Friday, December 9, 2022

How does inflation affect the value of stocks

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This graph can be used as a starting point…

main qimg 45172638b57417034efceebd56ee017f pjlq

It’s important to remember that when there’s inflation, each unit of currency loses value.

Because we live in a world where central bank intervention is common (due to central bankers’ desire to control everything), whenever inflation rises, central bankers will taper bond purchases (cut back on money printing) and even raise interest rates to make each unit of currency more expensive, thereby easing inflation.

Take a look at how the financial markets (S&P 500) are driven by central bank monetary policy…

main qimg 6d86308f34cf7c937012e13102ee2d2b lq
  • Red Arrows = When the Fed’s balance sheet has reduced or stopped increasing.
  • Green Arrows = When the Federal Reserve declared that it will inject more liquidity into the economy through quantitative easing (or money printing).

Interest rates, as I previously stated, are very important…

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Stock prices are inversely tied to interest rates because of:

  • When interest rates are rising, interest rates on all debts are raised.
  • This entails higher borrowing costs, which reduce profits and make it more difficult for businesses to borrow money for expansion.

Now for a fun fact…

Did you know that the years 2020 and 2021 produced 35% of all US dollars ever printed?

Yes, the Fed continues to print money and suppress interest rates, causing the stock market to rise, but take a look at the US debt-to-GDP ratio…

main qimg d2f36089c5d4bacac2c9de74df6302d1

There are only two possible outcomes…

  1. A Deflationary Default – occurs when the US government refuses to pay its debtors, causing individuals to hoard dollars (making it more valuable).
  2. An Inflationary Default – The United States will be unable to repay its lenders unless it continues to produce money, so inflating its debt away. It’s worth noting that 51 of the 52 countries that have reached a debt-to-GDP ratio of 130 percent (like the United States) have defaulted on their obligations due to inflation or hyperinflation since 1800. The probabilities of this situation don’t require a genius to figure out… To me, this sounds like a “when-not-if” opportunity.
See also  How to master the stock market with no money, no experience, and no knowledge about stocks?
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