Investors seem to be only now realizing that we have begun to live in an environment of elevated inflation, which may have translated into declines in stock market indices this week. The markets waited until the last minute to bring up the topic, as inflation data from the US will be released today.
Why has the topic of rising prices suddenly become so important? We have been writing about the higher inflation environment for quite some time, but today could be the highest annual US price growth reading in a decade. However, compared to Poland, it may not be much, as inflation in Poland is expected to be the highest in two decades. However, returning to the USA, year-on-year inflation in April is expected to reach 3.6 percent. Moreover, it may remain above the 3 percent level during the summer.
Historical data shows that inflation in the U.S. being above 2.7 percent can affect stock valuations on the U.S. stock market. Mostly, if history were to repeat itself, as it may but does not have to, with the kind of inflation the market is currently expecting, stock prices have been at the levels of a year ago. In other words, if U.S. inflation remains above 3 percent in July or August, U.S. stock indexes could find themselves at July or August 2020 levels.
Because the bull market in stocks has taken the indexes enormously upward, with the Nasdaq Composite index scoring its biggest annual gain since 1999, the corrections could range from 12-18 percent over the summer. With such a pullback, the stock market would be in the region of the levels from the summer of last year. It would be the biggest correction since the Covid panic of last March. This is what the stock markets are afraid of.
But high inflation may not translate into interest rate hikes by the Fed. Hence, money from stocks may flow in other directions. On the one hand, safe-haven gold may be tempting to protect against inflation, and on the other hand, cryptocurrencies are hitting record highs even with a pullback on Wall Street. Capital will thus look for new markets, as it is unlikely to return to cash, due to negative real interest rates.
So while higher inflation may mess with the stock market, it could be an opportunity for other markets to rise. Data from the U.S. will be released at 2:30 p.m. today.
Daniel Kostecki, Chief Analyst Conotoxia Ltd.
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