Inflation Is Unlikely To End The Stock Market Rally Any Time Soon

 | Feb 19, 2021 12:10

Inflation is unlikely to end the stock market rally any time soon

With inflation expectations reaching multi-year highs, worries about the impact on equities are increasing. But if history is any guide, the now-expected temporary upswing in inflation to between 2.5% and 3.0% is unlikely to derail stock markets. Today’s chart shows the relationship between the return of the S&P 500 and annual inflation since 1955. The chart incorporates both coincidental returns as well as the return on the index 12 months before, as equity markets are forward-looking. It shows that there is indeed a negative relationship between the level of inflation and S&P 500 returns. But only when inflation becomes ‘high’ (in this data sample meaning inflation of 3.8% and upwards) does the market start to falter. When inflation rises above 6%, the return becomes outright negative. However, with current headline CPI at 1.4% and inflation expected to average 2.20% over 2021 (I wouldn’t even rule out inflation of 2.5%) there is no imminent danger. Other indicators, however, paint a less rosy picture, but we’ll save that for another day.