Inflation: what you need to know about the "silent tax" and the value of your stocks
The impact of an inflationary environment on the prices of your stocks. Knowing this can put you at a massive advantage.
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Happy Monday!
Let’s start the week off strong.
The agenda for today:
👉 There’s no stopping the S&P 500 📈
👉 Companies continue to beat earnings 💸
👉 The effect of inflation on your portfolio and how to combat it 📉
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Weekly Market Update 🗒️💡
Indexes
The S&P added 1.3% this past week, while the Nasdaq gained 2.3%. The Dow finished flat.
All three major indexes notched their 5th straight winning week and 14th positive week in the last 15.
Additionally, the S&P 500 closed above 5,000 for first time ever, nothing its fifth straight winning week.
Good times ahead?
The S&P reaching 5,000 for the first time ever is a good sign for stocks, said Adam Turnquist, chief technical strategist at LPL Financial.
In the past, the S&P 500 has more often than not risen in the 12 month period following a new milestone.
Looking back to 1968, the last 9 times the index hit a new milestone, it averaged a 10.4% gain in the 12 months following.
In March 1995, when the index reached 500 for the first time, it rose by ~30% in the 12 month period following.
The same thing happened in 1998, when the index hit 1,000 for the first time, it rose ~26% in the 12 month period following.
Will the S&P 500 continue to rise over the next year? Only time will tell, but it looks promising.
Some Notable All Time Highs in the S&P 500
36 stocks in the S&P 500 reached an all time high this past Friday.
Here are 5 notable names:
Nvidia NVDA 0.00%↑ trading at all-time high levels back to its IPO in Jan 1999
Microsoft MSFT 0.00%↑ trading at all-time high levels back to its IPO in March, 1986
ServiceNow NOW 0.00%↑ trading at all-time high levels back to its IPO in June, 2012
American Express AXP 0.00%↑ trading at all-time high levels back to its IPO in May, 1977
General Dynamics GD 0.00%↑ trading at all-time high levels back to 1952 when it was incorporated and listed on the NYSE
Earnings are Solid
On average, companies are beating earnings, but revenues are lagging.
73% of the 795 stocks that have reported quarterly earnings so far have beaten them, fueling the S&P 500’s steady gains.
The effect of inflation on the stock market and…. your portfolio
Whenever you think about inflation, there’s a chance you associate it with rising prices on every day items.
Things like groceries, public transit, car prices and any other necessities we buy on a recurring basis.
But what about your stock portfolio?
What is Inflation?
Also known as the “silent tax”, inflation is the rate of increases in prices over a given period of time.
It’s a broad measurement, such as the overall increase in prices or the increase in the cost of living in a specific country.
Inflation is seen as a bad thing, and rightfully so, people don’t like when the prices of every day goods start rising.
It causes living costs to rise and when wages don’t keep up with the inflation rate, consumers begin struggling financially.
You’re probably aware of how inflation affects us in our daily lives, but what is the impact on your investments?
Should you be worried about inflation as an investor?
Short answer: Yes.
Investors should be taking inflation into account when putting together their investing strategies.
Sudden spikes in the inflation rates have historically caused volatility in the stock market.
This is typically because share prices are based on the expectation of a companies future earnings. When inflation is high, it might create a barrier on their ability to generate the returns they hoped for.
Inflation can squeeze the margins of a business, putting strain on their earnings which can lead to poor performance and stock sell-offs.
On the other side of the coin, the Fed’s response to long periods of inflation has proven to be a catalyst for stock prices in the past, so realistically it’s difficult to predict exactly what inflation will do to the value of your investments.
To put this more into perspective, let’s look at some examples of the inflation rate Vs. the historical performance of the stock market in the U.S.
1942
Inflation: 10.9%
S&P 500 return: 19.2%
1973
Inflation: 6.2%
S&P 500 return: -14.3%
1980
Inflation: 13.6%
S&P 500 return: 31.7%
Although a small sample size, you can see that there have been periods of very high growth in the U.S. despite astronomical inflation rates.
It’s important to note that past performance does not guarantee future returns, especially when it comes to the relation between inflation and stock prices.
Options for Investors When Inflation is High
Although you have absolutely zero control on the inflation rate and how the Fed decides to handle the situation, you do have control over how you manage your investment portfolio.
There are ways to hedge against inflation and at least protect your purchasing power as much as possible.
Because let’s face it, keeping money in a traditional savings account just isn’t a good option.
I’m a firm believer that there is always opportunity in the market, no matter what the economy is doing. You just have to be willing to look for it.
Not all stocks/sectors are negatively impact by high inflation either.
Those with strong balance sheets, small amounts of debt, solid margins and good cash management will thrive during unexpected periods of high inflation.
Here are a few hedges you can use.
High-Yielding Dividend Stocks
A good hedge against an inflationary environment is investing in stocks that offer a high dividend yield.
This goes against everything I preach as a dividend investor, but sometimes transferring your money into high yielding stocks is a good option to help offset the effects of rising prices and volatility in share prices.
From 1973-1981, which was a period of high inflation and low growth, the highest dividend paying stocks produced an annualized return of 9.9%, better than inflation (9.2%) and the S&P 500’s dividend adjusted annualized return of 5.2%. - MarketWatch
Real Estate Investment Trusts (REITs)
REITs are a good option in a period of high inflation because they provide steady streams of income from the rental payments of the properties they own, which can help offset some volatility in the market.
“In 2021, considered a high inflation year (7.0% or greater), REITs outperformed the S&P 500 by 12.6 percentage points with an annual return of 41.3% compared to 28.7% for the S&P 500. REITs tend to outperform in the high inflation periods, with strong income returns offsetting falling REIT prices. On average, REITs outperformed the S&P 500 by 5.6 percentage points during these periods.” - Seeking Alpha
Inflation Resistant Sectors
There are some sectors in the stock market that are less affected by inflation than others.
These include energy, health care and consumer staples, which all produce and provide essential goods and services that are in high demand regardless of what’s going on in the economy.
These sectors also tend to pay out higher dividends on average than others, providing investors with a cushion against market volatility.
Final Notes
Hedging against inflation is an important part of financial planning, which is why I love buying cash flowing assets like dividend stocks.
Being able to average an annual dividend growth rate that outpaces the inflation rate is the key to maintaining purchasing power and enabling your dividend income to continue growing and compounding into something much bigger and more significant.
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Thank you. For any1 interested, here is my article about whether inflation has become a problem for the Fed:
https://open.substack.com/pub/arkominaresearch/p/has-inflation-become-a-problem-for?r=1r1n6n&utm_campaign=post&utm_medium=web
Really good article thanks for sharing being aware of inflation is a MUST and more nowadays and as an investor we have to be aware of this so we know all REAL RETURNS !!