Few things screw up the financial system like a surprise dose of inflation. The assumptions that underlie a million financial models have to change. Everything gets repriced. Inflation is unequivocally bad for bonds. Bonds are a fixed income stream, and inflation reduces the real value of the income. With stocks, the effect of inflation is less cut-and-dried. A stock is valuable because it’s a claim on a future stream of cash flows (the company’s profits). In trying to decide what a stock is worth, investors weigh up two things: the expected size of future cash flows, and the appropriate discount…
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