INFLATION & STOCKS

We are currently in an inflationary environment. It is important to understand how it affects stocks

Consumer Price Index

Have you ever heard the economists talk about CPI and they just assume we all know what they are talking about?

CPI is the price of a basket of goods. The basket mimics the average household in an economy. In SA, they review the CPI basket every four to five years. We all feel like food prices are out of control and no ways inflation can be 5%, well it is because of the other items in the basket, so we get an average. You can see the image attached.

In the basket you have things like:

• Food
• Housing
• Clothing
• Communication
• Healthcare
• Education
• Transport
• Recreation & Others

Inflation

Inflation is simply the change in CPI. If the basket was R1000 in year 1 and R1100 in year 2, Inflation is 10%.

If you ever hear people talk about Deflation, it simply means that CPI is decreasing. The basket costs R1000 in year 1 and R900 in year 2. Okay, we would love that, but I havent lived through Deflation yet.

Hyperinflation is rapid, excessive, and out-of-control general price increases in an economy. Zimbabwe and Venezuela currently have hyperinflation with 132% and 222% respectively.

Inflation is not necessarily a bad thing. It is a sign that an economy is growing. All central banks have inflation targets. In SA we currently target 3-6%. The problem arises when inflation goes outside of the target area and becomes uncontrollable. Then central banks respond by increasing interest rates to curb spending.

How the General Economy & Stocks respond to Inflation:

1. Interest rates go up to curb spending
2. Companies need to pay more interest on their debt
3. Prices are generally higher, so the cost of production also goes up
4. Workers demand higher salary increases, so the cost of labor goes up too
5. Customers have less money to spend, so sales drop
6. Profits naturally drop because sales are down and costs are up
7. Companies become risk-averse & invest less in higher risk projects
8. Share prices drop

The immediate impact of Inflation on Share Prices is thus negative. There is however no need to panic. Central governments have been managing this for centuries and will continue to do so long-term. We are long-term investors after all.