DECODED: How inflation impacts the stock market? What investors should know - EXPLAINED

When the inflation rate increases, the cost of living increases too, which in turn eventually results in lowering your purchasing power.

Inflation is basically a gradual rise in the prices of goods and services. Reuters pic.

Many times people remain confused and curious over inflation as a business term. They wonder what it is, its causes, what happens when it increases and what impact its leaves on your pocket. Inflation is not a devil as it is generally assumed. In fact, a controlled rise in inflation rates is a sign of a growing economy. Ravi Singhal, Vice Chairman, GCL Securities, shares his knowledge on inflation from various aspects and its impact on stock market in coming months:-

"Inflation is basically a gradual rise in the prices of goods and services. When the inflation rate increases, the cost of living increases too, which in turn eventually results in lowering your purchasing power.

What are the key causes of inflation?

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1- Demand-Supply

2- Increase in the cost of production

How does rising inflation impact you?

- Rising inflation decreases the purchasing power of investors

How does rising inflation impact the Stock Markets?

1- For dividend-paying stocks: An increase in the rate of inflation can cause a drop in their market price. This is because, with rising inflation rates, dividends can fail to beat inflation making such stock less attractive to investors.

2- For metal stocks: As inflation rises, the price of raw materials also go up and this helps scrips in increasing profit, while metal users as components, their profits decrease.

3- Stocks with high debts will be impacted more as RBI increases rates of interest

Value stocks vs Growth Stocks: Impact of inflation

In a nutshell, we can say that the market value stocks prices are usually directly proportional to the rate of inflation. Therefore, when the inflation rate rises, value stocks tend to perform better.

On the other hand, growth stocks have minimal cash flows. Therefore, they have a negative correlation with the rate of inflation. The market price of these stocks drops when the inflation rate rises.

Long-term investors must consider the fact that the government constantly takes measures to keep inflation in check. Hence, during the times when inflation goes up, investors must not panic so as to avoid emotion-based decisions. Moreover, investors must look for fundamentally strong stocks that can brave any economic storms with ease."

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