Be careful what you wish for
With its new symmetric inflation target, the Federal Reserve will allow consumer prices to (temporarily) overshoot the 2% level. If the Fed succeeds in creating such an overshoot, however, equities may actually struggle. Today’s chart by Deutsche Bank reveals an inflation level between 1% and 2% has historically been the sweet spot for stock market valuation, measured by the price-earnings ratio. This is likely due to the fact that inflation levels of between 1-2% do not immediately cause deflation worries, while at the same time forcing the Fed to stimulate more to get inflation up. If levels exceed 2% inflation, however, market valuations start to come down. Hence, an inflation overshoot of, let’s say, 3% could be troublesome for equities.
As a senior portfolio manager I use charts to illustrate financial issues every day. I tweet my favorites as @jsblokland and was named 'one of the 50 most important people for investors to follow in 2018' by MarketWatch.
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