You may be wondering why we are suddenly jumping into economics. Here’s a thing to note: the stock market is not limited to market studies and stock analysis; all other factors like geographical, political, environmental, and economic factors have a huge impact on the stock market.
Inflation is another major economic factor that plays a significant role in the stock market. The impact of inflation on stock market is crucial. But before getting started, you need to understand what is inflation.
So, what is inflation?
An increase in the price of goods and services produced which results in a devaluation of the purchasing power of money is known as inflation. In simple terms, inflation is a rise in the price of goods and services that reduces the buying power of the public.
The inverse of inflation is deflation.
Deflation refers to a decrease in the price of the goods and services produced, resulting in a rise in the purchasing power of money. It strengthens the economy as it allows more goods and services to be bought with the same amount of money.
TYPES ON INFLATION
There are generally two types of inflation; they are as follows:
1. Demand-Pull Inflation.
Demand-driven inflation is an increase in the price of goods and services caused by an increase in demand. It occurs due to a shortage of supply that leads to an increase in prices. Demand-driven inflation also occurs when there is an increase in the money supply and credit stimulates the overall demand for goods and services in an economy.
2. Cost-push inflation.
Cost-push inflation is a rise in the price of goods and services due to the higher cost of production. It is caused by an increase in the price of inputs like raw materials, labor, etc. These developments lead to higher costs for finished goods or services and work their way into rising consumer prices.
Now that you know everything about inflation, it’s now time to study the impact of inflation on stock market.
So, without any further ado, let’s get started:
Impact of inflation on stock market.
We invest to grow our hard-earned money and beat inflation. Professional investors are constantly monitoring global inflation rates. Wondering why? The impacts of inflation on the stock market are endless.
Here’s how inflation affects the stock market.
1. Low Purchasing power.
Rising inflation is accompanied by higher interest rates. Central banks tend to increase the interest rate to correct inflation. Higher interest rates and higher inflation rates will reduce the purchasing power of consumers.
Since the purchasing power is lower, investors will not be able to save and invest much in the stock market. This can decrease liquidity in the market and cause market corrections as well.
2. Volatility
It is observed that the market becomes extremely volatile due to rising inflation. This occurs due to aggressive buying and selling in the stock market. Retail investors try to withdraw their investments to avoid losses, and the FII and DII try to acquire a significant part of the stock market by taking advantage of the anxious retail investors.
I would suggest being patient and holding the stock as long as possible. The volatile market won’t last forever, so stay invested and avoid reacting to the daily news as much as possible.
3. Unprofitable Businesses
As discussed before, the high inflation rates reduce the purchasing power of the general public. Since people aren’t able to buy more, businesses fail to generate profits. However, businesses that cater to the regular needs of the consumers like medicines, groceries, etc., tend to survive.
Businesses are the backbone of the GDP (Gross Domestic Product). Unprofitable businesses also lead to a low GDP and affect the economy of the country.
Impact of inflation on Indian stock market.
As I mentioned earlier, rising inflation is accompanied by rising interest rates, so if there is inflation in the US or any other country, the federal bank will also raise interest rates.
Due to increased interest in the US or any other country, foreign investors, i.e., FIIs, will withdraw or reduce their investments in the Indian stock market. FII reportedly has an overall 21.7% stake in the Indian stock market. The stock markets would experience excessive capital losses because of the intense selloffs and reduced entry of new investors.
Low investments by the FII or withdrawals will lead to a massive market crash in the Indian stock market.
Bottom Line
Keep in mind the old proverb “inflation is a silent killer” at all times. You must maintain close observation and have the proper balance of both equity and debt assets in your portfolio.
As per my concern, investors should not panic in such a situation and try to hold investments as much as possible. I hope you find this article informative. Also, feel free to reach out to us if you have any questions or want to add anything.
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