“Rising inflation is an unlikely cause for stocks to fall; Vietnam is in the optimal stage”

9:49:20 AM | 6/23/2021

That is a remark in an analysis report on the impact of inflation on the Vietnamese stock market released by Agriseco Research. Although inflation may increase and in case it exceeds the Government's target of 4%, the buffer zone of 4%-8% is still favorable for the stock market, especially when Vietnam's economy is still growing.

In Vietnam, inflation in the first five months of the year was still under control but, with an open economy like Vietnam that is vulnerable to world commodity prices, inflation pressures are on the horizon in the coming period.

How does inflation affect stocks?

According to Agriseco, rising inflation is not necessarily a cause for stocks to lose their value. Historically, inflationary impacts on the stock market are not simply a cause-and-effect relationship, but the outcome depends on the inflation rate placed in an economic growth picture and the prospect of how inflation is controlled.

Moderate inflation can be good for the economy, instrumental for companies to boost business operations in a price-rising environment. Rising inflation in the growing economy is usually a good thing but it will have a bad effect when the economy falls into a recession. Historical data in the last 10 years showed that the S&P500 Index of the United States performed best when inflation rose by 2-3%.

On the contrary, when inflation spiked suddenly, the U.S. stock market often plummeted. Historical data in the last 50 years showed that, when U.S. inflation grew by 3% or more, the S&500 Index sank by an average of nearly 10% a year. Typically, during the oil crisis of 1973-1974 when inflation exceeded 10%, the S&P 500 Index collapsed 17.3% and 29.7% in 1973 and 1974, respectively.

In Vietnam, Agriseco assessed that the inflationary environment is optimal for the stock market. According to Agriseco Research, inflation of 4% or lower is best for the stock market. Specifically, since the establishment of the stock market, Vietnam's economy had 106 months with a year-on-year CPI growth of less than 4%. VN-Index grew by an average of 2.73% a month in these months, much higher than the median.

The inflation growth in the first five months of 2021 was the lowest in six years. The May CPI climbed only 2.9% from a year-ago period. At present, inflationary concerns are coming from the high prices of gasoline and construction materials. Besides, the demand recovery is pushing up inflation to new highs in the second half of the year. However, Agriseco Research believed that although inflation may pick up and in case it exceeds the Government's target of 4%, the buffer zone of 4%-8% is still favorable for the stock market, especially when Vietnam's economy is still growing.

Historically, VN-Index witnessed 77 months with inflation growth of 4-8% and the gauge still added 2.0% to its value, a positive level. Vietnam's inflation forecast for 2021-2022 by world-leading institutions like ADB, IMF and World Bank ranged from 3-5%. This is an important motivation for the stock market to extend growth in the next two years.

When inflation accelerates to a double-digit rate, stocks often plummet and cause huge loss to investors. Statistical data showed that VN-Index spent 37 months with an inflation rate of over 10%. The measure sank 2.83% a month during this time. More specifically, some months witnessed a terrible loss of over 20% each as in the 2008-2009 period. Another example was in 2011 when inflation stayed in the range of 12-23% throughout the year (mainly due to ineffective fiscal stimulus), stocks fell for most of the year, with the VN-Index losing 30% in 2011 alone.

What stocks benefit from rising inflation?

According to research by Bloomberg, when inflation escalates, commodity prices often increase sharply, especially sensitive items like oil, metal, or agricultural commodities. While investing in international commodity price indices is now not suitable for the vast majority of investors, investing in businesses that are manufacturing and trading commodities expected to increase in prices in an inflationary environment is reasonable.

In addition, research by Goldman Sachs on the sensitivity correlation between the breakeven point of stocks of industries (versus the inflation index) and returns shows that high performing industries reasonable for investment include energy & industry, banking & insurance, and essentials.

Besides, Agriseco believed that value stocks often have higher yields than growth stocks in a high inflationary environment. Growth stocks have strong future earnings expectations, so valuation ratios like P/E for such stocks are often very high. Stock valuations are often very sensitive to changes in the discount rate, which will pick up when inflation rises. The stock market experienced many episodes where inflation increased and growth stocks plunged and caused great loss to investors. Investors can choose stocks of companies with stable business results, regular cash flows, and reasonable valuations, which will be suitable hedging tools.

In addition, Agriseco believed that industry-leading stocks are capable of making good price deals. Normally, in the inflationary cycle, input and output prices both tend to look up. However, benefits of such movement often come from industry-leading enterprises that hold advantages in price negotiation. This allows businesses to rein in input price hikes while easily communicating output price rises to customers. Through each economic cycle, inflation is sometimes high and sometimes low; leading enterprises will often gain more market share after each economic crisis and recession and make stronger development.

Source: Vietnam Business Forum