Understanding Inflation and the implications for the performance of Stock Markets
Inflation is having a widespread impact across the global economy. What is important to understand is that the composition of inflation is different in different economies. If we can look at inflation from this standpoint this can help to give us some indication of the trajectory of stock markets.
In the United State (US) for example, one of the biggest components of their inflation spike is made up of wage inflation. Leading indicators of the status of the US economy have shown that it is weaker than previously but still in positive territory. The growth in the US jobs figures in July is reflective of the growing possibility of a mild recession in the US, possibly ending as early as the first half of 2023.
Interest rates will continue to be raised by the Federal Reserve (Fed) to try and dampen inflation but the softer than expected Consumer Prices Index Report in the US on the 10th August, indicates we are closer to the peak of the interest rate tightening cycle in the US. Once markets appreciate this and see inflation reducing there is great potential for a bounce back in equity valuations.
Compare this to the position in the UK and Europe. At present these economies are suffering a significant supply shock due to the impact of exponential increases in gas and oil prices, combined with the rise in the cost of staple foods.These shocks will bring about a slowdown in economic activity, irrespective of interest rate increases. Recession is looming and for this reason there would appear to be less need for the Bank of England (BofE) and the European Central Bank (ECB) to take interest rates significantly higher. Gas, Oil and food costs will stay higher for longer which will have a longer economic impact on these two economies.
What we do have to remember is that the performance of individual stocks and shares does not necessarily follow the same trajectory as the economic markets they operate in. While volatility is prevalent there will be winners as well as losers. Our job is to try and find the stocks that will offer value in times where market fundamentals are challenging.
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