Higher Inflation = Lower P/Es and Stock Prices

Consumers are seeing the increase in inflation, which pleases the Fed.

The median inflation expectations for a year from now rose to 3.4%, matching the previous highs in 2013, according to the New York Fed’s April Survey of Consumer Expectations, published yesterday.

Even though customers expect their earnings to rise by only 2.1 percent over the next year, and their overall household income to grow by only 2.4 percent, they expect the following price increases, according to the survey:

  • Home prices: +5.5%, a new high in the data series
  • Rent: +9.5%, fifth month in a row of increases and new high in the data series
  • Food prices: +5.8%
  • Gasoline prices: +9.2%
  • Healthcare costs: +9.1%
  • College education: +5.9%.

Consumers who expect higher inflation are more likely to pay for price increases. That’s why the Federal Reserve is keeping such a close eye on inflation expectations.

Higher Inflation = Lower P/Es and Stock Prices

P/E ratios and interest rates are said to have a fundamental relationship, according to conventional stock market wisdom. It is predicated on the fact that inflation is positive.

P/E ratios rise as inflation rates trend toward price stability and fall when inflation rates trend away from price stability (above 1% inflation), as seen in this graph.

As a consequence, the “Y Curve” trend occurs, in which the P/E ratio falls amid higher than average interest rates (and lower than average rates).

______________________________________________________________

Asset Allocation

Question: How do you achieve higher long-term investment returns and grow assets safely?