How does inflation impact the stock market? Well, when inflation rears its ugly head, many investors shift their prospective investments accordingly. Often the winners in the stock market are directly based on current inflation expectations. With the Federal Reserve announcing its first interest rate hike since 2018 yesterday, many investors have hunkered down with stocks able to endure the rampant uncertainty.
One of the most immediate and impactful changes investors make in the face of inflation is the shift from growth to value stocks. While growth stocks tend to provide better long-term returns, inflation breeds uncertainty. As such, startups and still-unprofitable companies are more vulnerable to volatility.
Why? Well, rising prices tend to weigh more on growth stocks than on more established companies. Younger companies also tend to suffer more from the increase in input costs that stems from inflation. The increased expenses are frequently passed over to investors in the form of lower dividends, as well as weaker revenue and profit margins. Growth stocks are especially dependent on strong quarterly figures to maintain investor confidence. Even minor doubts in a startup’s staying power could spell doom for a company’s share price.
How Else Does Inflation Impact the Stock Market?
Higher dividend yields are one of the more immediate and obvious benefits of value stocks during periods of higher inflation. Startups and other growing companies frequently earn minimal, if any, profit in their first years of business. For example, Uber (NYSE:UBER) has been around since 2009, but reported its first profitable quarter just in November 2021. As such, growth stocks tend to offer lower dividends (if they do at all) than established companies with realized revenue flows.
In addition to value stocks, certain asset classes gravitate toward stronger performance. Certain commodities, like gold, oil and copper have historically been viewed as solid inflation hedges, with Bitcoin (BTC-USD) and other cryptocurrencies recently entering the conversation. Real estate is another example of a less inflation-adverse industry that could prosper in times of higher prices.
Inflation continues to weigh on every savvy investor’s mind. With the Fed planning up to seven interest rate hikes this year to combat the rising prices, staying ahead of the curve can be a sure fire way to ensure persistent growth — even in times of uncertainty.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
