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The impact of inflation on the stock market

by , 03 August 2015

Whilst Europe and the UK face deflation, South Africa is contending once again with rising inflation.

So what impact does inflation have on the stock market and shares? And what about the effect of hyperinflation on stocks?

Read on to find out more…

The two main effects of inflation on the stock market

Inflation can impact the stock market in two main ways…

  • The first is that company profits can come under pressure.
  • The second is that what investors are willing to pay for these profits changes.

Historically, periods of severe inflation (or hyperinflation) are bad for shares.

The impact of severe inflation on shares

When companies face period of severe inflation, they struggle to contend with rising input costs. For example raw materials rise in price along with wages.

These businesses then face the problem of passing these costs onto their customers at a rate needed to combat the severe inflationary environment.

This results in companies with margins under pressure, Cris Sholto Heaton in Money Week explains.

A positive of high inflation is it offsets fixed costs. Fixed costs include rental agreements and debt repayments.

But high inflation leads to the growth of company profits lagging behind inflation. And during times like this, there will be worries about the economic outlook.

This can lead to investors selling out of stocks and turning to hard assets instead, like gold, other commodities and property. This results in the valuations of stocks falling.

In real terms (when adjusted for inflation), stocks markets can rack up huge losses.

What happens when severe inflation becomes hyperinflation?

If severe inflation steps up to hyperinflation, this can be good news for the stock market.

This is because investors who’ve stayed in cash and bonds see the value of these assets tumble, so they turn to the stock market. In many instances when there’s hyperinflation, the local currency will also be weakening.

This results in investors taking their money and putting it to work overseas.

What is the best inflation environment for stocks?

Stocks appear to perform best in a mild inflationary environment. Looking at the S&P 500’s returns from 1926 to 2009, this was certainly the case when inflation hovered between 0.1% and 3%.

So there you have it, the impact of inflation on the stock market.

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The impact of inflation on the stock market
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