To The Moon

As we have seen some of the Fed officials expressing the possibility of higher interest rates, does it make us wonder why do they say that? Since they have just implement a pause on the rate hike in June.

Does this mean that inflation re-acceleration is going to happen?

In this article, I would like to explore the relationship between inflation and the stock market, discussing the causes of inflation re-acceleration and examining the potential implications for investors.

I will also be sharing how Paul Volcker “broke the back” of inflation by substantially raising rates in the early 1980s with CPI value.

Some of the key strategies that we can adopt if inflation re-accelerate at the end of article.

As prices rise across various sectors, the stock market, a key indicator of economic health, is feeling the impact of this re-acceleration of inflation.

Understanding Inflation Re-acceleration

Inflation refers to the general increase in prices of goods and services over time. It erodes the purchasing power of money and can have far-reaching consequences for businesses, consumers, and financial markets. After a period of relatively low inflation, the global economy is witnessing a resurgence in inflationary pressures. Several factors contribute to this re-acceleration:

Supply Chain Disruptions: Even after the pandemic has ended, we are still seeing disruption in the global supply chains, leading to shortages of raw materials, labor, and intermediate goods.

These supply constraints have caused an imbalance between demand and supply, driving up prices.

Pent-up Demand: As the pandemic-induced slowdown has recovered, there is a surge in consumer spending.

The release of pent-up demand, coupled with fiscal stimulus measures, has created increased demand for goods and services, adding to inflationary pressures.

Monetary Policy and Central Banks: Central banks around the world responded to the economic downturn by implementing expansionary monetary policies, such as low interest rates and quantitative easing.

While these measures aimed to stimulate growth, they also contributed to the increase in money supply, which can lead to inflationary pressures.

Implications for the Stock Market

The re-acceleration of inflation has significant implications for the stock market. Here are some key factors to consider:

Impact on Corporate Earnings

Inflation can affect corporate earnings in multiple ways. Rising input costs, such as raw materials and labor, can squeeze profit margins for companies.

Additionally, higher inflation may prompt central banks to tighten monetary policy, increasing borrowing costs for businesses. As a result, companies may face challenges in maintaining their profitability, which can impact stock prices.

Sectoral Performance

Inflation affects different sectors of the economy differently. Certain sectors, such as commodities, energy, and industrials, may benefit from rising prices, as they can pass on increased costs to consumers.

Conversely, sectors that are more sensitive to interest rates, such as technology and growth stocks, may face headwinds due to higher borrowing costs and reduced investor appetite for high valuation stocks.

Investor Sentiment and Asset Allocation

Inflation can influence investor sentiment and their allocation of assets. Higher inflation expectations may lead investors to seek inflation hedges, such as commodities, real estate, or inflation-protected securities.

Consequently, stock market investments may face increased competition from other asset classes, potentially impacting stock valuations.

Monetary Policy Response

Central banks play a crucial role in managing inflation. If inflationary pressures persist, central banks may respond by tightening monetary policy.

This could involve raising interest rates or scaling back stimulus measures. Such actions can have a direct impact on the stock market, as they affect borrowing costs, business investments, and consumer spending.

I think in order for us to under the inflation re-acceleration, we can look at the past history of how Fed manages and bring down inflation.

How Paul Volcker Broke the Back of Inflation in the Early 1980s

In the late 1970s and early 1980s, the United States faced a severe economic crisis—a raging inflation that eroded the purchasing power of the dollar and threatened to destabilize the nation's economy.

It was during this tumultuous period that Paul Volcker, then Chairman of the Federal Reserve, implemented a bold and controversial strategy to curb inflation. Through his resolute determination and decisive actions, Volcker "broke the back" of inflation, leaving a lasting impact on the US economy.

Short-Term Pain for Long-Term Gain

The decision to raise interest rates was met with fierce criticism, but Volcker remained steadfast in his belief that it was necessary to break the cycle of inflation. His unwavering commitment to restoring price stability helped instill confidence in the financial markets and among consumers. While the short-term consequences were painful, they were vital for the long-term health of the economy.

Success and Lasting Impact

Volcker's relentless pursuit of taming inflation began to yield results. By the mid-1980s, the US economy had undergone a dramatic transformation. Inflation rates, which had reached double digits, were brought down significantly. The Federal Reserve's actions, combined with other economic factors, set the stage for an era of relative price stability and robust economic growth that would last for decades.

Why Fed will need to continue raising Interest Rate.

If we bring ourselves back to June 2023 pause to the rate hike, Fed wanted to see if the substantial rate hike so far have been working. Look like it does not seem to be that way, as we can see from the Fed officials comment that more higher interest rates is needed to curb inflation.

I hope Fed can take a leaf from what Paul Volcker did to really broke the back of the inflation, a short term pain will result in a longer term gain.

Summary

If inflation re-accelerates, the stock market will face a complex set of challenges and opportunities.

Rising input costs, sectoral performance variations, and potential shifts in investor sentiment all contribute to market volatility.

It is essential for us, as investors to closely monitor inflation indicators, central bank policies, and the overall economic landscape.

These are some of the key strategies which I believe can help us to navigate these uncertain times and manage the potential impact of inflation on the stock market.

1. Diversification (portfolio should include defensive assets)

2. Careful stock selection (look for stock with high cash flow of defensive nature)

3. Long-term investment (set the investment horizon for longer period)

Appreciate if you could share your thoughts in the comment section what do you think of the possibility of inflation re-acceleration?

@TigerStars @Daily_Discussion @TigerWire appreciate if you could feature this article so that fellow tiger would benefit from my investing and trading thoughts.

Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.)