Me: “Boss, 2 portions of chicken and 1 portion of vegetable please.”
Boss: “Ok, that’s SGD6.”
I was at a government operated hawker center 3 weeks back. When I heard of the price, my eyes opened wide. I couldn’t believe that my dinner cost SGD6 ($4.50) when it had cost me just SGD4.50 ($3.40) a while back!
A quick mental calculation revealed that the price of my dinner had jumped by more than 30%! What in the world just happened?
Simply put, inflation is the rise in prices.
Inflation, when kept under control and with wise monetary policies, and spur economic growth. On the other hand, misjudged monetary policies will hinder economic growth or even lead to disastrous outcomes as experienced in Venezuela and Zimbabwe.
The chart above shows Venezuela’s inflation rate. Though it has decreased from a record high of nearly 350,000%, it is still high today (Apr 2021) at 2,940%.
The chart above shows Zimbabwe’s inflation rate. Though it has decreased from a record high of more than 800%, it is still high today (May 2021) at 161%.
Both nations continue to fight this problem and their citizens face unimaginable hardship.
What Are The Consequences Of Inflation?
Knowing that inflation is the rise in prices, a little inflation is actually beneficial.
When would you expect prices to rise – in rosy or dark economic times?
I’m certain you answered “in rosy economic times”.
It is in favorable economic times that people are optimistic. They see money-making opportunities everywhere, hence they don’t mind spending (and spending more). They won’t mind spending a bit more on the things that they enjoy or like such as a new business, sports car, or even a luxury property!
This results in an economic boom. As prices for goods and services rise, demand rises alongside instead of falling due to optimism.
As more money enters the economy (through optimism and the printing of money), the rate of inflation picks up. A portion of this money will flow into the financial markets. We have experienced this for the past 12 years. This cycle feeds on itself and grows until…
Remember the inflation rates in Venezuela and Zimbabwe?
When inflation gets too high (determined by central banks), central bankers will use the tools at their disposal to reduce inflation. One of these tools is interest rates.
An increase in interest rates leads to higher borrowing costs, which effectively deters borrowing and spending on large ticket items such as automobiles and renovation. This cools the economy as consumers and businesses are incentivized to save in an environment with higher interest rates.
Let’s examine the relationship between inflation and the stock market.
The Relationship Between Inflation And The Stock Market
Let’s have a look at the inflation rate of the US since 2007.
How did the US stock market react to periods of low inflation? Periods of low inflation have been circled out in the monthly chart of the US stock market below.
What do you notice?
In periods of low or even negative inflation, the stock market took a tumble or went sideways (in 2015).
Do you remember what central banks will probably do when there’s high inflation? They’d increase interest rates. This increases the cost of borrowing. Companies which need to borrow money will incur higher interest rates payment and this may possibly erode part of their profits. There’d be less money in circulation too as the amount of loans decrease while the amount of savings increases.
Thus, the forecast of companies would be less optimistic, leaving investors to seek for opportunities elsewhere.
What Can You Do To Fight Inflation?
We are in the midst of the greatest and longest bull run in history. As the US stock market continues to soar, inflation continues to soar too.
What can you do to fight inflation?
#1 Buy Bonds
Bonds are known to be a safe hedge against inflation.
But not all bonds are the same. You may look to buy bonds that are protected by inflation by by purchasing TIP. TIP is an exchange traded fund (ETF) for inflation protected bonds. The price of such a bond rises as inflation rises.
Is there an optimal time to buy? YES!
When To Buy?
This is the million dollar question.
You can utilize the TPB (abbreviation for Trend Pullback) strategy to help you spot buying and selling prices.
#2 Buy Strong And Good Stocks
The key is to buy stocks that have been outperforming the overall stock market even in times of crisis.
FB is such a stock. The price of FB has risen by 147% from the crash caused by COVID-19 while the US stock market has risen by 92%.
When To Buy?
Again, you can utilize the proprietary TPB strategy to help you spot buying and selling prices.
3 Lessons You’ve Learnt Today
#1 High inflation leads to an increase in interest rates
#2 High interest rates leads to a cooling of the economy and stock market
#3 There are 2 things you can do to fight inflation – buy inflation protected bonds and good and strong stocks
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