Wall Street Can’t Agree If Inflation Is Good or Bad for Stocks
Wall Street Plaza near the New York Stock Exchange (NYSE) in New York, U.S.. (Photographer: Michael Nagle/Bloomberg)

Wall Street Can’t Agree If Inflation Is Good or Bad for Stocks

It seems like a pretty basic question: what’s the impact of inflation on stock-market returns?

The answer, however, depends on whom you ask and what historical data you think is germane.

As economists grapple with whether the U.S. is in store for a prolonged bout of inflation or a mere blip on the chart, equity analysts have turned their attention to answering just what it would mean for the stock market if inflation were to take hold.

Strategists at Credit Suisse Group AG led by Jonathan Golub make the case that over the last year, rising inflation expectations -- measured by changes in the five-year breakeven rate -- have coincided with positive returns for stock indexes.

“In contrast to the market’s recent pullback, stock prices tend to increase in periods of higher inflation,” the strategists wrote in a note Thursday.

Wall Street Can’t Agree If Inflation Is Good or Bad for Stocks

In the S&P 500 Index, every sector has, on average, gained on days when concerns over inflation were also on the uptick, they note. The biggest beneficiaries have been energy and financial companies, while the staples and utility sectors saw the most muted returns.

Wall Street Can’t Agree If Inflation Is Good or Bad for Stocks

Leuthold Group reaches a different conclusion based on the historical relationship between the U.S. consumer price index and the price-earnings ratio for the MSCI U.S. Index.

“Equity investors might feel it’s too hot, as higher inflation has historically been associated with lower equity valuations,” Leuthold’s Chun Wang wrote in a Thursday report.

But that finding came with a caveat.

“Admittedly, this relationship has weakened over the past two years but, given the heady valuation level today, it wouldn’t take a big increase in inflation to trigger a derating move.”

Wall Street Can’t Agree If Inflation Is Good or Bad for Stocks

A prior research note from the firm postulated that such a move could translate to a fall of 37% for the S&P 500 Index if its multiples to sales and earnings return to their mean levels since 1995.

Ultimately, the answer might lie not in whether inflation appears, but in the extent to which it manifests, said Keith Lerner, chief market strategist at Truist Advisory Services.

“Some inflation is fine for the overall equity market,” Lerner said. “If you have some inflation and it’s not moving at too rapid of a pace, companies can pass along costs, there’s not sticker shock for the consumer. Yes, some inflation is healthy, but if it gets too hot too fast, there are concerns.”

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