Here's a question. What happens to stock prices when inflation gets underway?

Here's an answer. Or at least part of the answer as it helps explain the stock market of the past few months:

Early on in a period of inflation, corporate profits will increase because inventory costs may reflect pre-inflation prices – but wages will not increase right away.

That should really read "wages and another cost will not increase right away", but you get the idea.

To the extent that stock prices reflect expectations of the future, the runup in stock prices in 2021 can be said to owe much to expectations of rising corporate profits from rising prices. That situation can last until inventories fully turn over and businesses have to pay higher costs when they replenish them. Once they arrive, higher costs put a cap on the rate at which businesses can grow the profits they book.

That's relevant today because higher costs have begun arriving for businesses.

Though producer prices are now rapidly rising, their effect is far from uniform in affecting all companies across the U.S. stock market. It is however becoming widespread enough to affect future expectations out where we can reliably project them. The dividend futures-based model we use to project the future for the S&P 500 (Index: SPX) indicates the early inflationary period where expectations of rising profits from rising prices can boost stock prices have perhaps a couple of more months to run. After that, betting on higher inflation by buying stocks looks to be a less rewarding proposition.

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