Is inflation going to crash the stock market?

(Photo credit: Ehud Neuhaus)

I don’t think so. Why?

Inflation has several causes, and different factors have different weights at different times. Production capacity, production utilization, energy costs, productivity, and monetary cycle play a big role. Some of these are interdependent, and sometimes they work reflexively.

In some ways, the current macro backdrop is very similar to the end of World War II. Like then, we now have high savings rates, consumption restraints, central banks with expanded balance sheets, and huge fiscal deficits.

(Source: FRED)
(Source: FRED)
(Source: FRED)

Ok, so what happened to inflation and interest rates then?

(Data source: the balance)
(Data Source: multpl.com)

What to expect now?

After WWII inflation rose due to the need to reconvert the factories to produce goods, in what was a highly industrial society. There were also many supply-chains that were disrupted and couldn’t be fixed overnight. The fact that right now:

  • There is no lengthy reconversion necessary to put factories back to work.
  • The sectors most affected, air travel and hospitality, by their nature won’t take long to react to an increase in demand.
  • Productivity seems to be on a secular rise.

Makes me believe that we won’t reach the same level of inflation as in 1946 and 1947. I also don’t think that the Fed will allow the interest rates to go much higher than 3.5% on the long-end. I derive my conviction from the huge debt burden. If the interest rates were to rise, the expenses with interest would skyrocket and leave the US government strangled.

Conclusion

Investors have been suffering from fear, uncertainty, and doubt. They mainly fear that higher interest rates will collapse the current valuations in the market. As we’ve seen, there is a strong case for interest rates to remain below 3.5%. At the current P/E ratio of 36 for the XLK, the implicit discount rate is 2.8% (almost double the current 10-year rate). It seems that even for the most exciting sectors of the tech market, we are not one step away from the cliff.

If you think this is too long to read, I’ve made an experimental video explaining this article. As I said, it is experimental so don’t expect much.

Disclosure: This text (and the video) expresses the views of the author as of the date indicated and such views are subject to change without notice. The author has no duty or obligation to update the information contained herein. Further, wherever there is the potential for profit there is also the possibility of loss. Additionally, the present article is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Some information and data contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. The author trusts that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.

2 thoughts on “Is inflation going to crash the stock market?

  1. Great reading. … Video is a nice idea. ….If I compare both informations, I prefer the reading (in 2 minutes I have got the clue) whereas video is scrolled through fast and I could have missed a beef. imo: simply, I don’t have 16 minutes left for any video.
    Final remark: I always read your investment gems because these ideas are superb.

    Have a good day.

  2. Hi FoxSr.
    Many thanks for the feedback.
    I will definitely try to shorten the video length. Ideally, I think 5 to 7 minutes should be enough to convey the ideas. I’ll have to execute better.
    Nevertheless, the videos will just be a complement to the blog posts.
    Regards,
    Nelson

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