Stock market investors: don’t fear inflation

The inflationary trend continues now, but that doesn’t mean investors can’t get great returns.

Start with today’s inflation:

The three underlying causes are:

  1. Too much money
  2. Interest rates too low
  3. Inflationary actions/reactions taken by businesses, other organizations, employees, consumers, investors and Wall Street

Number 3 is why an inflationary trend is so hard to stop. It’s a chain effect of ‘sellers’ pushing prices up at least in line with cost increases and ‘buyers’ trying to hold off the inevitable.

Therefore, don’t expect this Fed to bring inflation under control with a “soft” landing. Inflation well above the Fed’s 2% target is likely here to stay and even rise until the Federal Reserve and political leaders accept the need for drastic and unsavory action.

Agree, this sounds terrible and distressing. So where does the happy investor share come from?

How investors can take advantage of periods of inflationary growth

Remember that inflation drives prices up. On the surface, this means that corporate revenues and profits benefit from higher inflation, which produces stock price gains for investors.

However, industries and businesses are affected differently. Therefore, succeeding in the upcoming inflationary bull market means adjusting strategies and expectations to the changed environment.

How to Adjust Strategies and Expectations

The conditions for understanding and accepting are:

Inflation – Expect an upward cycle of higher highs and higher lows as organizations and consumers get on the bandwagon

Interest rates – Realize that they are still well below the level that the capital markets would set without the intervention of the Federal Reserve. So consider this a bonus inflationary period where the Fed says it is tightening, but in fact it is just reducing the easing already in place. In other words, there’s a long way to go before conditions get really tough.

Economic growth – As long as there is no recession, “real” GDP growth (adjusted for inflation) will remain positive. This means that “nominal” (unadjusted for inflation) growth will increase at a higher rate as prices rise.

Company growth – This is where things get interesting. An inflationary environment creates winners and laggards. So don’t expect yesterday’s winners to be tomorrow’s winners in this new environment. Most likely, a significant change will occur. And that brings us to…

Company actions – As financial, economic and business conditions transform, so will Wall Street. Expect to see new strategies, picks, and valuations based on inflation-based logic. And that means the biggest change to come is probably…

The move to actively managed funds from index funds

The period of inflationary growth will push “outperformance” to the top of investors’ wish lists. The matching of the intermediate results of the entire market will no longer be satisfactory. As active managers charge in, investors will start to come on board.

Skeptical? Do not be. The combination of new, different and outperformance will be like meat to malnourished investors today. It’s a bull market cycle driven by extraordinary conditions that will replace the ominous refrain of inflation-interest-and-recession (Oh, my God!)

Note: As with many trading periods, reasons and results come from a combination of conditions and actions, not a simple explanation. Therefore, be sure to read my previous article, “Exceptionally good conditions for the start of the bull stock market in JulyI list four actively managed funds in which I have invested.

MORE FORBESExceptionally good conditions for the start of the bull stock market in July

The Bottom Line: Many Conditions Create Inflation Trends, So Ignore Simplistic Comments

Many (most?) media reports combine simple explanations with results. Ignore them. They are written by journalists in a given timeframe with no time for analysis. Just think back to the spinning explanations for every daily (or intraday) stock market move. The reason given is normally a coincidence. For example, “8.6% inflation!” Or, “Consumer sentiment at a new low!” Or, when a simple reason is lacking, something like this The Wall Street Journal (June 27) – (emphasis mine)

“U.S. stocks tumbled on Tuesday, giving up early gains and falling for a second day in a row as investors scanned fresh economic data for clues about the pace of monetary policy tightening.”

No, the market did not fall because investors were looking for clues about anything. In fact, most short-term market moves are noise, often reversing a day or two later. A better short-term timeframe to watch is a week, as the weekend market close forces day traders to sit on their money.

Instead, follow economic, business and financial developments without trying to tie them to a stock market movement. A beneficial approach to tying everything together is quarterly analysis. Why wait three months? Because each quarter contains all of the earnings reports (and management outlook), followed by the quarter-end report and active managers’ analysis. Moreover, examining a quarter-by-quarter trend eliminates all intermediate fluctuations which may produce more uncertainty than understanding.

Robert D. Coleman