Often the anticipation of rising levels of inflation is met with a negative connotation. “How can the general rise of prices ever be good?” people ask. We tend to view inflation as a negative force, or even as a predictor for economic disaster. This is especially easy to understand because the last decade has had relatively low inflation. It’s been years since inflation has gone over 3% for sustained periods and concerns are starting to rise; what does this mean for our lives?
What is inflation? Inflation, as Google defines it, is “a general increase in prices and fall in the purchasing value of money.” As the Federal Reserve takes actions like quantitative easing (essentially making more money) and raising rates, this produces an overall increase in the rate of inflation.
As a result the cost of rent, food, gas and common household goods generally rises. Isn’t this all bad? Yes from one perspective it is. It’s easy to see how an increase in broccoli or fuel prices hurts the single mom who is struggling or the family trying to save up for that family vacation.
Almost everywhere in the economy, costs rise as a result of inflation. But there is another side to this. When prices of goods rise, what does this mean for businesses? Well, business are usually the entities who sell the goods and therefore they usually “profit” from rising prices. However this increase in dollar profit doesn’t necessarily translate to a net increase after adjusting for inflation.
What this means though, is that businesses profits generally, at the very least, increase with inflation. What this does do is cause stock prices to naturally rise as earning and assets raise in price to match the inflation. So stocks, naturally are a built in inflation hedge because over long periods of time they usually increase, at a bare minimum, with the rate of inflation.
This truth of rising inflation is partially an inevitable inconvenience or problem for consumers but it is a completely normal and in some ways beneficial aspect of business development. To take advantage of it one must own a business though.
There are many more ways that inflation is impacted and has impact. But what I want you to get out of this is that inflation is actually a good thing for equity investors. Investing in stocks is not only a great move before adjusting for inflation, but after inflation it becomes a beautiful hedge against the “evils” of this powerful economic force.