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Inflation: Measurement and Determinants As the inflation debate was heating up in the middle of last year, I wrote a comprehensive post on how inflation is measured, what causes it and how it affects returns on different asset classes. Rather than repeat much of that post, let me summarize my key points.
In general, higher and more volatile inflation has negative effects on all financial assets, from stocks to corporate bonds to treasury bonds, and neutral to positive effects on gold, collectibles and real assets. I then examine how equities have performed in the less than five months of 2022, where inflation has returned to the front pages.
At the start of the year, the consensus of market experts was that this would be a difficult year for markets, given the macro worries about inflation and an impending recession, and adding in the fear of the Fed raising rates to this mix made bullishness a rare commodity on Wall Street.
The first has been the steep rise in treasury rates in the last twelve weeks, as investors reassess expected economic growth over the rest of the year and worry about inflation. for the year are at war with its concurrent promise to keep rates low; after all, adding those numbers up yields a intrinsic risk free rate of 8.7%.
In a post at the start of 2021 , I argued that while stocks entered the year at elevated levels, especially on historic metrics (such as PE ratios), they were priced to deliver reasonable returns, relative to very low risk free rates (with the treasury bond rate at 0.93% at the start of 2021). The year that was.
Looking at US equities, the S&P 500 is up about 11% and the NASDAQ about 5%, from start of the year levels, and the underperformance of the latter has led to a wave of stories about whether this is start of the long awaited comeback of value stocks, after a decade of lagging growth stocks.
The Lead In To understand the market effects of the Russia-Ukraine conflict, we need to start with an assessment of the two countries, and their places in the global political, economic and market landscape, leading in. Ukraine, a part of the Soviet Union, has had its shares of ups and downs, and its economic footprint is even smaller.
The second was that, starting mid-year in 2020, equity markets and the real economy moved in different directions, with the former rising on the expectations a post-virus future, and the latter languishing, as most of the world continued to operate with significant constraints.
I pointed to the flaw in the logic, but the comments thereafter suggested such deep confusion about what returns on equity or capital measure, and what comprises an efficient market, that I think it does make sense to go back to basics and see if some of the confusion can be cleared up.
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