How Inflation Affects Growth Versus Value

How Inflation Affects Growth Versus Value

By Ben Carlson   Posted by TEBI on May 3, 2020

It seems bizarre to worry about inflation during the sharpest, more severe economic contraction of our lifetime.

But the sheer amount of government spending and monetary policy being instituted by the Federal Reserve means it’s something that’s on people’s mind as a potential risk in the not-too-distant future. The “worry” is once the virus is contained the economy could potentially overheat through a combination of pent up demand and government spending.

My initial read on this is if we do get inflation from all of this spending that’s a good thing — it means we beat the virus and things are back to normal (if there is such a thing).

The Fed would have a much easier time fighting inflation than the current predicament.

Here’s former Fed chair Janet Yellen in the Wall Street Journal discussing this idea:

Bigger federal borrowing needs will make it costly for the Treasury should interest rates eventually rise. “If the economy recovers and inflation is a problem, that will be the test,” says former Fed Chairwoman Janet Yellen. That isn’t a problem now. If it ever is, she says, “I think the Fed is going to win out on that.”

You have to be thinking 12 moves ahead to start planning for higher inflation at this point but there are likely some areas of the market that would benefit more from an inflationary spike than others.

Earlier this week I posited that low interest rates may be the simplest explanation for the stock market’s resilience. A few people pushed back with the fact that rates have been low in Japan and Europe as well and their markets haven’t been quite as strong.

Japan is on another planet when it comes to market relationships in general but there is an explanation for this. Because of the differences in the sector make-up of the underlying markets, U.S. stocks are more heavily weighted towards growth stocks while European and Japanese stocks are more in the value camp.

 In a low rate, low inflation world, growth stocks tend to perform better while value stocks tend to do better when inflation is higher:

Think about growth stocks like they are a bond. The reason inflation is such a big risk for bondholders is because the purchasing power of your fixed rate income payments is eroded over time by inflation.

To continue reading, please go to the original article here:

https://www.evidenceinvestor.com/how-inflation-affects-growth-versus-value/