Markets worth watching
US stock indices: US500, US100
There is an ongoing debate about the relationship between stock markets and inflation. Stocks are holding instruments covered by the real assets of the companies that issued them. Because inflation reflects increase in the prices of goods and services, should eventually translate into revenues of companies selling these goods and services. From this perspective, stocks can be seen as a hedge against inflation.
However, looking at history, we can confidently say that there is no linear relationship between company earnings and stock prices. So-called the price-to-sales ratio can fluctuate significantly for a number of reasons. After first, even if higher prices translate into higher revenues, costs can increase in even faster pace. A period of high inflation creates a lot of uncertainty and some companies can not be able to maintain the current profit margin. Second, the stock market is always trying discount the future. And if that discounting is done using higher rates interest rates - typical of higher inflation - the present value of future gains will be lower.
Because periods of high inflation in the US are rare and far apart in time, there is no such thing confirmed relationship. The S&P 500 hit a ten-year low in October 1974, just before the peak of inflation that year. However, the markets were much more overvalued back then - the index fell from the peak (in 1973) to the trough of 50%, and the price-earnings ratio was below 8 - almost 3 times lower than today. Moreover, the Fed has started to cut interest rates in November 1974, thus supporting the bull rally.
Precious metals: GOLD, SILVER
Commodities are considered a leading indicator of inflation as the prices of goods and even services are in highly dependent on raw material costs. Therefore, there is a belief that raw materials are a good hedge against inflation, and the first example that comes to mind is gold. Is it really so?
Gold is an excellent diversifier for an investment portfolio due to its low and even negative correlation with other asset classes. But what about inflation? Gold tends to respond to relative dollar strength as well as changes in bond yields.
We can see a very strong negative correlation between gold price changes and profitability bonds in the long term. Therefore, we are dealing with a relatively weak sentyment against gold in an environment of the highest inflation in the US in 40 years. Of course, gold can too respond to other risk factors, such as natural disasters or war, which the world unfortunately experienced this year, which for a short time pushed gold prices to historical levels maxima.
As mentioned earlier, the key factors for the price of gold are changes in the level yields and valuation of the dollar. Further changes are the most important for the dollar and bond yields Fed interest rates. The dollar already seems to be very overbought, especially if we will look at historical standards and this could be an opportunity for gold. Of course, gold is still there relatively expensive in nominal terms, but high bond yields led to a significant drop in gold prices from near historical highs. Moreover, correcting prices for inflation, gold is not extremely expensive compared to the 1970s or even 1970s 2011. It is also worth mentioning that gold often retains its value during periods of recession, especially when compared to more volatile assets such as stocks.
