In my opinion, the risk of increased inflation is one of the key risks to further equities growth this year. As the following chart shows, inflation expectations are rising very strongly in both the United States and the euro area. I see the reason for the increased inflation mainly in the continuation of the unprecedented quantitative easing of key central banks and still very loose fiscal policies.
At the same time, equities have historically performed very well, with inflation moderating close to central bank inflation targets. High inflation has historically pushed bond yields up, leading in DCF models to a higher discount rate and lower fundamental intrinsic value of equities, and consequently weaker stock performance. In general, with higher inflationary pressures, most companies today have difficulty passing on higher costs to prices, and therefore profit margins suffer as well as absolute corporate profitability. And it is the weaker corporate profitability that could be reflected in weaker equity performance.
Investment Strategist at Conseq Investment Management, a.s.