Inflation vs. Stock Market: Can Your Portfolio Keep Up?

Inflation is an important factor in long-term investing. When prices and wages rise, it can hurt company profits and reduce spending, which may lower stock prices. But some companies, like those that can raise prices or sell commodities, may benefit. Because investors respond differently based on how inflation affects them and what they expect, it often leads to market volatility.

A financial advisor can help you create a plan to protect your portfolio from inflation. Connect with fiduciary advisors today.

What Is Inflation and How Does it Work?

Inflation refers to the rate at which the general level of prices for goods and services rises over time, reducing the purchasing power of money. It’s typically measured by indexes like the consumer price index (CPI), which tracks changes in the cost of a standard basket of goods.

Inflation can result from increased consumer demand, higher production costs or expansionary monetary policies. Inflation is generally present to some degree and is not always regarded as a negative factor. Moderate inflation often signals a growing economy. Excessively high or low inflation, on the other hand, can disrupt financial stability.

Given its importance, inflation naturally is of great interest to economists and policymakers. Central banks, such as the Federal Reserve, monitor inflation closely and may raise or lower interest rates to keep it within a target range.

How Inflation Impacts the Stock Market

Inflation affects the stock market in uneven and often unpredictable ways. Higher inflation tends to raise costs for businesses—particularly in areas like labor, raw materials and energy—squeezing profit margins if those costs can’t be passed on to consumers. This can lead to downward pressure on stock prices, especially for companies with fixed pricing structures or limited pricing power.

Interest Rates and Monetary Policy

When inflation exceeds monetary policy targets, central banks are often prompted to raise interest rates in an attempt to slow economic activity. Higher rates increase borrowing costs for both businesses and consumers, potentially dampening corporate growth and spending and, it they work as intended, exerting downward pressure on inflation. Rising bond yields can also make fixed-income investments more appealing, pulling money away from equities and leading to stock market declines.

Sector-By-Sector Performance

High inflation is generally negative for the economy, but some sectors handle it better than others. Energy and materials companies can benefit from rising commodity prices, and financial firms may gain from higher interest rates. Comparatively, technology and consumer discretionary sectors may struggle with higher costs and weaker demand.

Volatility and Market Sentiment

Inflation tends to increase market volatility, especially when it deviates from expectations. Investors closely monitor inflation reports for clues about future interest rate policy. Markets often react more to surprises in inflation data and central bank signals than to the inflation rate itself. When inflation indicators deviate significantly from forecasts, it can lead to sharp shifts in sentiment and pricing.

How to Hedge Against Inflation

Protecting against inflation often means allocating capital to assets that tend to retain value or generate rising income as prices increase. Below are several categories of investments commonly used to hedge inflation risk.

Treasury Inflation-Protected Securities (TIPS)

TIPS are U.S. government bonds designed specifically to combat inflation. Their principal adjusts with changes in the CPI, and interest payments are based on this inflation-adjusted amount. They offer a direct and relatively low-risk way to preserve purchasing power.

Commodities

Raw materials like oil, natural gas, copper and agricultural goods often rise in price during inflationary periods. Investors can access commodities through futures contracts, exchange-traded funds (ETFs), or stocks of commodity-producing companies.

Real Estate and Infrastructure

Real assets such as commercial real estate and infrastructure projects generate income that can increase with inflation. Real estate investment trusts (REITs) offer a liquid way to gain exposure, while infrastructure funds focus on utilities, transportation and energy networks with inflation-linked revenue.

Equities With Pricing Power

Companies able to raise prices without losing customers may outperform during inflation. These often include firms in sectors like energy, consumer staples and materials. Dividend-growing stocks can also offer partial protection if payouts rise along with inflation.

Floating-Rate Bonds and Tactical Allocation

Unlike most bonds, which pay a preset and unvarying rate of interest, floating-rate bonds adjust interest payments based on current rates. Floating-rate bonds are generally of relatively short duration and often have limits on how much the interest rate they pay can rise or fall. However, they do offer some insulation from inflation-driven rate hikes.

How Growth and Value Stocks React to Inflation

Inflation tends to widen the performance gap between value and growth stocks. Growth stocks, which are often priced based on the expectation of future earnings, are more sensitive to rising inflation because higher interest rates reduce the present value of those future cash flows. This effect can lead to declining valuations, even if the companies maintain strong revenue growth.

In contrast, value stocks—typically established companies with steady earnings and lower price-to-earnings ratios—are less impacted by shifting discount rates. Many value stocks also operate in sectors like financials, energy and industrials, which may benefit from inflationary trends.

As inflation persists, investors often rotate out of growth-oriented positions and into value stocks that offer immediate cash flows and potentially stronger relative performance in a high-rate environment. This dynamic can alter portfolio composition and sector weightings as inflation expectations evolve.

Bottom Line

Inflation trends typically have significant influence on financial markets, but markets don’t always move in a single direction when impacted by inflation. Some businesses falter as costs rise, while others adapt or even thrive. With that in mind, it’s advisable for investors to understand how different assets respond to changing price levels. Thus informed, investors can reposition their portfolios accordingly, using tools like inflation-linked bonds, sector rotation or real assets to adapt to shifting economic conditions.

Investment Planning Tips

• A financial advisor can help you manage investments for your portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you want to diversify your portfolio, here’s a roundup of 13 investments to consider.

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