Inflation rates in the United States have climbed to a five-year high. It reached 2.24 percent in January, resulting in an upward adjustment in inflation expectations for investors.
Although stocks are seen as an asset that protects relatively well from the effects of inflation, this lesson may not apply at a time when inflation expectations are changing significantly. There are two opposing effects on investors’ decisions. First, higher inflation means that future corporate earnings must be discounted at a higher percentage when converted to current value. This means that the present value of future profits is declining, discouraging investors from buying shares of companies at present.
Second, higher inflation means that firms will be able to raise the prices of their production, which will mean an increase in nominal earnings. This, in turn, improves expectations of a rise in its share prices, and investors have reason to buy them today. So the question is which of the two effects will prevail with investors. While analysts consider the latter line to be rational, investors tend to behave irrationally.
That’s why there’s concern about whether Stocks on Wall Street still have a place to grow. But they are playing into the hands of a recent statement by Fed Chairman Jerome Powell, who said that central bank policy would put full employment ahead of inflation.