Inflation’s Effect on the US Stocks in 2021
Inflation can reduce purchasing power drastically. The Federal Reserve is the main go-to for questions related to the topic. As expected, inflation has had an impact on the US dollar in 2021, but what about US stocks?
Correlation between stocks and inflation
The Federal Open Market Committee (FOMC), part of the Federal Reserve, judges a 2% increase in inflation year-over-year. However, the price index for personal consumption expenditures (PCE), is the most realistic measurement. That is, in the Fed’s mandate for price stability and maximum employment. When it comes to stocks, higher inflation can be beneficial to value stocks. However, that’s not the case for growth stocks and US indices.
At a corporate level, companies will struggle with higher inflation. That’s only if they don’t increase their prices in line with higher input costs and pass them on to their consumers. As inflation erodes buying power, it impacts consumers instantly. Higher inflation can influence corporate profits as well, causing companies to put a halt to their hiring programs. Consequently, the standard of living of individuals with fixed incomes is reduced.
Inflation’s impact and how we can make it work for us
There are industries whose stocks flourish during a time of high inflation and those that benefit more from low inflation. Since the US dollar is the benchmark pricing mechanism for most commodities, the value of gold, for example, is also impacted by inflation. Traders who have an understanding of inflation and the economic cycle can use it to their advantage when placing trades on a stock or an index and when timed correctly, returns can be significant.
Types of US stocks
Most stocks are classified as either value stocks or growth stocks. Different economic factors will have an impact on their profitability and will fare differently during times of inflation. Value stocks are those that seem undervalued by the market but are likely to rise over time. At the same time, growth stocks are normally correctly valued by the market but offer substantial growth prospects. They are expected to grow at an above-average rate relative to the market. Investors hope to make returns based on the long-term potential rather than its current performance.
Growth stocks tend to underperform in times of inflation since interest rates rise and earning expectations are subsequently affected. Value stocks, however, tend to perform better when inflation is higher because they are often from well-established industries with higher cash flows and are able to increase their prices in line with inflation much better than other industries can. Now that the Biden administration has signed the stimulus package in light of the coronavirus pandemic, $1.9 trillion is on traders’ minds. If inflation continues to rise, US growth stocks will suffer, but specific industries will flourish.
In an interview with The Motley Fool, financial planner Matthew Frankel and host of Fool.com’s podcast, Jason Moser, discuss this topic. They reason that while the Federal Reserve has a mandate to control inflation, it’s more that its monetary policy is loose. Last year’s second half had a lot of inflationary pressure. That was the case partly due to the fact that there was a fiscal stimulus. US stocks are not the only assets that are impacted by the Fed’s decision to keep its monetary policy as it is.
You can go long or short on growth stocks
Nonetheless, it could be a good time to consider going long or short on value and growth stocks. With Eightcap, you can open an account and begin trading or try a free demo account first in just a few minutes. The exceptional support team will be able to guide you and answer any questions you may have throughout your trading journey.
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