Soaring inflation to hit ASX returns

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Higher inflation in Australia is set to have a negative impact for ASX investors, according to new quantitative analysis.

SigTech, a quantitative technology company, provided analysis on how various inflation levels over the past 50 years have impacted the Australian stock market.

Australian inflation peaked at almost 4% in 2021, after a decade of remaining at or below the RBA's 2-3% target range.

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SigTech's research found that historically the Australian stock market has achieved its greatest risk premia with inflation levels of 2-3%. Higher rates of inflation have typically resulted in lower equity risk premia.

The analysis suggested that the negative correlation between inflation and valuation multiples is typically explained by increased uncertainty about a company's ability to pass on rising inflation.

Another contributing factor is that higher inflation generally results in rising interest rates, which in turn makes stocks less attractive to investors compared to bonds.

"As inflation increased in 2021, uncertainty about the longer-term level at which it will stabilise abounds. At the same time, the Australian stock market is trading at valuation multiples markedly above the long-term average," says vice president of investor solutions at SigTech Daniel Leveau.

"If history were to repeat itself, higher long-term inflation suggests that valuation ratios of the Australian stock market are likely to decrease and negatively impact share prices."

Leveau added that accurately modelling inflation data is a complex exercise, involving multiple macroeconomic variables.

"Investors need to build complex research models and processes to be able to create realistic inflation forecasts," he says.

This article first appeared on Financial Standard

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Elizabeth McArthur was a journalist at Financial Standard from March 2019 to April 2022. She has a bachelor's degree in journalism from UTS and a master's in creative writing from Melbourne University.

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