A common misunderstanding among investors–and, sadly, a misunderstanding sometimes repeated in dubious publications floating on the internet–is that rising stock prices not only is a sign of inflation, but is actually part of itself. This makes sense on the surface; inflation is defined as higher prices, so higher stock prices is an inflation in stocks, right? The answer is quite simply no.
To understand why, we first need to think about what inflation is. Investopedia’s definition of the term is helpful here: “Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time.” This is a conventional definition of the term, and it also helps us understand why rising stock prices isn’t inflation.
Note how inflation is defined as the decline of purchasing power; it isn’t defined as the rise in the price level. However, declining purchasing power is reflected in the price level of goods and services. Thus we measue inflation by measuring the cost of goods and services. Of which, assets such as stocks and bonds are neither.
This is why economists do not define the increase in the price level of assets as inflation; that, instead, is asset appreciation. These are two entirely separate things that need to be understood–and analyzed–separately.
The confusion here is that the two are often very closely linked, although that link isn’t always there and doesn’t need to be there (a fancy way of saying this is that increases in the price level does not deterministically relate to changes in asset valuations). So, we could see a market in which asset prices go up and inflation does not. Or we could see the opposite: an increase in inflation and a decline in stock prices.
The latter scenario is quite common; we saw this in 2011, in late 2015 and early 2016, and in 2018. The former is less common but does still occur. However, for most of the time inflation and asset prices rise, because asset prices are valued in relation to the net present value (NPV) of their potential cash flows. Since cash flows come in the form of earnings (with stocks) or rents (with real estate), and since those are denominated by a price level of goods and services, inflation most often causes asset prices to rise.
Thus the common misconception is exactly backwards; asset price appreciation does not cause inflation, but rather inflation causes asset price appreciation. And that is partly why economists and financial professionals measure them separately and consider them on their own.