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You can’t turn on the TV or open a newspaper without hearing about rising inflation. The inflation rate in the UK doubled in April and kept growing through May. In the US, the annual inflation rate is up to 5%.
For investors, the big question is how will this affect the stock market?
What Does Inflation Mean for the Markets?
During the last decade, the stock market has performed better during low-inflation times. So, if prices rise, what will that mean for the markets? It depends. Some sectors can be expected to struggle.
For example, high inflation often leads to a rise in interest rates. If interest rates go up, many tech stock’s rapid growth assumptions become less attractive to investors.
When interest rate worries were high around April or March, we witnessed tech stocks take a slight correction. Many experts are worried that fresh inflation concerns could see an interest rate adjustment, bringing trouble for tech stocks.
Which Sectors Struggle With Inflation?
In a recent investor note, Goldman Sachs looked at market data over the last 50 years. They suggest that specific sectors struggle in times of high inflation.
According to Goldman’s research, real estate, health care, consumer staples, and the energy sector are all strong inflationary market performers.
However, they caution that past performance suggests that the materials and technology sectors could be set to struggle.
Of course, it’s not just Goldman Sachs that is issuing warnings. Chief investment officer at HSBC, Willem Sells, made some interesting points about the market lately.
He cited low inventories, supply chain issues, and wage pressure in the hospitality and retail sectors as significant factors causing inflation. However, he suggests that this inflation is temporary. Additionally, Sells indicates that the Fed and US policymakers agree with him and won’t intervene too quickly.
His two tips are to invest in the financial sector and reduce your portfolio’s exposure to tech stocks.
Will Monetary Policy Change to Stem Inflation?
In the UK, the Bank of England is under pressure. The BoE’s failure to forecast growth and price rebounds has left many economists wondering how they will manage inflation. But, of course, this news comes after the Fed suggested they will start raising interest rates in 2023.
After a 2-day meeting, the Fed has revised its view on the economic situation and will likely implement two interest rate jumps in 2023. But, for now, the rates will stay around the 0 to 0.25% levels they have maintained during the pandemic.
Again, this might signify poor news for tech stock in the longer term.
Are Stocks the Best Way to Beat Inflation?
Though many experts suggest high inflation will not last, investors need to have a plan in case it does. Analysts at Citigroup have indicated that investors may find the best way to beat inflation in markets outside the US.
In a research note from June, Citi analysts looked at the cyclically adjusted price-to-earnings (CAPE) across global markets. The US market’s high rating of 39x has led Citi to suggest it will have a 6% return for the rest of this decade. However, with inflation at 5% currently in the US, Citi says investors should look towards other markets.
Citi believes that four other stock markets will provide double-digit returns: The UK, Germany, France, and Japan.
Will Inflation Cause a Market Crash?
A decade of cheap money and low interest rates have fuelled a bull market. However, rising inflation could hit both of these causes and hurt the market.
Again, the Federal Reserve and the Bank of England’s actions are important here. If they feel the economy is overheating, they may pull back the stimulus and make it more costly to borrow. This scenario could hit the market heavily. However, it’s just one of many possible outcomes.
Alpesh Patel’s Conclusion
While inflation rates in the UK and the US are higher than most economists would like, their cause is unclear. Several factors seem to be influencing the rise of prices — including the economic rebound. Indeed, supply chains and even labour market shortages are also a factor.
For investors, worries about inflation causing a stock market crash are a bit overblown. Instead, adjustments in monetary policy will be used to manage an overheating economy.
Short-term, as prices continue to rise, real estate, energy, and health care look attractive. Similarly, any portfolio with excessive exposure to tech stocks could do with a bit of diversification.
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Alpesh Patel OBE