Does The Stock Market Go Up With Inflation?

Does The Stock Market Go Up With Inflation? It’s been a difficult year for stock market investors.

Since the start of 2022:

  • The S&P 500 is down roughly 16 percent,
  • The Nasdaq lost just over 23 percent, and
  • The Dow Jones Industrial Average is nearly 12 percent lower as of late July.

The driving force behind the market’s decline is a general sense of economic gloom – and that’s true across the nation and around the world.

In the United States, consumer sentiment hit a record low in June, and it only improved by a small percentage in July.

A rapid rise in inflation has made must-have goods and services far more expensive. All but the wealthiest households are feeling a financial pinch.

Non-essentials are off-the-table for many consumers, and many are choosing less-costly alternatives to their favorite brands.

Production is down, and it shows in the gross domestic product (GDP). For two consecutive quarters, the GDP has contracted, which is widely considered a sign of recession.

Some economists worry that recession is inevitable – not because the nation is on shaky financial ground, but because consumers and investors are so worried about a recession that their behavior is creating a self-fulfilling prophecy.

The issue that has some investors puzzled is this: as inflation has gone up in 2022, the stock market has gone down.

That doesn’t track with fundamental financial planning advice that says investing in the stock market is critical to keeping up with inflation.

So, which is it?

Is it a good time to invest in the stock market or not?

Why Does Inflation Make Stock Prices Fall?

There are an endless number of factors that influence market conditions in the US, many of which are related to events occurring in other countries. For example, when a swath of Chinese manufacturers shut down due to COVID, the global supply chain felt the impact.

Other examples of potential disruptors include trade disputes, conflicts, and natural disasters. These are just a few of the issues that can affect the US economy regardless of where in the world they occur.

The COVID-19 pandemic created the conditions that led to the 2020 market crash. Now, the biggest issue facing the US economy is the high price of oil. The Russian invasion of Ukraine prompted a sudden, dramatic increase in energy prices, and it has fanned the flames of inflation that contributed to current market conditions.

Higher fuel prices increase the cost of goods because manufacturers must pay more for the materials they purchase to produce various products.

On top of that, everything must be transported to store shelves or consumers’ homes, which requires fuel.

Basic items like food and clothing cost more, and it is more expensive to heat and cool homes and other buildings. The combination of these higher prices and other factors create inflation.

However, inflation isn’t actually to blame for stock market losses. In fact, higher prices often translate into higher revenues and higher profits for companies as they pass on costs to consumers.

The trouble is that the excessive rate of inflation is bad for consumers when their paychecks aren’t keeping up, so the Federal Reserve keeps a close eye on this figure.

Investors know that one of the tools used by the Federal Reserve is the federal funds rate. That’s the interest rate banks pay to borrow money, which they, in turn, lend out to consumers and businesses.

When the federal funds rate goes up, banks pass the increase in interest to borrowers, making it more expensive to buy on credit. The result is decreased borrowing and spending, which reduces the pace of inflation.

The big concern for investors is that high-growth companies must borrow to maintain or increase their expansion. If borrowing is more expensive, some companies reduce growth objectives.

Others pay the additional interest, which affects bottom-line profits. That’s the reason the market goes down when inflation goes up – but the good news is that the drop is usually temporary.

How Does Inflation Affect The Stock Market?

Financial advisors recommend investing in the stock market to achieve long-term goals because the stock market grows with – and sometimes faster than – inflation. It just takes time, and for investors, it takes patience.

When prices go up, the companies selling those products generate more revenue. When they successfully pass inflation-related costs to consumers, they see their profits grow at a proportional rate.

However, there is a lag between price increases caused by inflation and related revenue growth – usually, at least six months. In the meantime, earnings reports are dismal, which prompts many shareholders to sell their stock and reinvest in safer assets.

Is that the right move, or is now the right time to invest in the stock market?

Is It A Good Time To Invest In The Stock Market?

Investing horizon is the critical point every investor must consider before making a trade. How long does the portfolio have to grow?

With the market’s immediate future in question, those with short investment horizons are better off filling their portfolios with lower-risk assets. In contrast, those with longer investment horizons can afford to take some risk.

However, lower risk doesn’t require avoiding the stock market altogether. It means choosing from companies that can withstand the pressures of a volatile market, whether because of their solid financials, their ability to pass price increases onto consumers more quickly, or their position in an industry that is thriving under current conditions.

Two companies that meet these criteria are Chevron and Nextera Energy. Both are financially sound and have been for years. Better still, they offer above-average dividends. When oil prices go up, the extra cost is passed onto energy consumers almost immediately.

Other energy stocks to consider include:

Healthcare companies like Walgreens-Boots Alliance and Lantheus Holdings check all of the boxes for investors who want to keep their risk exposure low. In addition, a long list of stocks in the consumer staples space are expected to weather current market conditions with ease. Examples include:

Investors with a long-term investment horizon have a tremendous opportunity to build their portfolios while the market is down.

In essence, stocks are available at a discount or “on sale,” which makes it possible to buy low, then sell high decades from now. Examples of solid companies with promising long-term futures include Amazon, Block, MercadoLibre, Pinterest, and Shopify.


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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.