The Investment Scientist

Inflation Change and Stock Return

Posted on: May 27, 2021

Last week, I wrote an article on inflation and stock returns. This week I will continue the theme but study it from a different angle. 

Specifically, last April the inflation rate was 0.3%, but this April it was 4.2%. In one year’s time, the inflation rate has gone up nearly 4%, what does that portend for the stock market? Again, Taro helped me run the numbers and we came up with this scatter plot relating inflation changes to stock returns. Please look at it and see if you can draw some inferences yourself.

Here we can observe a stronger negative correlation: the faster inflation increases, the worse the stock returns. The best interval for stock returns is [-2.5%, 0%], which is when inflation decreases somewhat. However, the most likely interval we will be in is [0%, 2.5%]. Excluding those dots near 0%, one can see stock market gains and losses are about evenly split.

In summary, an increasingly inflationary economy is not the best scenario for the stock market. There are elevated odds of a market drop. One should prepare a balanced portfolio, so when the drop happens, one can pick up shares at a discount.

If you are a client of mine, and you have concerns (or insights) about inflation, let’s talk. Feel free to schedule a time with me here: HTTP://calendly.com/mzhuang/30min.

Schedule a 2nd opinion financial review, buy my wealth mgmt books on Amazon.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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