Inflation is the gradual increase in the prices of goods and services over time, which reduces the purchasing power of a currency. On the other hand, the stock market is a platform where investors can buy and sell shares of publicly traded companies. The stock market and inflation are interconnected, and understanding the relationship between the two is crucial in making informed investment decisions.
What is the relationship between stock market and inflation?
The stock market and inflation have an inverse relationship. When inflation increases, the value of the currency decreases, and investors demand higher returns to compensate for the loss in purchasing power. This increased demand for higher returns leads to higher interest rates, which negatively impacts the stock market. On the other hand, when inflation decreases, interest rates decrease, and investors have more disposable incomeThe income statement provides a summary of a company's revenue and expenses over a specified period of time, typically a year or a quarter. It shows the company's total revenue, th..., which leads to increased demand for stocks and positively impacts the stock market.
How does inflation impact stock market performance?
Inflation can impact the stock market performance in several ways. First, inflation increases the cost of goods and services, which reduces the profitability of companies. As a result, the stock prices of companies that are sensitive to inflation, such as consumer staples, utilities, and healthcare, tend to underperform during inflationary periods. Additionally, companies that hold a high amount of debt, such as real estate companies, may also suffer during inflationary periods as their debt becomes more expensive to service. On the other hand, companies that have pricing power, such as technology and energy companies, tend to outperform during inflationary periods.
Strategies for investing during inflationary periods
Investors can take several strategies to protect their portfolio during inflationary periods. One strategy is to invest in assets that provide a hedge against inflation, such as gold, real estate, and infrastructure. Another strategy is to invest in companies that have pricing power or are less sensitive to inflation, such as technology and energy companies. Additionally, investors can consider investing in inflation-protected securities, such as Treasury Inflation-Protected Securities (TIPS), which are designed to keep pace with inflation.
What is an institutional investor?
An institutional investor is an entity that invests large amounts of money on behalf of other individuals or organizations. These investors are typically large financial organizations such as pension funds, mutual funds, hedge funds, insurance companies, and endowments. Institutional investors have significant resources and are able to influence the market due to their size and financial power. They invest in a variety of assets including stocks, bonds, real estate, and other alternative investments. Their primary objective is to generate returns for their clients while managing risk.
What SPY Is Telling Us about Institutional Investors
It’s no coincidence that SPY bottomed in October of 2022, right as we got the last high reading on inflation. As inflation has come down from Fed rate hikes, the stock market has gone up. The fact that institutional investors still believe that we’re past peak inflation shows up on SPY in two ways: first, the market has not yet gone back to retest the October 2022 lows, and second, the 200 day moving average on SPY is still holding.
Consider that when the PCE and CPI numbers came in a little hot, SPY began a short-term downtrend move in mid-February 2023. That downtrend came to an end when SPY hit its 200 day moving average. The very level that SPY needed to hold, it did. What does that mean? It means institutional investors are still confident that we’ve hit and are past peak inflation and, while the inflation numbers were a little hotter than hoped, the Fed’s rate hikes from months ago are still being priced into the market. They are confident that the Fed’s rate hikes are still enough to bring inflation down to the 2%+ area, albeit at a slower pace than initially hoped.
We can think of the 200 day moving average and the October lows as mind-reading tools at our disposal. We can actually read the minds of institutional investors by looking at the chart of SPY.
Extending this logic into practice, if the 200 day moving average fails to hold, it means institutional investors are becoming increasingly concerned that the Fed is unable to bring inflation down. If the October 2022 lows are retested, it means that institutional investors are in serious doubt over the Fed’s ability to get inflation under control.
The fact that SPY rallied off the 200 day moving average means that institutional investors are not that concerned about inflation or the Fed’s ability to bring it down. That means you and I shouldn’t be that concerned about it either. If SPY breaks below the 200 day moving average in the near future, that’s when we will get more concerned about inflation. Until then, we’ll continue to look for chart setups on the long side.
