Inflation and Business Cycle: What will happen next?
Inflation has been rising aggressively since 2021. It accelerated from 2% to hit an all-time high of 9.1% in June 2022. As inflation rose, central banks like the Fed raised interest rates to control inflation . But this effort to control inflation, on one hand made money more expensive for the industries and on the other hand pushed consumers to reduce their spendings.
Many economists had already predicted rising inflation and its impeding worst impact on the global economy and stock markets. Still, there are fears everywhere that bear markets could persist and even a further decline is likely.
Here the basic question arises that must be understood:
WHAT IS INFLATION & WHY DOES IT OCCUR?
In fact, inflation occurs whenever demand for goods and services increases while supply remains constrained.
Growth is everyone's dream...
To capitalize on this aspiration, banks provide cash at low interest rates to support growth, but unfortunately this cash is used by people to buy luxuries like cars, electronics and homes. Cars need fuel and metals, electronics need high R&D spending and skilled human capital, and houses need building materials. Pressure on luxury items leads to price increases.
Technically speaking, when demand accelerates faster than supply, it has a net effect on price. This phenomenon is referred to as the law of demand, which states: "If more people want to buy something, when there is limited supply, the price of that thing will be higher." (The same law of demand applies in the stock market: as demand for stocks increases, their price increases.)
After Covid-19, global demand for goods and services began to normalize (increase). But to boost growth, which had been severely hampered in Covid times, banks made easy loans available at attractive interest rates. The resulting increase in the supply of money in the markets stimulated consumer spending. Ideally, if growth had been at a sustained pace and in the productive sectors, inflation would not have occurred. But that never happens - a phenomenon that creates the business cycle.
A business cycle has phases of expansion and contraction.
We are currently in the contraction phase of the business cycle - inflation is still high, interest rates and yields are unbearable, and industrial performance has declined.
WHAT WOULD HAPPEN NEXT?
- Unbearable prices will force consumers to reduce their spending/demand
- High interest rates and reduced demand will reduce industry revenues and profits
- Equity markets will continue to show poor performance
But good times will come again!
When the market bottoms out in the business cycle, expansion begins. This will be an ideal time to invest in growth and value stocks.
Many economists had already predicted rising inflation and its impeding worst impact on the global economy and stock markets. Still, there are fears everywhere that bear markets could persist and even a further decline is likely.
Here the basic question arises that must be understood:
WHAT IS INFLATION & WHY DOES IT OCCUR?
In fact, inflation occurs whenever demand for goods and services increases while supply remains constrained.
Growth is everyone's dream...
To capitalize on this aspiration, banks provide cash at low interest rates to support growth, but unfortunately this cash is used by people to buy luxuries like cars, electronics and homes. Cars need fuel and metals, electronics need high R&D spending and skilled human capital, and houses need building materials. Pressure on luxury items leads to price increases.
Technically speaking, when demand accelerates faster than supply, it has a net effect on price. This phenomenon is referred to as the law of demand, which states: "If more people want to buy something, when there is limited supply, the price of that thing will be higher." (The same law of demand applies in the stock market: as demand for stocks increases, their price increases.)
After Covid-19, global demand for goods and services began to normalize (increase). But to boost growth, which had been severely hampered in Covid times, banks made easy loans available at attractive interest rates. The resulting increase in the supply of money in the markets stimulated consumer spending. Ideally, if growth had been at a sustained pace and in the productive sectors, inflation would not have occurred. But that never happens - a phenomenon that creates the business cycle.
A business cycle has phases of expansion and contraction.
We are currently in the contraction phase of the business cycle - inflation is still high, interest rates and yields are unbearable, and industrial performance has declined.
WHAT WOULD HAPPEN NEXT?
- Unbearable prices will force consumers to reduce their spending/demand
- High interest rates and reduced demand will reduce industry revenues and profits
- Equity markets will continue to show poor performance
But good times will come again!
When the market bottoms out in the business cycle, expansion begins. This will be an ideal time to invest in growth and value stocks.
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