What is inflation?
Inflation is the persistent increase in the general price level of goods and services over time and the loss of value of a currency. When the general price level rises, a unit of currency buys fewer goods and services than in the past, so inflation reflects a decrease in purchasing power per unit of currency.
Levels of inflation:
Inflation is classified into three levels: moderate inflation, galloping inflation and hyperinflation.
1. Moderate Inflation:
characterized by slow and predictable price increases. The annual inflation rate is single digit. When the price is relatively stable, people believe in the currency, they are willing to hold the money because it mostly stays the same in value for a month or a year. People are willing to do long-term value-for-money contracts because they believe the value and cost of buying and selling won't deviate too far.
2. Galloping inflation:
the rate of price increase above 10% to < 100% is called 2- or 3-digit inflation. Currencies depreciate a lot, real interest rates are often negative, no one wants to keep cash. People keep only the minimum amount of money needed for daily payments and prefer to hold commodities, gold or foreign currency.
3. Hyperinflation:
the rate of price increase is over 1000%/year. The currency has almost completely depreciated. Transactions take place on a barter basis because money can no longer function as an exchange. The financial system is in crisis.
The relationship between inflation and stock market
As an example demonstrating the correlation between the stock market and the inflation rate, let's take a look at the VN-Index chart from 2002 - now and how the CPI affects stocks. . CPI in 2008 reached the highest level, the stock market also peaked and fell into a shock reduction cycle. In 2009, inflation was successfully controlled, CPI was at the lowest level, making the macro-economy stable and the stock market rose again. In 2011, inflation increased again, causing stocks to fall again. In 2015, inflation was at a record low, stocks increased strongly.
Looking at the correlation between the inflation situation and Vietnam's stock market in recent years, it can be seen that when inflation increases at a moderate level, combined with a strong increase in money supply and expansion of public spending. government, the result will make the stock market grow hot. If inflation rises too high, out of control plus monetary tightening will cause the stock market to decline rapidly. If inflation falls and monetary and fiscal policy easing, the stock market will rise again as a result. When inflation increases to a degree but not to a too high level, coupled with tight monetary policy, the stock market will go sideways.
In general, high inflation is often considered a negative signal for the stock market because it causes borrowing costs, input costs (raw materials, labor) to increase, and lower people's living standards. Most importantly, inflation will lower expected earnings growth, weighing on stock prices.
Unexpected inflation is the problem.
Through the rate of inflation each year, the stock market will make a forecast and thereby adjust the expected return to escape the influence of inflation. For example, if an investor targets a net return of 6%/year after inflation (including dividends), and inflation is at 2%/year, he or she would certainly expect a return at least 8% in that year. But if inflation suddenly increases from 2% to 4% in a short period of time, the data collected in the past shows that the market will react negatively. That's because investors now demand higher rates of return to offset the risks they face. Instead of an 8% return, investors would raise their expectations to at least 10% and the stock price would be more likely to fall. To achieve portfolio efficiency, investors should learn the news about the world economic situation as well as the macroeconomic situation to come up with suitable investment and risk management strategies.
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