Is inflation really a bad thing for stocks? Spoiler alert: No. The Daily Breakdown explores the relationship between inflation and stocks.
Friday’s TLDR
- Inflation is mild right now
- And stocks do well with that
- Meta stock is holding support
The Bottom Line + Daily Breakdown
Investors are scarred from inflation. That much is clear given how much emphasis went into this week’s CPI report. That report showed that inflation climbed less than feared, triggering a massive relief rally on Wall Street.
Was this deep sigh of relief necessary, though?
I get that investors are a bit gun-shy when it comes to inflation because of what people endured in 2021 and 2022. Inflation was topping out around 9% and it was followed by a record pace of rate hikes from the Fed and a bear market in crypto and stocks.
At that point, the party was officially over for the bulls. But investors are forgetting one really important thing: Inflation means asset prices are increasing…and stocks are assets too!
Inflation Can Be a Good Thing For Stocks
Because of the last few years, there’s an enormously negative connotation with the word “inflation.” Investors want nothing to do with it, even though the S&P 500 has actually performed pretty well with mild inflation.
I went back to 1975 to look over the last 50 years of data and here’s what was found:
- Years where year-over-year (YoY) CPI was between 2% and 4%…
- The S&P 500 was up 20 out of 23 years (or up about 87% of the time)
- Years where YoY core PCE was between 2% and 4%…
- The S&P 500 was up 14 out of 16 years (or up about 88% of the time)
- Years where both YoY CPI and core PCE were between 2% and 4%…
- The S&P 500 was up 10 out of 11 years (or up about 91% of the time)
They don’t have a crystal ball, but for what it’s worth, the Fed expects core PCE of 2.5% this year.
I must say though, the obvious caveats apply to this situation. Meaning that just because inflation is between 2% and 4% doesn’t mean there’s a ~90% chance that the S&P 500 finishes in the green this year. It’s just how it’s played out historically. A lot of the bigger components — like earnings growth and the economy — are still critical pieces to the stock market puzzle.
The Bottom Line: Forget 2%
The Fed is trying to work inflation back down to the 2% level, but be careful about putting too much weight into this number.
Remember, from 2010 to 2020, the Fed struggled to get inflation up to 2%. The world didn’t fall apart in that time, and when the ground shook, it wasn’t because of inflation. Inflation isn’t a black-and-white situation — there’s a lot of gray area to work within.
So long as we avoid the runaway inflation days of 2021, investors don’t have to flinch when they hear the word “inflation.”
Want to receive these insights straight to your inbox?
The setup — Meta
Meta stock is holding up better than its Magnificent 7 peers, down just 3.5% from its all-time highs. That stands out particularly well when looking at names like Apple, Nvidia, and Tesla, all of which are down more than 10% from their highs.
The stock continues to hold the 50-day moving average as support, while the $590 to $600 area has seemingly gone from resistance in October and November to support in December and January.
From here, bulls are looking for two things. First, they want to see support continue to hold up from the two areas we just mentioned. Second, they’d like to see an eventual rally over $630.
Bears are looking for the opposite. They want to see Meta continue to struggle with $630 and eventually break below the current support levels mapped out above.
Options
One downside to META is its share price. Because the stock price is so high, the options prices are incredibly high, too. This can make it difficult for investors to approach these companies with options.
In that case, many traders may opt to just trade a few shares of the common stock — and that’s fine. However, one alternative is spreads.
Call spreads and put spreads allow traders to take options trades with a much lower premium than buying the calls outright. In these cases, the maximum risk is the premium paid.
Options aren’t for everyone — especially in these scenarios — but spreads make them more accessible. For those looking to learn more about options, consider visiting the eToro Academy.
Disclaimer:
Please note that due to market volatility, some of the prices may have already been reached and scenarios played out.