Higher inflation is generally considered to be negative for inventors and lower expectations of higher profits, putting downward pressure on stock prices. The stock market obviously includes certain inflation each year and adjusts what the expected returns should be in relation to the expected inflation.
In the case for example inflation is 2% per annum with an expected return of about 5% per annum, investors will expect a return of about 7% per annum. But if inflation suddenly goes from 2% to 4%, the overall market will normally react negatively as investors will demand a higher return to offset the higher risk, and instead of a 7% return, investors can demand a 9% return. Money will likely go down in value, input costs will go up, borrowing costs will rise and could also lead to a lower standard of living.
What Causes Inflation?
Inflation is a measure of how the price of goods and services increases in an economy. Higher inflation leads to higher prices for basic needs, which may adversely impact market stability.
- Inflation can occur when prices go up because of rising costs of production.
- Higher demand for goods and services can trigger inflation.
- Inflation is usually the result of higher production costs or increased demand for goods and services.
- Rising commodity prices, such as oil and metals, which are important inputs to production, are one of the signs of inflation that may push costs. In this case, traders who invested in energy companies could see an increase in their stock prices if energy prices rise as a result of inflation.
As traders, why is it important to keep a watchful eye on the Consumer Price Index (CPI)?
The Consumer Price Index (CPI) is a critical indicator of price pressures in an economy as well as an indicator of inflation. Generally, the CPI measures the prices of a basket of goods and services in the economy, including food, cars, education, and is used as a measure of the inflation rate.
How should you invest as inflation increases?
Multiple asset classes work fine in inflationary environments and assets, like real estate and commodities, have historically been seen as inflation hedges. However, the most important thing you should be concerned about during inflation is maintaining the value of your portfolio. You can diversify your portfolio to keep it valuable,however, you must be careful not to be put at greater risk.
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