Inflation rate has continued rise this year – starting off the year at 21.82% in January and increasing all the way to 22.79% in June of 2023. Experts anticipate a continued increase in the rate if appropriate measures are not taken. The effects of rising inflation can be very harmful to any economy, as it impacts many aspects of the economy including the equities market. Inflation affects investors, companies, and market dynamics, and can also lead to negative consequences for the market; the question is in what way.
When there is inflation, the purchasing power of investors and the people decreases. Someone may be forced to sell some of their stocks to afford certain things like food, and rent, among other things. On the other hand, investors, concerned about the purchasing power of their returns, may demand higher returns to compensate for the declining value of money. As a result, stocks that fail to outpace inflation might become less attractive, leading to potential declines in their prices and overall market volatility.
Inflation and interest rates, which play a crucial role in the equities market, also go hand in hand. Central banks often raise interest rates to combat inflation. We saw this happening during the July Monetary Policy Committee Meeting where the committee voted to raise its benchmark rate to 18.75% to tame inflation and stimulate investments. While high-interest rates could curb inflation, it would also increase the cost of borrowing for companies, limiting their growth prospects and leading to lower earnings. As a result, investors might become more risk-averse, causing a shift away from equities and towards fixed-income investments, which offer higher returns due to the rising interest rates.
Also, different sectors within the equities market are affected differently by inflation. Some sectors, such as commodities and real estate, tend to perform well during inflationary periods due to their tangible nature and potential to act as a hedge against rising prices. Conversely, sectors that rely heavily on borrowing or have limited pricing power may suffer, as their profit margins are squeezed by higher costs. For instance, the
Lastly, inflation can impact investor sentiment and behavior. Uncertainty about the future purchasing power of money may lead investors to adopt defensive strategies, such as diversifying their portfolios or investing in inflation-protected assets like Such investor sentiment shifts can lead to equity price fluctuations and affect market liquidity.
Although the Nigerian stock market seems to be unresponsive to the high inflation rates, the effects of the contractionary measures the government employs to combat the issue are felt in the market. It is important that investors stay vigilant and adopt appropriate strategies. Diversifying portfolios across various sectors, regions, and classes while considering the current economic landscape and newly implemented policies are essential in mitigating the risk of inflation.
In conclusion, inflation has a multifaceted impact on the equities market, influencing valuation, interest rates, sector performance, and investor behavior. Understanding the interplay between inflation, the equities market, and the economy as a whole is vital for investors, businesses, and policymakers as they strive to navigate the complexities of a dynamic and ever-changing economic landscape.