Are Stocks At A Major Turning Point When It Comes To Inflation?
We’ve now reached the point at which inflation will become a major problem.
Inflation is not inherently bad for stocks. The reason for this is that companies report growth in nominal terms, not in “real” or inflation-based terms.
Think of it this way: XYZ company sells widgets for $1.00. Then inflation hits and the company raises widget prices to $1.10. Even if the company sells the EXACT same number of widgets, revenues “grow” by 10%. After all, they don’t have to report that the 10% in growth was 100% due to inflation!
This is why stocks often spike higher when inflation initially hits. We saw this during the last major bout of inflation in the early 1970s. At that time, stocks roared higher, rising 50% while CPI, which measures inflation, gradually rose to 6.3%.
(Click on image to enlarge)
However, the relationship between stocks and inflation quickly goes from love to hate once costs rise fast enough that profit margins are squeezed. To return to the 1970s, this started in 1973 as CPI hit 11%. From that point onward, stocks crashed losing almost 50%.
(Click on image to enlarge)
I bring all of this up because we are likely about to witness something similar today. Stocks have erupted higher on the back of inflation, courtesy of $11 trillion in Fed QE/ fiscal stimulus from the Federal Government between March 2020 and today.
(Click on image to enlarge)
This is the good part of inflation. And by the look of things, it’s about to go sour. Indeed, we are getting clear signs that costs are about to explode higher for corporations.
Profit margins are at all-time highs (there’s nowhere to go but down), while real wages (incomes adjusted for inflation) are DEEPLY negative.
(Click on image to enlarge)
Workers are now demanding higher wages. This means higher operating costs for corporations, which in turns means lower profit margins.
In simple terms, the clock is ticking for stocks. Sure, they might not crash this week, but another bloodbath is coming. The markets will soon be a sea of red. And the losses will be staggering.
The markets are warning us, but few have noticed.
(Click on image to enlarge)
For more market insights and investment ideas, swing by our FREE daily e-letter at www.gainspainscapital.com.