What rising inflation means for stock market investors?
Namaskar Dosto and welcome back to another exciting stock market special podcast.
As promised, here we are with yet another stock market topic - and as usual I promise to explain it to you in a fun, easy to understand and memorable manner.
Inflation is generally seen as a negative term whether you are a corporation, a buyer, a retailer, the government… inflation ka matlab hai rising prices and nobody likes that.
Lekin stock market investments mein, how does inflation play out?
Sach bolu toh, it is rather complicated and in some cases it defies all logic until you sit and try to understand it. For example, long term and short term investors do not react the same way to inflation. Inflation that comes unexpectedly and inflation that pans out as projected, have different outcomes. Growth stocks aur value stocks mein bhi inflation ka asar alag rehta hai.
But worry not, we have it all worked out for you.
Aaj ke podcast ka format thoda bahut alag rahega - we will observe different stock market reactions to various inflationary situations.
Chaliye let’s start with what inflation that was anticipated means, for long term stock market investors when it comes to their earnings expectations - in normal times.
Let’s say you are expecting 10% return from your shares of stock A in a given year. The inflation that year was 3%. Inflation-adjusted returns expectations rahega 13% for that year, lekin in the long term. A long term investor is quite likely to remain invested and not make sudden moves, but he will adjust his long term ROI expectations.
What if you are not a long term investor, lekin these are normal times and the inflation is as anticipated - inflation ka aapke earnings expectations pe kya asar padega?
Well generally, in the short term, inflation is seen as an omen of lowered returns. Yeh kyun? Prices badh jayegi. Shouldn’t the companies be more profitable?
Not necessarily dost, because
Price of raw materials and labour might rise
Price of credit/ borrowing typically rises
People might have less money to invest or might become more risk sensitive resulting in fewer buyers
Purchasing power kam ho jata hai meaning that the sales of companies listed on the market could fall
Overall negative sentiment bhi rehta hai and iske karan - along with lower demand - you might notice that stock prices start falling. This is also because investors ke earnings expectations bhi reduce ho jate hai due to the overall negative economic scenario.
Situation number 3 hai effect of unexpectedly high inflation on short term investors
In such a situation as the inflation rate rises suddenly, the expected rate of returns from the stocks also rises suddenly. Kuch weeks pehle, mera ek friend Mayur ne kaha ki usko apne investment se 13% returns chahiye. Woh Stock A khareedne ke liye tayaar tha. Now inflation has risen to 5% and suddenly he wants 15% return. He no longer wants Stock A that gives him 13% returns.
Yeh micro picture hai. Zoom out karna and imagine the large majority of potential investors going like nahi-nahi-nahi mujhe abhi woh stock nahi kharidna hai. Fewer buyers on the market or less demand means that the stock prices will start to fall. Aapko already pata hai demand supply economics ke baare mein: when supply exceeds demand, prices fall and vice versa.
4th situation mein dekhenge how unexpectedly high inflation affects the earnings expectations and behaviour of long term investors
Some long term investors look at this as a good opportunity to enter the market. Inka soch hai ki stock prices filhal kam hai lekin kabhi nah kabhi increase ho jayega and they will have a higher chance at earnings since they bought at a lower than usual price. Some investors might even reduce their target downward to match the lower stock price that they entered the trade at.
Ab dekhte hai the effect of inflation on growth stocks
Growth stocks earn an increasing rate of return so let’s say you earn Rs 10 this year, your earnings the following year are expected to be Rs 20 and in the following year Rs 40 and in the year after, Rs 80 and so on. That means, if in a given year, inflation affects returns or prices negatively, the negative impact will be compounded. Is liye high inflation ke samey the demand for growth stocks usually drops.
Now let’s have a look at how value stocks fare amidst high inflation
Value stocks are those stocks that deliver a steady rate of return but are - at present - trading below their actual worth. It could be that, what we talked about in situation number 2 is happening: that is, people want to sell stock because they do not feel like the stocks will keep up with the need for higher inflation-adjusted returns. But people are also not buying stock for the same reason. The prices drop.
At this time value investors will gladly accept the discount price. In ke liye full party. In ka goal hai ki kam price mein stocks le lo, taki earnings bhi jaada lene ke chances hongein badme.
What about the effect of inflation on debt or bonds
Aha! Higher rate of interest ka positive effect hota hai nah dost when the investor is the lender and the company is the borrower. Bonds mein kya hota hai? The bond issuer borrows your capital and promises to return it by a certain date with a certain rate of interest. If interest rates in the market are high, investor ko fayda ho sakta hai.
Lastly the effect of inflation in various sectors might be different
You can say ki kai sectors recession-proof rehte hai jaise ki education aur pharma. Jitna bhi recession ho, inflation ho, job loss ho...log apne bacchon ko phir bhi school mein bejenge.
Jitna bhi inflation ho, davai ki zaroorath hogi toh log lenge hi davai. That’s what makes pharma inflation proof. Atleast to some extent.
Lekin phir bhi the profitability of such companies might be impacted by rising input costs, so make sure that you get a thorough picture. Don’t invest based on assumptions.
Overall, inflation that is at about 2% or 3% is seen as favourable and inflation that progresses as projected is also seen as favourable. Aap apne individual holdings pe dhyaan zaroor dena - this is only a guide as to the various ways inflation affects stock market investors.
Even if stocks are trading at a discount in an inflationary period, hamesha us company pe theek tak research karein aur apna risk appetite soch samaj ke hi invest karein. Remember that there can be no guarantees in the stock market and risk is a constant, even if the risk reward ratio is appealing.
Aaj ke liye bas itna hi. Reiterating what’s been said earlier, this podcast has been made for educational purposes only, and the investor must do his own research before investing.
Investments in the securities markets are subject to market risks. Read all the related documents carefully before investing.
Source for inflation adjusted returns