- Inflation is considered to be an increase in the price of goods and services due to an end number of reasons.
- But let us see how it affects the share market.
Causes of inflation
- The causes of inflation can be broadly divided into demand-pull, cost-push, and inflation expectations.
- Demand-pull is when the demand for the goods and services is greater than the supply.
- This will lead to the manufacturers increasing the overall price.
- Cost-push is when the cost of manufacturing is increased, which will lead to an increase in the price of the goods as well.
- Inflation expectation is when it is assumed that the price of certain goods and services might increase due to several external factors, and then it does.
- The best example of this is the Russia-Ukraine war, which has led to an exponential rise in fuel prices across the world.
Effects of inflation on the share market
- Inflation will reduce the overall purchasing power of the economy of the country.
- This will cause the economic growth of the country to come to a halt, unless the situation is not resolved by an increase in wages.
- This in turn will also impact the purchasing power of the people.
How does inflation affect the share market?
Inflation will affect the share market in a few ways.
Some of the factors that will affect the share market are as follows:
Lower returns
- One of the many ways in which inflation affects the share market and trading is that the returns on investments are usually lower.
- We are saying usually because it might not always be the case, but it can be due to very rare circumstances.
- Higher returns during the inflation will heavily depend on the type of the asset and the listed firms that you are trading with.
Less value of the growth shares
- Growth shares are defined as the shares that will belong to the company whose growth is faster than the average listed firm on the share market.
- The investments that are made in such a company by the traders are long-term and do not bring them any returns until they sell their shares.
- During inflation, the value of the growth shares will go down a lot more than any other type of equity, which will also cause the traders to lose money.
High interest rates
- An increase in the interest rates is negative for both bonds as well as equity in the share market.
- The interest to be paid out on the bonds or the mutual funds will increase the interest rates, which in turn will also cause the principal value of the bond to go down in order to maintain balance.
- In the case of an equity, the value of the future cash flows of the company is directly impacted by the increase in the interest rates.
- The future cash flows are valued lower, which will also lead to the valuation of the equities going down as well.
- This is because this valuation is done by discounting future cash flows.
- The impact of inflation is negative for the share market.
Conclusion
High inflation will always mean lower returns, as it has a varying impact on the shares.
Frequently Asked Questions (FAQs)
Q1) How does high inflation affect the stock market?
High inflation will lead to a decrease in stock valuations.
Q2) Will inflation cause a stock market to crash in India?
Higher interest rates will indicate greater borrowing costs, which will tend to slow down the purchasing activity, which will also cause the equities to fall.
Q3) How does inflation affect investment?
Inflation will significantly reduce the real returns on the fixed-income investments.
Q4) How does inflation affect the market environment?
Inflation can increase the cost for businesses, which will also lead to higher prices for consumers.
Q5) How do you know if Nifty 50 will increase or decrease?
If the price of the individual stocks in the index will increase, then the value of the index will also rise.
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