Higher inflation Doesn't equal Higher Stock prices PART1
There is a prevalent opinion today that if the US economy achieves higher inflation rates, that corporate earnings will be higher and households' dipsosable income (and dollar value going into investments) will get higher, thus elevating stock prices. Most evidence i have found from the past leads to the contrary!!!
The 3 reasons i believe we see this phenomenon is:
1) Lower and middle income households income is based on wages. Wages are sticky and usually don't increase directly with inflation. Thus, the dollar amount contributed to consumtion is increased and the dollar amount contributed to investing stays the same or even decreases!!!
2) Hyperinflation is always in pair with tensions in the political environment (Always Bad for stocks)
3) The stock market is forward looking. And a higher inflation rate means a higher expected rate increase.
Of course the way inflation is calculated has changed from the 1970's. That gives investors a false feeling of security (USA has 12 to achive inflation higher than 5% and 39 years to achive higher than 10%). The truth is US consumers are beginning to notice as more people live paycheck to paycheck and that will only elevate reason 2).
The counter-arguments
The "Money Printer" argument is a valid one, but investors need to keep in mind that this provides a "floor" for the SP500 (you may have heard the FED Put). That gives a good risk-reward for equities by reducing risk, but doesn't necessarily justify higher valuations.
The paradigm shift in tech is the most valid argument in my opinion. But this is (mostly) priced in, FANG stocks are priced at more than 35 P/E each. While being 1 or even 2 TRILLION dollar businesses!!! You can achieve more than 10% growth for 30 years each year if you have 100 million EBITDA. But AMZN at 40 Billion EBITDA if we assume 10% growth in 30 years they will have EBITDA equal to 698 Billion (That is 125% of Sweden's GDP). It is obvious that you can't have a private company commanding that much growth, especially AMZN which grows at the expense of smaller shops.
Having in mind all the parameters. The SP500,NDX can achieve 3650-4000, 13000-15000 just because of the money that are now on the sidelines (Asset managers that are forced to buy and hold a certain portfolio percentage in equities).And because of Lower-tier Large cap Tech Companies like TSLA,AMD, etc. . But don't fool yourself we are in bubble territory and equities will probably NOT be the top investment of the 2020 decade.
The 3 reasons i believe we see this phenomenon is:
1) Lower and middle income households income is based on wages. Wages are sticky and usually don't increase directly with inflation. Thus, the dollar amount contributed to consumtion is increased and the dollar amount contributed to investing stays the same or even decreases!!!
2) Hyperinflation is always in pair with tensions in the political environment (Always Bad for stocks)
3) The stock market is forward looking. And a higher inflation rate means a higher expected rate increase.
Of course the way inflation is calculated has changed from the 1970's. That gives investors a false feeling of security (USA has 12 to achive inflation higher than 5% and 39 years to achive higher than 10%). The truth is US consumers are beginning to notice as more people live paycheck to paycheck and that will only elevate reason 2).
The counter-arguments
The "Money Printer" argument is a valid one, but investors need to keep in mind that this provides a "floor" for the SP500 (you may have heard the FED Put). That gives a good risk-reward for equities by reducing risk, but doesn't necessarily justify higher valuations.
The paradigm shift in tech is the most valid argument in my opinion. But this is (mostly) priced in, FANG stocks are priced at more than 35 P/E each. While being 1 or even 2 TRILLION dollar businesses!!! You can achieve more than 10% growth for 30 years each year if you have 100 million EBITDA. But AMZN at 40 Billion EBITDA if we assume 10% growth in 30 years they will have EBITDA equal to 698 Billion (That is 125% of Sweden's GDP). It is obvious that you can't have a private company commanding that much growth, especially AMZN which grows at the expense of smaller shops.
Having in mind all the parameters. The SP500,NDX can achieve 3650-4000, 13000-15000 just because of the money that are now on the sidelines (Asset managers that are forced to buy and hold a certain portfolio percentage in equities).And because of Lower-tier Large cap Tech Companies like TSLA,AMD, etc. . But don't fool yourself we are in bubble territory and equities will probably NOT be the top investment of the 2020 decade.
