Have you noticed your grocery bill lately? It’s crazy how much meat prices have risen in the last year. Should you be worried about the impact inflation has on your investments?
Many of us have never experienced meaningful inflation, as it’s been 30+ years since inflation has been this high. Consumer price inflation (CPI) first peaked above 5% in May of 2021. At the time economists chalked it up to supply constraints caused by the pandemic. Inflation was most pronounced in timber (wood used to build homes) and used car prices, but the consensus at the time was that inflation was “transitory”. They predicted that prices would moderate over the balance of the year. They were wrong!
As consumer price inflation continued to rise and stubbornly remained above 5%, economists began to worry that inflation may be more persistent than what they originally thought. This is where the art of investing starts to get interesting and it helps to understand the basics of how this information is absorbed by markets and impacts the prospects for the stocks in your portfolio.
Information is absorbed instantaneously by markets. That is why so many people have been quoted saying that “the market is never wrong”. Turn on CNBC and I’m sure you will hear some talking head use this phrase at least one time during the day. So you need to know that your investments already reflect the fact that inflation is running hotter than many experts believed. Professional investors process news much faster than you can comprehend, they know that higher inflation expectations will drive higher interest rates. Interest rates and the money supply are the two tools the Federal Reserve can use to tamp down inflation.
Why does this matter? Because higher interest rates act as a dampener on valuation multiples, as the market looks at inflation as a tax on future growth. Thus, the higher the implied future growth of the company the more of a discount the market will take when inflation overheats. That is the primary reason so many high-flyer stocks (typically unprofitable and listed on the Nasdaq) have traded down 50%+ over the past month. The market is less willing to pay for those companies’ future growth, because inflation will destroy its fair share of the opportunity.
The question you have to answer is whether conditions will deteriorate or improve from what is currently known. That is the only question that matters when you are investing in stocks. How does your view differ from what is known by everyone else? Because what everyone else knows is already priced in by the market. If you don’t have an opinion that is different from Jim Cramer’s then you might want to schedule some time to talk with a professional.
Inflation is a known risk to stock prices in the near-term and already priced in, but what’s the next opportunity or risk that nobody is talking about yet? That’s where you’ll make your money. We’ll explore this concept a little more next time.
If you’re interested in investing in the stock market it’s always a good idea to have a check-up with a professional once or twice a year. Join Iryss now and get a free checkup on your investments.