Inflation & Equity Markets

Yogesh Supekar discusses the correlation between inflation and equity returns while highlighting which sectors to focus on during inflationary environment.

- Yogesh Supekar

The interplay between inflation and equity markets is not as straightforward as one would like it to be. In reality, the relation between inflation and equity market returns is much more complex. If consistent inflation is bad for equity market returns, how come the BSE Sensex had a dream run starting in 2003 running up to 2008 till the global financial crisis hit us? BSE Sensex jumped from ~3,300 in January 2003 to ~19,600 levels in January 2008 when the inflation skyrocketed from 3.81 per cent in 2003 to 8.35 per cent in 2008. We can see that the five years of consistent rising inflation saw stock prices almost multiplying in a similar period.

However, when inflation jumped from 8.35 per cent in 2008 to 11.99 per cent in 2010, there was a sharp dip and a consequent recovery in the equity prices. Says Amit Challani, a successful long-term investor: “I think inflation is good for the equity prices. It is very difficult to access as an equity investor as to what level of inflation is optimal for the equity markets. In other words, it is almost impossible to ascertain the exact level of inflation from investors’ point of view as to what starts impacting the aggregate demand in the economy. Investors will always know about it a little late and by that time the stock prices could have already slipped from the top.”