Inflation, which involves the rise in the price of goods and services, tends to lower the purchasing power of each unit of currency. Kavan Choksi Wealth Advisor mentions that rising inflation might be quite harmful to the economy, as input prices are higher and consumers may lose purchasing power unless their incomes rise. Moreover, monetary policy measures undertaken to contain inflation can hamper employment and growth. Inflation hurts stocks as consumer spending drops. However, value stocks do fare better than growth stocks during inflation.
Kavan Choksi Wealth Advisor sheds light on the impact of inflation on stock returns
Due to the negative impact of rising inflation, the Fed stays diligent and focused on detecting its early warning signs and try its best to anticipate any unexpected rise in inflation. A sudden rise in inflation can have significant negative implications, as it may take companies multiple quarters to be able to pass along higher input costs to consumers. Similarly, consumers also feel the “pinch” as services and goods start costing more. However, with time, consumers and businesses typically do become acclimated to the new pricing environment. The consumers become less likely to hold cash as the value over time decreases with inflation.
In certain situations, high inflation can be good as it may stimulate employment growth. However, high inflation might even squeeze corporate profits while incurring higher input costs. This would cause companies to worry about their future, and they may stop hiring or even lay off employees. Such as a situation lowers the standard of living of individuals, particularly the ones who live on fixed incomes.
Understanding the implications of inflation on the stock market can be confusing for newbie investors. After all, inflation does impact the stock market and economy, but not always at the same rate. To gain more clarity, investors can examine historical returns data during periods of high and low inflation. Real returns refer to the actual gains an investment makes after factoring in inflation. Analysis of S&P 500 returns over different decades and adjusting for inflation reveals that the highest real returns occur when inflation rates range between 2% and 3%. When inflation deviates from this range, it often indicates broader macroeconomic challenges in the United States., which can have varied effects on stock performance. As Kavan Choksi Wealth Advisor says, gaining a good understanding of the volatility that inflation introduces into returns is crucial for making informed investment decisions in such environments.
Stocks are commonly categorized into value and growth segments. Value stocks typically exhibit stable cash flows that may grow slowly or decline over time, while growth stocks represent rapidly expanding companies that may not yet be profitable. When assessing stock values by making use of discounted cash flow analysis, rising interest rates negatively impact growth stocks more than value stocks. As higher interest rates are often used to counteract inflation, during periods of elevated inflation growth stocks tend to experience more significant declines. Hence, it is better to invest in value stocks to inflation proof a portfolio.
