Inflation vs Stocks - Which Companies Win and Which Lose?

[00:00:00]What is the relationship between inflation and the performance of stocks?

[00:00:05]Imagine this. You wake up 2 months from now. Then you realize the price of for example a loaf of bread has increased by even 50%.

[00:00:15]Right? The cost of fuel has increased by 200%.

[00:00:21]Generally that is inflation happening in the economy. Right? But what most people out there don't understand is that inflation impacts different companies in a different way in the stock market because with inflation there are companies which gain very big in the stock market and there are others which lose. That is what I want to talk about in this video. How inflation affects the price of stocks and most importantly for you as an investor actionable knowledge for you. how different sectors or even different companies are impacted. So watch the whole of this video for you to really appreciate how inflation affects the price of stocks in the stock market and end up making informed decision. In case you are new here, my name is Afagaam. I am a finance expert and qualified accountant bringing you amazing videos about making money and investing each and every day. In case those are kind of topics which you like, down there is a button called subscribe.

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[00:01:43]As a starting point, let's first of all look at what is inflation.

[00:01:48]Inflation is a general increase in price of basic commodities in the economy.

[00:01:56]What do I mean? Case in point, the basic commodities are for example food stuff.

[00:02:01]You know the cost for income for transport, right? And so forth. So in case the price of food stuff maybe loaf of bread has increased by 130%. Maybe sugar has increased by 20%. Right?

[00:02:15]Vegetables have increased by 10%. On the other side issue relating transport fuel has increased by maybe 180% or even 200%. And all these other related costs which are people utilize each and every day increase. Ultimately the average increase in the price of the average bucket of commodity that is inflation.

[00:02:35]And just looking at Kenya's number for example, according to Kenya's National Bureau of Statistics, the inflation for sometime last month was 6.4%.

[00:02:46]The previous month it was 6.7%, it did decreased a bit. Okay, please remember this annualized inflation rate. That tells you inflation is trending on single digit. Okay, so in case it jumps double digit, it begins being runaway, what is bound to happen? And how is that going to affect you as an investor?

[00:03:09]First things first, in case inflation increases severely, your purchasing power is going to reduce because chances are your salary is not increasing commensurate to how inflation is behaving in the economy. And that means in case you're purchasing something for example with 1,000 Kenya shillings, if you are purchasing five items with 1k Kenya shillings, most likely you'll only end up purchasing two or three things because your purchasing power is going to have been reduced. And then again at the macro level when inflation starts to be run away also at central bank level central bank is going to do something is going to implement something called contractionary monetary policy. How?

[00:03:53]When inflation is rising and continuing to rise, central bank is going to increase its bank rate. Simply put, the bank rate is what determines percentage of interest on loans out there. So when the central bank increases its bank rate, which is a contractionary monetary policy to assist counter increasing inflation, then it means the cost of borrowing is going to increase.

[00:04:18]And remember not just the cost of new borrowing even existing borrowing because in the country we use a regime of borrowing which is called floating interest rate or variable interest rate.

[00:04:31]That's what most people don't understand. When you are signing a loan agreement you are also agreeing to the repayments which you're going to be making are going to fluctuate based on how the interest rate is going to be behaving in the country. So the central bank increases the bank rate it means commercial bank are going to increase also the interest lending rate and with that the existing obligations are going to be affected and the cost of borrowing loans is going to go higher simply the cost of financing is going to increase right remember behind the scenes as individuals are being impacted also businesses are operating and I've actually touched on one of the business which is operating In this context, commercial banks remember the ripple effect. Inflation increased as part of controlling inflation. The central bank increase its bank rate. As a ripple effect, the commercial banks increase their interest rates. Guess who's in business? Commercial banks. It means they're going to make more money through the cost of lending money to people. And if they make more money, what does it mean? The perception in the market on their stocks is amazing. Take note it is amazing and if the perception on the stocks is amazing the shareholders sentiments are going to reflect in the price of stocks. So even if the inflation in the economy where individuals are being impacted they are feeling the pinch. Central bank is stepping in to assist curb inflation by implementing the contractary monetary policy through increasing the bank rate.

[00:06:11]the cost of financing through banks is going to increase and banks are going to make more profit. That is a good signal for the market and that is why we we're most likely going to see the stocks of banks continue to do well. The share prices are going to appreciate because BS is doing well. And even at the end of the period whether at the interim stage or even at the very end upon audited financial reports the banks are going to declare interim and final dividend to pay to shareholders. Simply put their share in profit because shareholders are part owners of the company. Guys, that is one set of companies or sector which is bound to benefit big time when it comes to inflation increasing in the economy and also related to that also insurance sector is going to benefit big time when inflation increases in the economy because of the ripple effect I was spoken about. Okay, having understood that let's now talk about another set of companies which is also going to see their stock increase. And then lastly I'm going to talk about the set of companies or sectors which are going to see their stocks deep. Another set of sector is those kind of businesses which do some kind of business called defensive investing style. What do I mean? I mean those kind of businesses which whose the products or services are necessary evils. You can't avoid them. Case in point a business in telecommunication a company like Safariccom whether inflation is increasing or not you are going to make phone calls you need data for you to be able to look at what is happening in the internet you're going to data okay you are going to conduct this through empa safar has market dominance and it solidified the space in a way that it's competitively very high and these products are in high demand despite the macroeconomic situations. So based on that and their defensive investment style or business approach it means that also even if inflation is increasing their stock price is most likely going to increase because demand is going to continue being there or even the worst can happen it can stay stagnant but given it's in demand and there's also volatility it means the stock price is going to increase okay and this also goes for those products which are used regularly in case for example there's a company which is listed at the and maybe it is selling for example washing detergents whether inflation is bad or not people must be clean they're going to continue utilizing washing detergents and as a result the stock of these companies is going to do well now when you justose that with other types of businesses which are impacted very highly by inflation right some businesses which are called cyclical businesses in case of very high inflation meaning the cost of borrowing is going to go very High interest rates are increasing.

[00:09:14]If there's a company which is relying on heavy debts, okay, in running its operations because of the nature of business, for example, construction, construction sector is a very expensive sector, right? That requires very high operating costs. If they are tapping into borrowing for them to operate, it means their business is going to be affected because there is going to be a cash situation. If they try to push this c this cost to consumers, are they going to lose business? If the risk is that they're going to lose business, they might decide to accommodate the costs within themselves despite there being an increased cost of borrowing. If they accommodate the costs, it means their profit is going to reduce. If there's a signal of profit going to reduce through a profit warning, that is going to send negative news negative signal to the market. Shareholders sentiments are going to be negative. Therefore, the stock price are going to come on plumating. That is an instance of a sector or specific businesses which might be negatively be impacted by inflation in the mid and long term.

[00:10:16]Guys, what do you think about this video? I hope by now you've understood the relationship between inflation and how the stock market performs. I hope this video has been amazing to you. Look forward to catching up with you in the next video. Cheers and take