Inflation & stocks
When economists speak of inflation they’re generally referring to the rising cost of living - i.e. the overall increase in price for goods and services in a specific time. In 2021, the UK’s central bank - the Bank of England (BoE) - has a target of 2% inflation, although it currently stands at about 0.6% according to the Consumer Prices Index (CPI). When inflation goes up, consumers are less able to buy goods and services, since each pound doesn’t stretch as far as it used to.
High inflation, therefore, is a “silent killer” on your stock investments. Suppose your equities do very well in a given year - say, 10% return (excluding fees and taxes). However, if inflation is also very high over that period (e.g. 7%), then your “real returns” are only, in fact, 3%. Moreover, high inflation also affects dividend investors. This is because more business revenue is needed to pay suppliers, which leaves less profit to distribute to shareholders.
Of course, as inflation increases, many companies will pass increased costs along to the consumer. This offers a degree of natural protection against inflation as the company adjusts its prices to preserve profits and dividend levels.
These factors are not always easy to predict, as companies will be affected in different ways, and prices are generally limited by what the market will bear. This is why stock-picking is best left to an experienced investment manager, who can position the portfolio appropriately for the economic cycle.