The primary measure of inflation is the Consumer Price Index (CPI), which represents the change in price for a basket of goods and services. The U.S. Federal Reserve has a mandate to keep inflation under control, and it targets a CPI increase of 2% each year.
But significant changes in inflation above or below the Fed's target can have a huge impact on asset prices, especially for stocks and housing. The CPI is on track for a steep deceleration in 2023 -- of a magnitude similar to 2009 and the early 1980s. The S&P 500 (^GSPC 1.18%) stock market index staged a huge move on both of those occasions, so here's what could happen in 2024.
Image source: Getty Images.
Inflation reached a 40-year high in 2022
Too much inflation can place pressure on households and businesses because their money buys fewer goods and services, leading to a slowing economy. On the flip side, not enough inflation -- or even falling prices (deflation) -- can force businesses to pull back on production and lay off employees. That also hurts the economy.
A few things can move inflation: interest rates, government spending, money supply, and supply chain shocks. Throughout the worst of the pandemic in 2020 and 2021:
- Interest rates were at historic lows.
- The U.S. government flooded the economy with trillions of dollars in stimulus.
- The Fed was using quantitative easing, which increases money supply to stimulate the economy.
- COVID-19 outbreaks caused factory closures around the world, which disrupted supply chains.
All of those things were inflationary, so it's no surprise the CPI soared to reach a 40-year high of 8% in 2022, far beyond the Fed's target. It sent the S&P 500 plunging 18% for the year.
In response, the Fed raised interest rates from 0.25% to 5.50% over the last 18 months to counteract that inflation. It's working so far with the latest CPI reading for Nov. 2023 coming in at an annualized rate of just 3.1%.
Data source: YCharts.
With December almost in the books, the CPI is likely to end 2023 with an average annualized increase of 3.5%. That would mark a 4.5 percentage point decline from 2022, when the CPI came in at 8%.
The last time the CPI slowed by more than 4 percentage points in a single year was in 2009, and before that, 1982.
Falling inflation is great for the stock market
As I mentioned earlier, deflation tends to be bad for the economy and the stock market. But when the CPI is rising too quickly, a decline toward the Fed's 2% target is exactly what consumers, businesses, and investors want to see.
It can boost corporate profit margins because businesses are paying less for their input costs, and it reduces prices for consumers leading to more economic growth. But most importantly, falling inflation prompts the Fed to reduce interest rates, which lowers the cost of capital. That means businesses can access funding more easily to grow and expand their operations.
CPI inflation averaged 3.8% during 2008, but it collapsed 4.2 percentage points to negative 0.4% in 2009. The banking crisis ground the economy to a halt, which is why the CPI fell into deflation territory. But the Fed responded by slashing interest rates and introducing quantitative easing for the first time. Plus, the U.S. government stepped in to bail out some of the major U.S. banks. Those moves gave investors confidence that deflationary pressures would be short-lived.
As a result, the ended 2009 with a gain of 26.4% (including dividends). But that's not all; inflation remained within the Fed's target for years even with interest rates near record lows, so 2009 sparked the beginning of a nine-year winning streak for the stock market.
There was a similar occurrence in the early 1980s. CPI inflation hit 10.3% in 1981 which sent the S&P 500 tumbling 4.9%. But it slowed more than 4 percentage points in 1982, driving a 21.5% return in the stock market. Inflation continued to fall, and 1982 marked the beginning of an eight-year bull run for the .
History points to more upside in 2024
The Fed hasn't started cutting interest rates yet, but the S&P 500 has jumped 24% in 2023 thanks in part to falling inflation. Plus, experts predict a shift in policy is right around the corner from the Fed. The CME Group's FedWatch tool points to a whopping six rate cuts next year!
As was the case in 1982 and 2009, it's possible 2023 is the beginning of a multiyear bull market in the S&P 500. If history repeats itself, 2024 will likely bring more positive returns.
Investors should keep an eye on CPI inflation in the coming months. So long as it continues to steadily decline toward the Fed's 2% target -- and absent any unexpected economic shocks -- the stock market will remain a great place for your money.
Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool recommends CME Group. The Motley Fool has a disclosure policy.
FAQs
What drove March 2024's inflation numbers? There are two big boulders sitting on the road to disinflation. Those two big boulders are the cost of housing and gas prices. The Bureau of Labor Statistics notes that “these two indices contributed over half of the monthly increase in the index for all items.”
What triggers high inflation? ›
More jobs and higher wages increase household incomes and lead to a rise in consumer spending, further increasing aggregate demand and the scope for firms to increase the prices of their goods and services. When this happens across a large number of businesses and sectors, this leads to an increase in inflation.
How does inflation affect the financial market? ›
As inflation in a country rises, the central banks increase the interest rates to gain control. Higher interest rates erode market liquidity, resulting in a bearish condition with reduced stock prices. In such a scenario, most investors sell off their stocks to avoid huge losses.
What was the biggest cause of inflation? ›
So, from this research, the authors find that three main components explain the rise in inflation since 2020: volatility of energy prices, backlogs of work orders for goods and service caused by supply chain issues due to COVID-19, and price changes in the auto-related industries.
Are we still in inflation in 2024? ›
For now, it looks like inflation will return to normal without a recession. As we had expected, inflation fell sharply in 2023 after reaching its highest level in over 40 years in 2022. In 2024, we project inflation to return to normal levels, in line with the Federal Reserve's 2% target.
Will inflation end in 2024? ›
Private sector experts expect inflation to drop below 2.5% in 2024, according to the Federal Reserve Bank of St Louis. Goldman Sachs projects core PCE inflation will fall to around 2.4% by December 2024. The firm anticipates rebalancing in the auto, labor and housing rental markets will spearhead the disinflation.
Why is inflation so high in Biden? ›
But to his credit, Biden acknowledged one of the main drivers of inflation: housing costs. The shelter index, a broader component of the inflation report that covers a majority of housing expenses, is up 5.7% year-over-year. That alone accounted for 60% of the overall annual rise in prices last month.
Will prices ever go down? ›
The reading was stronger than expected - but the pace of price increases has still fallen significantly since peaking in summer 2022. But the reality is that even as the inflation rate falls, it's unlikely that most prices will decrease alongside it, though some individual items might cost less.
Who benefits from inflation? ›
Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.
What are the worst investments during inflation? ›
Cash, fixed-rate bonds and certain types of stocks are generally seen as poor investment choices during high inflation.
Stay invested with the "buy and hold" strategy
Your length of time in the market is the best predictor of your total performance. The buy and hold strategy is exactly what it sounds like — you buy stocks that you believe will perform well over the long-term, then hold onto them for years to come.
Do stocks keep up with inflation? ›
Value stocks perform better in high inflation periods and growth stocks perform better when inflation is low. Stocks tend to be more volatile when inflation is elevated.
Who is responsible for inflation? ›
For centuries, economists have known that reckless money printing causes inflation. And that inflation then causes higher prices, higher paper profits and higher paper wages. Since the beginning of our current inflation, corporate profits have taken the brunt of this scapegoating.
What is causing inflation in America? ›
In fact, most of the rise in inflation in 2021 and 2022 was driven by developments that directly raised prices rather than wages, including sharp increases in global commodity prices and sectoral price spikes driven by a combination of pandemic-induced kinks in supply chains and a huge shift in demand during the ...
How to fix inflation? ›
Monetary policy primarily involves changing interest rates to control inflation. Governments through fiscal policy, however, can assist in fighting inflation. Governments can reduce spending and increase taxes as a way to help reduce inflation.
What is the trend in inflation in the US in 2024? ›
U.S. monthly inflation and core inflation rates 2020-2024
In March 2024, the inflation rate of the consumer price index increased by 3.5 percent when compared to March 2023. Inflation continues to trend downward. Core inflation has held more steady, decreasing only slightly from the year prior.
How high will inflation be in 2025? ›
Inflation is expected to continue to ease gradually, as cost pressures moderate. Headline inflation in G20 countries is expected to decline from 6.6% in 2024 to 3.8% in 2025. Core inflation in the G20 advanced economies is projected to fall back to 2.5% in 2024 and 2.1% in 2025.
Why is everything so expensive right now? ›
Ongoing supply chain disruptions, droughts, avian flu, labor shortage and more continue to keep grocery prices high.
How long can inflation last? ›
Price growth is slowing, but high inflation could still persist through most of 2024 and beyond. Inflation dropped from a year-over-year rate of 3.7% to 3.2% in October, according to the latest consumer price index report released by the U.S. Bureau of Labor Statistics Tuesday morning.
