Inflationary adjustments are fueling the stock market and economic volatility

Wall Street has had a rollercoaster week, with stocks swinging back and forth between highs and lows. The erratic move left markets and investors in turmoil, leaving many wondering what is causing this turbulence and what the future holds. Is volatility a blip on the screen, or a long-awaited market correction?

Seth Levine, a lecturer in the Department of Accounting at the University of Miami Patti and Allan Herbert Business School, and alumnus Marcelo Zinn, president of Maredin Wealth Advisors, shared their insights on the stock market turbulence.

What can we expect in the coming weeks after Monday’s wild stock market ride?

Zinn: So much of what will happen in the coming weeks and months is the result of the Fed’s response to inflationary pressures. The Fed is focused almost exclusively on inflation, as it can create significant volatility in both the economy and the stock market. If inflation continues to run high and the Fed raises interest rates in response, the stock market will fall further – possibly significantly – with growth stocks, especially unprofitable ones, being penalized the most.

If inflation has peaked and weakened, the Fed will raise interest rates more deliberately and the general market may continue to rise.

Is inflation a driving force behind stock market fluctuations? How does that work?

Levine: Inflation is a driver in that it causes the Fed to respond by using interest rates to maintain stable prices – one of its two core mandates.

When interest rates rise, the cost of money rises, making borrowing and borrowing more expensive. This motivates people into “lower risk” assets (such as bonds) that offer better risk-adjusted returns. This usually causes the stock market to react negatively; all investment decisions are relative.

When interest rates fall, the cost of money falls, making it cheaper to lend and borrowing money, and motivating people to buy higher-risk assets, such as growth stocks, to get good returns. This generally causes the stock market to move higher.

Should anyone with a modest 401K retirement savings be concerned about volatility?

Zinn: Financial markets are full of opportunities to take advantage of and avoid pitfalls, regardless of the economic environment. An investor’s time horizon is much more important than the amount invested. That said, everyone should be concerned about their retirement savings because the stock market has historically been significantly high and inflation is running high.

As mentioned, there are good sectors to invest in – and many to avoid. If you know what’s what, you’ll be fine, both in the medium and long term. If you are nearing retirement, you should think carefully about the current market situation and your individual positioning to determine whether it makes sense to stay invested.

Real estate prices have soared lately. Stocks are showing signs of weakening. What other investments should people consider to protect their savings and retirement?

Levine: In some markets, such as Florida and Texas, we are seeing a large migration from New York, New Jersey and California. This will help drive house prices further, but we could see moderation in the coming months and years depending on Fed policy actions. Real estate is very local. Some markets may continue to rise, while others fall with rising rates. Real estate can be a good investment these days, but as with any investment there is a significant nuance.

Of all the sectors that have done well in an inflationary environment, few have outperformed energy, but it’s not a general investment as there are different risks here too. While history is a guide, as Mark Twain once said, “History doesn’t repeat itself, but it rhymes.” We believe energy will do well, but there’s no guarantee when you consider how dependent it can be on global economic conditions.

What is the fault of all this? Just the pandemic?

Zinn: People underestimate how much of an effect the Fed has on the markets, both in the short and long term. The pandemic caused the Fed, like all branches of government, to react strongly. Printing more than $4 trillion in 18 months has consequences. After enjoying the increase in asset price, we are now witnessing the negative side of this capital injection.