As per the recent data on inflation, the CPI inflation for the month of January stood at levels higher than expected and this economic indicator has a considerable impact on stock and bond markets which move in tandem with rate of inflation. Also there are a host of other economic factors which lend their influence of stock markets including interest rates, GDP etc.
With increase in inflation as in the current scenario there is an increase in the bank interest rate sooner or later
By investing in stocks, we actually bet on the future cash flows of the company depending on the earnings and profits of the concern. And present value, a finance concept, of these future earnings of the concern are arrived at by taking into account both inflation and interest rates.
And any probable hike in interest rates, pushes bank interest rates higher and with it the present value of these future cash flows takes a hit and hence in this stock prices and inflation share an inverse relationship.
Also, this can then be associated to the rising bond yield with which then again debt instruments get in favour.
One theory suggest inflation to increase stock prices
In the second concept, when inflation is on the rise, the companies are able to extract more cost from the consumers and as a result present value of the future cash flows increases and hence the stock price should likewise increase. But in the scenario, when inflation plays out, the two effects in theory should cancel out.
But what happens actually is that with inflation, stock prices take a hit and are in a general trend battered.
Factors that produces gains in stock markets most probably
Also, an argument being given since long per se investment in stock markets is that it should provide for enough returns to beat inflation. Also as per a previous research by Citi Investment Research for equities to offer you gains, inflation should be range bound i.e not very high and not very low, inflation should be on the decline and valuations should be reasonable. Liquidity and other fundaments also play their part with the stock returns.