Inflation is Obstacle for Stocks and Bonds!
By Mitchell Anthony
June 15, 2022
Money managers, market strategists, and economists generally agree that financial markets are driven by three things. 1.) Expectations for inflation, 2.) Expectations for central bank policy, and 3.) Expectations for economic growth. And in that order! When all three of these economic criteria are friendly money tends to flow heavily toward risk assets (stocks, real estate, and bonds). When even one of these economic criteria becomes unfriendly, than money flow will change direction and move away from risk assets. The reason why these criteria drive financial assets is that when inflation is very low interest rates are also very low and investors are forced to embrace investment in risk assets by the simple fact that low-risk investments return nothing. Conversely when inflation is high interest rates are also high and investors are more likely to allocate their capital toward fixed income investments or short-term cash instruments with high return and little risk. Interest rates have always risen and fallen with inflationary expectations. Inflation has been down for the count for over 30 years and many of us have forgotten about how this relationship works. All we have known is that inflation has been anchored at 2% and this combined with very slow economic growth, and very accommodative monetary policy, has worked to keep interest rates near zero. This in turn caused financial assets to rise in value dramatically over the last 30 years as investors piled into risk assets.
Inflation is no longer anchored at 2% and is currently running at 6-9% depending upon the gauge. This high inflation has come from the pandemic induced Government stimulus that caused demand to be pulled forward and production of raw materials and durable goods to be reduced. Producers of raw materials and durable goods have taken advantage of the pandemic induced production cutbacks to raise prices considerably and keep them high by continuing to restrict and hold back production. There has been strong cohesiveness amongst producers and price wars have not developed to bring down prices and increase production as demand has returned to normal after the pandemic.Read more
