For most of this year, inflation has been over the Fed’s target rate of 2%. This shouldn’t be news to anyone since a quick trip to the grocery store will let you know “real” inflation is probably in the double digits.

What does this mean for the stock market?

It means holding cash is making people poorer, forcing them to risk their money in the market to get some yield.

This has always been the case ever since the US brought the world onto its monetary standard 50 years ago. The difference now is the problem is much more severe.

The following explanation shows the problem of inflation clearly.

Let’s just assume the government isn’t lying about their inflation numbers. And let’s assume you want to maintain your purchasing power for 10 years. In other words, how much does $1 have to be worth in 10 years so you can buy the same amount of stuff?

Before COVID lockdowns, inflation was around 1.5%/year. Assuming it stays at 1.5%, you will need $1 to be worth $1.16 in 10 years to maintain your purchasing power.

$1 with 1.5% inflation compounded over 10 years: $1 * (1.015^10) = $1.16

Now do the same calculation with 2021’s inflation of 6.2%.

$1 with 6.2% inflation compounded over 10 years: $1 * (1.062^10) = $1.82

In the first situation, you would only need a 16% return in 10 years to keep your purchasing power/”keep up with inflation”. This can be reliably done by holding lower risk assets like certain bonds or stable, dividend-paying blue-chip stocks like 3M.

In the second situation, you would need an 82% return in 10 years. That’s almost a double. This can’t be done (as reliably) with stable, blue-chip companies since they don’t grow fast and economic conditions may be poor some years. So the only logical next step is for you to go “further out in the risk curve”, which means throwing money at riskier, typically overvalued companies in hopes they can outgrow inflation.

This is exactly why people are jumping into overvalued tech stocks and EVs – since 3M’s 3% dividend is not enough, people have to pray an EV company with nothing but a CAD design will be able to sell enough cars 10 years in the future.

Most recently, even many tech stocks are not enough to combat inflation. Thus we’re seeing people piling into shitcoins like Shiba Inu and NFT “art” I can create in MS Paint in 5 minutes!

And that’s just various asset markets. The labour shortage, labour destruction, energy crisis, massive trade deficit and political unrest all stem from inflation.