Wednesday, December 14, 2022

Inflation a Lagging Indicator – Useless to See Inflation and Trade the Markets

 Inflation looks to be the logical reason why markets are moving up or down to majority of traders.

However, historical data suggests that inflation is lagging whereas stock market is leading.

Below research is picked up from monthly research report published on 14th November 2022 – The Financial Waves Monthly update

Inflation and Markets - Above chart shows overlap of Sensex chart along with inflation data. We can clearly see from above that Sensex has continued to rise despite of rising inflation which has no strong correlation with prices. The reason being inflation is economic data that is lagging indicator. The data that we see now is for past months or quarter. Whereas, stock market is forward looking and discounting the future. So, Sensex is leading whereas Inflation is lagging.

Above chart highlights this lead lag behavior clearly. We can see that the major bottoms made in Sensex much earlier than the inflation started picking up. Classic example can be the top made in February 2020 when Sensex crashed sharply. Inflation was still running higher near 7% at that point of time which shows sharp decline only later in September 2020. Similarly, Sensex bottomed out in last week of March 2020 but Inflation bottomed out in November 2020 before slowly starting to inch higher. Sensex topping near 61000 in October 2021 is also followed by Inflation topping out in April 2022.

With equity markets again starting to inch higher there is high likelihood that we will start seeing inflation picking up again in lagging fashion. So many, who might be thinking inflation and interest rates have peaked out are here for a surprise and both the inflationary cycle and interest rate cycle is still in upward trajectory. It is only once we see fall in Nifty or Sensex we can have comfort of easing inflation in near future.

In a nutshell, many are tracking inflation to forecast the markets whereas it has to be exactly the opposite way of tracking markets to see if inflation is going to increase or not and in turn the interest rates! Simple way of looking at things that can change the very perspective by plotting out in form of charts.

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