That inflation is a bigger problem than initially imagined, and not just in the UK, is becoming clearer every day. The US’s inflation number just came in at an unbelievably high 7% on a year-on-year basis for December 2021, the highest in 40 years, no less. This follows 5% inflation in the UK last month, which prompted the Bank of England to step in and increase interest rates.
What does high inflation mean for my investments?
This is bad news, because high inflation impacts my stock market investments negatively in many ways. The first impact of high inflation is to lower the value of my money. So even if stock markets continue to rise, my capital might not appreciate very much in real terms if prices are rising fast too. Similarly for dividends. The dividends I earn can buy me far less now than they could, say, a year ago.
It also follows that if I have to pay higher prices, then the amount of money I could potentially save is lower too. And this means that I now have lesser to invest in the stock market. If this is true for all of us, then the stock market might just slow down too.
In any case, companies listed on stock exchanges are often negatively affected by inflation as well, which could make the markets sluggish. Their costs rise, as many FTSE 100 and FTSE 250 companies have highlighted in the past year. This in turn could impact their margins, which would then impact both their share price and their dividend payouts. As an investor, both my capital and my passive income is impacted in this way too.
A slowing economy?
Some lucky companies might just be able to pass on their costs to end consumers. But that also just adds to the upward price spiral, which could further reduce demand levels in the economy. The global economy is yet to recover from the pandemic, and potentially galloping price rise is the last thing it needs. I am particularly concerned about this combination of shaky growth and rising prices right now, because it could send us right back into slowdown if it’s not contained soon.
How I’d make stock market investments
As an investor, I do have a few options to consider even keeping these risks in mind, however. One of them is to buy stocks that rise with rising inflation, like oil stocks. Although, if growth comes to a standstill, they would be impacted too. We are not there though, so I think there is still some upside to these stocks.
Another way for me to combat the high inflation situation is to buy luxury stocks. Purchases of luxury products can often be seen as ‘conspicuous consumption’, which is made with the express purpose of displaying wealth. So, a premium price might just make them more desirable, making it easier for these companies to pass on higher costs. Of course, if growth slows down significantly — and for a long time — these too could face stagnant demand. But we are far away from that right now. I would focus on these stocks now.
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Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2022