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Should Investors Worry if Inflation Rises?

April’s Consumer Price Index was a shocker.

  • The CPI rose 0.8%. Excluding food and energy, prices jumped 0.9%, the fastest monthly reading in 40 years (U.S. BLS).

A debate is raging whether the recent spike is temporary, as the Federal Reserve argues, or something more worrisome.

While a 1970s-style price spiral seems remote, what might be the consequences for investors?

Using data back to 1958, rising rates of inflation have historically depressed stock market valuations.

Valuations have been highest when the CPI has averaged 0–2% annual inflation (Charles Schwab).

Investor’s corner

Why might high inflation depress valuations?

Unwanted inflation can quickly lead to higher interest rates, which compete for investor cash.

High inflation dilutes real earnings.

For example, 10% earnings growth with 2% inflation equals 8% ‘real’ earnings growth. 10% earnings growth with 10% inflation equals 0% ‘real’ earnings growth.

Much higher inflation is not a foregone conclusion and longer-term disinflationary trends remain intact, but the recent pressure on prices may not abate over the short term.

@LWMLLC