Over the last couple of months, the stock market hasn’t been a great performer. Plenty of growth stocks have seen their valuations slashed in half. Even those delivering promising results. At the heart of this decline is a growing level of uncertainty among investors that’s been brewing for a while. And it seems record-breaking inflation was the final straw.
Inflation is currently at its highest level since the early 1990s. But after taking a closer look at the figures, the situation may not be as bleak as many think. So if inflation isn’t all that bad, does that mean the stock market has over-reacted? And could we see it surge in the near future? Let’s take a closer look
Analysing inflation
At the end of February, UK inflation stood at 5.5%. That’s more than double the Bank of England’s (BoE) 2% target. And consequently, with the value of money going down, stock valuations are suffering considerably, leading to the recent stock market sell-off.
But a closer look at the numbers reveals something interesting. Almost half of the increase in inflation was driven by two sectors – Household Services and Transportation. In fact, if I ignore their contributions to the consumer price index (CPI), inflation today stands at only 2.85%.
The good news is, as far as I can tell, the rising prices in both sectors appear to be almost entirely temporary. Let me explain.
The biggest catalyst for inflation growth in both sectors is related to oil. Namely, rising household energy and fuel expenses. With oil now priced back around $110 a barrel, versus $60 only a year ago, seeing prices rise isn’t exactly a surprise.
The price hikes can be attributed to a restricted oil supply. But with oil companies ramping up production to capitalise on the opportunity, prices have already begun to fall. And analyst forecasts currently estimate oil will be around $85 per barrel by 2023.
A similar story exists with semi-conductor chips used in cars. And with supply lines for both raw materials being re-established, prices will naturally start to fall, taking inflation with it.
Will the market surge?
Assuming my analysis is correct, inflation could begin to reverse within the next few months. It’s worth noting this also matches the expectations of the BoE.
If inflation returns to normal, the value of future cash flows will rise, potentially leading to an upward stock market move. In other words, the growth stocks that have been hit so hard in the last couple of months could be first in line to start climbing rapidly again.
That, to me, sounds like an excellent buying opportunity for my portfolio. It’s not guaranteed, of course, and nobody knows what else might derail the stock market’s growth or even if other shares might be as buoyant as growth stocks. As we’ve seen in the last two years, the unexpected can and does happen. But with plenty of high-quality companies out there trading at a discount, I feel I’m spoilt for choice.