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What are the effects of inflation on investing?

  • November 11, 2021
  • Front

The effects of inflation have consistently been one of the most discussed topics throughout 2021 and a primary concern for many Americans as the economy rebounds from last year’s pandemic-related slump. Google Trends data even bears this out, as we’ve witnessed evident spikes in search queries for the keyword “inflation” throughout the year. 

Hyperinflation searches [Google Trends]

You’ve likely been hearing that this inflation might be inevitable to an extent, right? When the Federal Reserve engages in expansionary monetary policy by lowering interest rates to the floor and quantitative easing to the tune of $120 billion a month, these are the kinds of policies that can contribute to inflation. And, a little “reflation” was expected anyway.

We now find ourselves at a crossroads where the economy has already recovered from the 2020 slouch on the inflation side of things, but other variables continue to crop up and threaten to keep our inflationary trend going.

So, a natural question arises for many retail investors:

Will inflation impact my investments? 

The effects of inflation ripple through the economy

Inflation is an economic phenomenon that rarely ever exists in a vacuum and, even on a local level, can impact products across multiple industries. Although a certain level of inflation is theoretically necessary for the prosperity and growth of a nation’s economy, consumers start to feel its negative effects when it gets out of hand. 

 Inflation is often viewed from a consumeristic standpoint, referencing the latest CPI data (Consumer Price Index) or the cost of gas. The reality is that businesses are actually one of the first to take a hit and are sometimes impacted by its effects for the longest–especially, when part of the issue stems from supply chains.

Effects of inflation: It hurts earnings

Eventually, this ends up making its way to a company’s bottom line. Public companies report earnings every 3 months to the SEC via what’s known as a 10-Q form, and this is usually what’s referenced by investors and analysts when they debate earnings reports. 

Inflation, however, usually puts a ding in earnings and this is not something the markets take kindly to. This was exemplified nicely in 2009 when inflation jumped, earnings dropped, stock prices remained high, and the S&P 500’s P/E ratio rose to its highest mark ever. 

It’s worth noting that markets eventually recover in most cases, because investing is a game predicated on the future of a business, not just the present, and investors proved this in 2009 as the S&P 500 did eventually climb to previous highs after that drop. 

That being said, today, bad earnings reports and fears of runaway inflation can stoke the fire of anxiety and can lead to dips of varying degrees depending on the stock. Some of the biggest burns seem to come to–you guessed it–growth stocks.

 

Mentions of inflation vs $SPY price [Market Sentiment]

Effects of inflation: It hurts market sentiment 

In 2021, investors have consistently wondered how bad inflation was going to be and whether or not it’s truly transitory. The inflation we’re currently experiencing is lasting longer than anticipated, but at this point it cannot be called hyperinflation, nor stagflation. Essentially, the end result remains to be seen.

Sometimes, though, that uncertainty can be just as bad and has negative implications on market sentiment, as opinions and fears percolate in the meantime. Headlines and new data are coming out constantly and the right storyline can quickly turn a green market to red.

Effects of inflation: The bottom line 

What can we conclude from all this? Inflation seems to, anecdotally, have a negative impact on stock prices in the short-term, especially on growth stocks. In the long run, this can sometimes serve as a buying opportunity to get in at a better price, but may cause some portfolios to suffer in the near term. 

Every stock is unique and should be evaluated on a situational basis. For example, some stocks can actually be impacted positively by inflation if investors view it as a potential hedge, whereas others can get hit hard in the short-term.

At the end of the day, your conviction in the company and the goal you have for that investment is what should help you make decisions. If you want to boost that investment decision-making process with data-driven insights, Front is your one-stop shop.

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