Will high inflation lead to a stock market crash?

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We are only two weeks into 2022 so far. And it is already becoming clear that inflation could be the one big risk to my investments this year. Concerns on inflation have been building up for quite a while. Companies have flagged rising cost pressures for around a year now. They appear to have been managed well so far, but inflation is only rising. And now it has risen enough for me to speculate about whether it could actually lead to a stock market crash. 

How big is the inflation problem?

The UK’s last inflation print, for November 2021, stood at 5% on a year-on-year basis. And the next one due soon is expected to be even higher. And inflation is hardly just a phenomenon restricted to this country. The US too, saw a pretty ugly inflation report earlier this week. Consumer prices rose to the highest levels in 40 years at 7%. Considering that many FTSE 100 companies have globalised interests, high inflation is particularly bad news. If it was restricted to just one country, geographical diversification could have softened the blow. But the cushion is not there now. 

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Fiscal stimuli’s double-edged impact

Part of the reason for the increase in inflation is high government spending. The stimulus provided during the pandemic resulted in high commodity prices, which at the time was good for the likes of FTSE 100 miners like Evraz, Rio Tinto, and Anglo American. But it also resulted more generally in higher inflation. In its trading update, sportswear retailer JD Sports Fashion estimates that some £100m of profit increase could have accrued just from the US government’s stimulus in the past year. 

As the effects of these stimuli wear off, inflation could come off too, of course. But it might just have a cost associated with it. Government spending was helping the economy sustain itself during a difficult time. There is no way of knowing whether the recovery will be robust even after the stimuli are withdrawn. So far, the UK has shown only tepid recovery and forecasters’ bullishness on US growth has also reduced in recent months. So in effect, we could be looking at muted growth as inflation is brought under control.

The likely outcome

However, even this is better than the possible impact if inflation continues to rise. It could result in a sharp growth slowdown, which in turn could well lead to a stock market crash, in my view. I do believe, however, that while the risk exists, its probability is unlikely to be high as policies are put in place to counter this possibility. I think the more likely effect of high inflation could be occasional pullbacks in the stock markets. This could be because of an impact on investor sentiment or due to companies’ results being impacted by high prices or both. 

Keeping this in mind, as an investor I do not see any reason to be deterred from buying FTSE 100 stocks. As long as I have a medium to long-term time frame in mind, I think inflation could well even itself out over time. If there are any dips in quality stocks in the meantime, I would buy them. 

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Manika Premsingh owns Anglo American, JD Sports Fashion, and Rio Tinto. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.