Inflation and the Market

The big news moving the markets yesterday was the government's report that inflation rose higher than expected in November, with the producer price index jumping 1.8 percent. Most of that was because energy prices were up 6.9 percent, but even so-called soft goods rose 0.5 percent for the month, their biggest increase in over a year.

And since the Dow was down for the day, much of the press leapt to equate the two. MarketWatch wrote: "US stocks finish lower amid signs of inflation." "Spike in wholesale inflation sends stocks lower," said the AP. "European, US stocks drop after inflation data," said Business Week.

But that's probably not what happened. Inflation is actually good for stocks; when everything starts to get more expensive, one of the prices that tends to rise is the price of stocks. In fact, there was a research paper on this subject not too long ago, by an economics professor at Columbia and a statistician for the Fed, which found that "bond and equity yields comove strongly and positively with expected inflation."

Inflation could play all kind of havoc with our economy, if it does return with a vengeance. But it's not likely to have a negative effect on the stock market - and it almost certainly didn't drive stocks lower on Tuesday.