The concept of inflation generally is deemed as a three- alarm fire in the context of stock market investments and other monetary instruments.
Investors thrive several misconceptions related to their capitals, returns, loss, and security.
They presume superficially that under the effect of inflation the stock market might possibly crash, and they are likely to suffer losses in their investments.
However, reality turns out to slightly at odds with what we imagine it to be. Certainly, the stock market is highly subject to market trends and inflation.
Nonetheless, it may potentially allow growth for many sectors involved while some sectors might see collapse.
What is Inflation?
Inflation basically refers to the sustained increase in the general prices of goods and services. This rise in commodities results in higher costs of living and decline in purchasing power of money.
Inflation is unavoidable and its high levels are a bad gesture for market.
Why does Inflation occur?
The decay in purchasing power of a given currency leads to increased expenses. Economists have been concerned in the past so to decipher the causes behind inflation.
Primarily there are two determinants of Inflation:
1.Demand exceeds Supply
When the demand for goods outpaces the supply factor, there is seen a general increase in prices in the economy.
High-demand and scarce commodities enable the consumers to purchase the products even at increased prices, thus causing inflation.
2.Increase in production costs
If the needed budget for production in a company surges, due to increase in expenses on raw material and its maintenance, it is inevitable that prices of the products will increase.
This also leads to limited supply of goods and services and hence causing inflation.
How does Inflation impact the Stock Market?
Inflation readily impacts the demand and supply of commodities in the market.
Similar is the case with stock market wherein prices of share depend upon the demand and supply and other political, social and economic aspects.
Various macro- economic factors which influence the investors, quite conceivably, have a bearing on stock market trends.
Impact of inflation on stock market:
1.Decreased purchasing power of investors
Inflation declines the value of money over time. Consequently, cost of living increases.
For instance, if the inflation rate in 2019 was 10% then Rs. 1000 would be worth 100 in the next year. This is why inflation is also considered as an ‘invisible thief’.
Thence, an investor would be able to access a lesser number of shares in the same price as compared to the current share prices.
2.Benefits of inflation on stock market in a long- term view
Inflation is a macro- economic indicator that is usually misconceived. However, increased inflation rates signify active growth of economy and upright GDP value.
Nonetheless, low inflation rates are suggestive of impeded economy and less GDP value while extremely high inflation rate is ruinous for the economy.
Thus, to determine whether it is safe to invest in stocks and other financial securities while considering inflation, analyse the graphs depicting the manner and rate of inflation.
Understand whether the rates of inflation in the past have been abrupt or steady.
If degrees of inflation are balanced, then it is favourable to invest in the stock market.
Increased inflation is usually escorted by hike in interest rates on deposits and loans by Reserve Bank of India.
This is done to stabilise inflation rates and compel people towards savings and curtail excess liquidity.
4.Impact on Stock market
Higher inflation rates imply increase in prices of products and services. This may subsequently affect the profitability of the companies.
Owing to the circumstances, shares of the enterprise would likely be dispensed at lower rates.
Low prices of stocks entice investors to buy them anticipating the bright future of the company which creates high volatility in the market.
Especially value stocks are contingent to market conditions. As the inflation increases prices of value stocks pitches too. Thus, during time of high inflation, value stocks tend to give better outcomes.
Contrarily, growth stocks correspond inversely to inflation. Higher inflation rates infer declivity in growth stocks.
From whatever that has been stated so far, we can conclude that inflation is inevitable and surely impacts the stock market in different ways.
It is up to us then how do we see and manage the affairs to reap benefits.
You may wisely choose to invest in segments that remain aloof or promises sizable returns during inflation.