*The newspapers and talking heads on TV are at it again. The ‘Awaam’ willface a wave of inflationlinkasglobal commodity prices drive the cost of living to unbearably high levels.Most CPI models show inflation spiking to 15%+ over the next few months andpossibly higher as the subsidies on petrol and electricity are reversed.*
The political ramifications of this are evident from the hesitancy on showby the government. The previous administration had deployed poison pills(aforementioned subsidies) in the face of a hostile takeover and willhammer the government with a very compelling narrative on spiralinginflation over the coming months.
It is unfortunate that economic decision making is so often hostage topolitical factors and the ramifications of it are becoming increasinglydire with each cycle.
Do stock markets succumb to inflationary pressure? What sort of returns aregenerated by equities in such an environment? For this we will take a lookat the historical record stretching back over the last ~15 years.
First some context — since 2009, we have 153 monthly CPI readings both yearon year (YoY) and month on month (MoM). That’s a fairly robust sample sizeto draw some conclusions on how the KSE 100 reacts to high inflationreadings. For accuracy, we have measured the monthly index return thefollowing month i.e. on a T+1 basis to the CPI announcement.
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Interestingly, monthly equity returns do not seem to show any inverserelationship to YoY inflation. Average KSE-100 returns are positive duringdouble digit CPI readings (+1.4%) while positive months outnumber negativeones by more than 2:1.
However, markets are more sensitive to MoM CPI numbers but only at theextreme end (2.0%+ MoM increase) of which we have just a few data points(10 instances in total). In such cases average returns turn negative(-0.69%) while positive months drop to 40% of the sample size.