Inflation has dominated my news feed over the past week. From the time that I wake up and look at pre-market reports to the time I am ready to switch off for the day, I read about rising cost pressures. The FTSE 100 index has been admirably resilient so far, though. Just yesterday, it closed above 7,500 once again. But I am bracing for more stock market volatility in February as macroeconomic risks grow.
Inflation’s impact gets pronounced
In recent articles, I talk about two FTSE stocks that mention inflation in their updates. Unsurprisingly, both of them are consumer-oriented companies. The first is the FTSE 100 alcohol manufacturer Diageo and the other is the AIM-listed mixer drinks producer Fever-Tree Drinks. Fever-Tree actually thinks that these increases could keep its margins unchanged. This likely sent its share price plunging after the update. Diageo has done much better, and is also optimistic about the future despite its expectation of short-term volatility.
But the key point I am making here is this. Inflation’s impact on companies is evident. It does not help that the inflation print is expected to stay elevated in the near future as well. In fact, the Office of Budget Responsibility predicts that the UK’s inflation will average an annual rate of 4% for 2022.
This is way above the Bank of England’s comfort level of 2%. So clearly, increasing interest rates are likely through the year. As per the US Federal Reserve, rate hikes will begin soon, possibly in March. With the authorities now likely to turn the liquidity taps off, it goes without saying that stock markets could be impacted.
Impact on stock markets
Stock markets thrive during conditions of easy liquidity, because like with any other commodity, there is greater demand for cheap money. And at least some of it finds its way into investments. Moreover, companies’ borrowings costs are also lower when interest rates are muted. When they rise, however, companies’ borrowings could slow down and existing borrowings become dearer. Coming out of the pandemic, when many companies have had to borrow more than usual, this could be particularly bad news for the recovery.
I expect more companies to talk about rising inflation in their updates in February. This could lead to a wobble in the broader stock market as well. The question now is, how should I invest? While the latest inflation numbers are admittedly quite atypical, the biggest FTSE 100 companies have seen far worse, like wars, depressions, and all other kinds of crises. I am focused on high-quality companies with resilient demand and positive outlooks as potential buys for my portfolio now. It might even be a good time to buy them as the markets dip.