Thread by @retaox

From 1960 to 1980 --> Inflation increased from 2% to 13%.

From 1980 to 2000 --> Inflation dropped from 13% back to 2%.

Inflation cycles are much longer and it creeps in on us slowly. It's in best interest of younger investors to study history and learn from the past.

"Stable prices provide a sense of security. They are like safe streets, clean drinking water and dependable electricity. Their importance is noticed only when they are missing."

How bad could it be for stocks in general?

Let's look at history. The Dow Jones Industrial Average was no higher in 1982 than in 1965 and this could very well be attributed to high inflation during that period.

A little inflation seems unthreatening. But just like a snowball rolling downhill, a little leads to a little more, and a little more leads to a lot.

Higher and higher inflation overwhelms the government's commitment to manage the economic cycle.

Let's define inflation :
It's too much money chasing too few goods.

Historically inflation is common occurrence during war times when the governments printed more money to pay for guns & soldiers.

Peacetime inflation is an unintended side effect of economic policies designed to reduce unemployment & eliminate the business cycles.

Is there a standard remedy for it?

To lower prevailing inflation it would take either an enormous recession or an extraordinary long one.

As you can imagine there is staggering human costs involved with such solutions and would be precluded politically.

How's inflation related to interest rates?

Prudent lenders want to protect against possible erosion of value of money they lend. They try to predict future inflation & set interest rates accordingly.

Hence with an uncertain lag, higher inflation causes interest rates to raise.

If you think about it, interest rates are the price of money. So they affect the price of everything that could be bought with money.

One can see that these are complex systems and they feed into each other.

This is why any attempt at predictions would be a pointless activity.

But how does inflation impact stock prices?

As we know from above, inflation leads to increasing interest rates. Higher interest rates mean, investors get higher yields in bonds. Stocks being riskier than bonds, investors demand a premium over bond yields.

Businesses already find it hard to manage increasing costs, let alone increase profits. When stocks can't increase their earnings to meet investor's expectations, money consequently moves into bonds. This puts pressure on stock prices, and their value falters eventually.

Unemployment and Inflation are inversely related (theoretically at least).

Governments want maintain an equilibrium between the two : ideally low employment with low inflation. But exogenous events happen all the time, disturbing the equilibrium.

investopedia.com/terms/p/philli….

What kind of businesses can do well in an inflationary environment?

* Companies that have high operating leverage.
investopedia.com/terms/o/operat…

* Companies that have high pricing power.

https://twitter.com/retaox/status/1354206874481156096?s=19

Businesses should possess both to do well in high inflation.