The Stock Market and Inflation: New Trends for 2017

Since 2015, economists and market analysts in the United States have been worried about inflation, but not in teh way most people would think. As members of the foremost consumer economy in the world, Americans worry about how inflation could hit their wallets; analysts, on the other hand, worry about inflation on a macroeconomic level.

Inflation is supposed to have an effect on the financial markets, but a certain correlation seems to have gone missing over the last few years. When the United States entered its Great Recession in 2008, inflation was where it needed to be; Wall Street crashed due to the realization that the housing bubble and the subprime mortgage market were built on a house of cards that had to come down. At that point, inflation took on a reverse course due to drastic monetary measures taken by the Treasury and the Federal Reserve. The economy has been recovering at a gradual pace, but inflation has stayed put despite greater consumer spending; all the while, stock markets around the world are shrugging off the absence of inflation.

An Emerging Trend

Market volatility is something that Fed Reserve Chairwoman Janet Yellen is not going to tolerate. In November 2016, when Donald Trump was surprisingly elected U.S. President, the global markets initially tumbled, quickly recovered and then rallied. When the Fed met to raise the prime rate days later, Yellen stated that she would approve another raise if she noticed extreme volatility again, and she also mentioned that the absence of inflation could be problematic.

Months later, the economic recovery continues and traders are reacting more rationally to White House scandals, and inflation is starting to creep up. At this time, the prospect of inflation could actually boost equity securities for a couple of reasons:

  1. The job market is getting tighter, which means that wages are set to push higher. When payrolls are disbursing more money to American workers, consumer confidence gets a boost that reverberates positively for the national economy and for Wall Street. Under these conditions, inflation could grow up to four percent over the next twelve months, and the stock market would benefit from the optimism.
  2. Members of the Federal Reserve have been very guarded, but their approach may accelerate once the consumer economy starts picking up steam. The way it usually works in the retail sector is that companies do not make a move until the Fed does, but this does not apply to the real estate sector. This means that the Fed will watch the housing market very closely and may raise the prime rate by half or three quarters of a point to cool things down, which would be the green light for most retailers to raise prices.

With the above in mind, investors should not worry too much about inflation making a sudden appearance that floors consumers and makes Wall Street nervous. Everything thus far points towards a gradual increase in consumer prices, and this is actually good for a recovering economy.

The Bottom Line

Investors should not become fixated on watching consumer prices. It is more important to keep an eye on major geopolitical events such as armed conflict and the production patterns of OPEC. Inflation is coming to the American economy, and the only thing that can stop it would be failure by the Trump administration to introduce fiscal stimulus measures.