing power, fixed securities are the best option to counterfoil the market volatility. Even the retirees are advised to keep some amount of their assets as a stock investment The interest rate sensitive stocks should be handled with utmost caution during the inflationary period.