Stock market investors don’t usually have to concern themselves with inflation. For the first two decades of the 21st century, central banks kept the rate of increase in prices well within their target ranges. And even in an environment where inflation is rising, the stock market tends to be seen as a good place to be. But is that really the case?
Well, the idea that the stock market is some kind of hedge for inflation is based on some broad assumptions that may not always hold true. To understand why, it’s first worth thinking about the basics of what inflation does. Put simply, rising rates of prices reduce the purchasing power of cash over time. And that accelerates when inflation rises.
For example, the same goods and services that cost £100 in the year 2000 would have cost around £172 just 20 years later. That’s based on a modest average inflation rate over that time of 2.8% (you can try this out yourself with the BoE’s inflation calculator)
Economists still debate the phenomenon of inflation and how it influences consumers, companies and the economy. But for investors, it’s worth knowing about how companies can be affected.
Generally, the assumption is that if your cash is invested in stocks, then it’s protected from inflation. That’s because companies can just pass on rising prices to their customers. In fact, this is precisely why rising inflation is often seen as a side effect of a strengthening economy. The idea is that (when it’s under control) growing demand propels company profits, which leads to rising production and stimulates the economy in a virtuous circle.
But the catch is that not all stocks are equal when faced with rising prices. Any investor reading market news at a time of rising inflation will know how many companies mention “rising input prices”. When the cost of raw materials goes up, they have to either absorb those extra costs or pass them on. The problem is that not all companies can easily pass them on - and that affects profitability.
In this article we’re going to explore some of these ideas and the financial indicators that might prove useful in finding companies that are less likely to be impacted badly by rising prices.
Grappling with rising prices
For much of the past 25 years, major economies around the world have enjoyed a period…
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