Inflation across the board of consumer and supply chain prices has grabbed headlines since 2021. And inflation continues to soar through the first half of 2022.

Now the Federal Reserve is taking action as the year over year percent increase in the consumer price index rises to levels unseen since the early 1980s. 

Today, I’m going to go over how inflation impacts the stock market, and give you some ideas for protecting your stock portfolio from inflation.

The CPI of all urban goods in a U.S. city average has grown a staggering 8.5% in May since last year. The central bank is now prepared to make the biggest interest rate hikes since 1994. The inflation and rate hikes to tame it will affect different stocks in your portfolio differently.

Usually the Federal Reserve hikes rates by quarter percentage points, but in this case the central bank is ready to raise rates by three quarter percentage points. 

When the Fed keeps interest rates low and expands the money supply, it’s called dovish. When it keeps rates high and contracts the supply of money, it’s called hawkish. Fed policy often has an immediate impact on stock prices across the board, as well as lasting effects.

U.S. Dollar inflation is now so high that the Fed hasn’t been this hawkish with its monetary policy since 1994. Both inflation and the inevitable federal funds rate increase as a result of it impact the stock market in different ways. Soon in this video I’m going to explain how today’s inflation will likely affect different sectors of the stock market.

Here’s a graph of consumer inflation from the Federal Reserve Bank of St. Louis, the Fed’s research arm. As you can see from the graph, inflation hasn’t been this bad since the U.S. economy’s uncomfortable bout with stagnation in the late 1970s that continued into the 80s.

This took years of high rates led by Fed hawks like Paul Volcker to finally whip down to within a percent of the Fed’s target rate of 2% annual inflation for most of the nineties and two thousands.

With inflation running to historical highs again, investors will find hedges to inflation proof their portfolios or even seek alpha from macro arbitrage trades that factor in rates and inflation.

Inflation is a dynamic market phenomenon and rolls through an economy. It starts out in the financial sector closest to the source of newly created money by the central bank or legislature and treasury.

Then it rolls through financial markets, equity markets, and into supply chain and consumer prices. Finally when the entire economy has adjusted to the new money supply and experienced inflation, the central bank raises rates.

That slows growth in business and many stock prices, but gives prices time to settle, starting the cycle over again. This gives rise to the cyclical charts for many stocks. 

There are three important ways to keep in mind that inflation impacts the stock market:

Tailwinds: Inflation supports stock prices in a fundamental sense because it encourages business and consumers to spend their cash quickly before seeing its value erode.

This increases the velocity of money and supports sales. Anything leftover to save is incentivized by rising prices to be invested in stocks, because cash positions and bonds are depreciating in an inflationary environment.

Headwinds: At the same time inflation can impact earnings for companies paying higher prices and dampen their stock price. It can also cause volatility in the stock market as investors shuffle trades while trying to understand where inflation took from and added to bottom lines.

Consequences: When the monetary cycle reaches the point of broad based consumer inflation, the Fed hits the brakes by raising the federal funds rate. Commercial lending rates for businesses and consumers are based on this rate.

So credit tightens and the economy slows, usually with stock prices settling broadly as well. The economic impact of credit prices is so important that the stock market reprices shares markedly ahead of and after Federal Open Market Committee announcements of policy changes.

So here are some stock ideas to think about for inflation hedges and strategies. These have worked well historically for investors in markets similar to this one.

Just keep in mind to do your research and remember past results do not necessarily indicate future ones, and nothing ever happens the exact same way or for the exact same reasons again.

ontinuing to make contributions to your portfolio whether it’s a tax benefit retirement account like a 401K or a commission free stock brokerage app is important with inflation on the rise.

That will help keep your excess savings after costs and discretionary expenses ahead of inflation on the equity balance of a cash earning business that might be profiting by charging some of those higher prices.

If you’re looking for a more exotic inflation investment to diversify your position and you know what you’re doing, commodities, gold, and precious metals mining stocks can do well. ETF investments that track the performance of commodities and gold make it easy to take a position.

Stocks in companies with high debt ratios and heavy dependency on corporate loans are in better shape when inflation is low and financing is cheaper. So don’t forsake reading SEC filings on the investors page at the company’s website if you’re serious about inflation proofing.

While the federal funds rate is high to tame inflation, commercial lending raises its own rates on top of the national target rate, and banks and corporate lenders tend to do well holding and lending larger deposits and charging more profitable interest rates for the loans.

In fact if you look at the max timeline view graph of JP Morgan’s stock chart, and compare it to a graph of the federal funds rate, the correlation between higher interest rates to tame inflation and growth in the largest U.S. bank’s stock price is evident.