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Stock market today: World markets are lower after China unveils 5% economic growth target for 2024
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Closing prices for crude oil, gold and other commodities

How does the Consumer Price Index affect the stock market?

how does the consumer price index affect the stock market? Learn more. Image of a shopping cart against a stock chart.

Key Points

  • The CPI measures the average rate of change in the prices of goods and services consumed by households over some time.
  • It also measures the most significant type of inflation related to your investments. 
  • We'll describe the effects of the CPI and why it's essential for your investments and explain how the consumer price index affects stock market action.  

The acronym "CPI" for Consumer Price Index may seem familiar if you pay attention to the stock market. It's constantly mentioned in the headlines when referring to inflation. 

How is an acronym few people knew or cared about just a few years ago now a top news story and significant stock market mover today? How does the Consumer Price Index (CPI) impact you and your money? 

In this article, we'll go over the effects of the CPI and why it's essential for your investments. We'll also explain how the consumer price index affects stock market action.  

How does the Consumer Price Index (CPI) work?

The CPI measures the average rate of change in the prices of goods and services consumed by households over some time. The CPI meaning coincides with inflation — they are interchangeable. The U.S. Bureau of Labor Statistics (BLS) releases a monthly CPI report, collecting the prices of over 80,000 items monthly through surveys with businesses to estimate overall price changes on baskets of goods and services. 

The research report details the price changes in over 200 categories arranged into eight groups: food and beverage, housing, apparel, transportation, medical care, recreation, education, communications and other goods and services.

how does the consumer price index affect the stock market

What is inflation?

Inflation takes the same action as prices for goods and services as they inflate and rise. It's the rate at which the general prices for goods and services rise. 


When you inflate a balloon, it grows. There are many causes for inflation, such as supply shortages, demand surges or rising input costs. Inflation causes your purchasing power to erode. As prices increase, you can't afford to buy as much with the money you're making now. 

Prolonged periods of inflation may cause wages to rise, and the labor market gets tighter as companies compete for a shrinking talent supply. The CPI measures the most significant type of inflation related to your investments. 

How the CPI is used

Economists, analysts, businesses and government policymakers use the CPI report differently to help influence their decisions regarding wages, salaries, pricing and interest rates. Employers use the CPI to measure the cost of living since it considers all the essential products and services typically purchased by households. With this information, they can adjust wages annually to better correlate with the economy. 

Employers that want to remain competitive for talent, retain employees and sustain the morale of their workforce will be prudent in adjusting worker pay relative to the CPI. The catch-22 is that raising wages can add fuel to the fire with rising CPI. This is especially tough for employers because once they raise wages, it's hard to pull them back down when the CPI falls.

Businesses use the CPI to price their products and services. Rising CPI can lead to the business eroding consumer purchasing power and margin compression. Companies must remain prudent and adjust pricing to accommodate a rising CPI. This can often mean raising prices, which may hurt demand but maintain operating margins. Businesses will decide if they're passing the rising costs to the customer or absorbing them internally as margins shrink. 

Perhaps most importantly, the U.S. Federal Reserve (the Fed) uses the CPI to determine monetary policy and interest rate changes. If you've wondered how CPI affects stock market reactions, it's to anticipate what the Fed will do with interest rates. The Fed will incorporate interest rate hikes when the CPI gets too high to cool inflation. Its goal is to bring prices back down without heavily impacting demand. However, rising interest rates tend to cause stock markets to sell off as investors take a risk-off stance and invest in fixed-income instruments. Loan demand also falls with rising interest rates since financing becomes more expensive. Therefore, the Fed must walk a tightrope in determining monetary policy. The CPI has a considerable influence on what the Fed will do. 

Effects of inflation on stocks 

How does consumer price index affect the stock market? The answer may be surprising if you've ever wondered how CPI affects stocks. It cuts both ways. Inflation refers to rising prices for goods and services and assets like stocks and commodities. Inflation occurs in expanding and growing economies. 

These are good conditions for a bull market as demand rises, causing prices to rise. In turn, this results in more spending and more revenues for companies, followed by rising wages. Eventually, wages must catch up with the inflation rate, or trouble could brew. It can be good for stocks, especially technology companies, as the market focuses on growth over profits, and financing is relatively cheap.

Inflation can also hurt stocks as consumers feel the pinch in their budgets due to the rising prices. Inflation can affect stocks and sectors differently depending on the top and bottom line effects. Consumer staples stocks, including grocery stores, manufacturers of perishable foods, toilet paper, diapers and personal products, tend to do better during inflation because their margins improve with higher pricing. Consumer discretionary stocks tend to fall as consumers have less discretionary income to spend on apparel, vacations, entertainment and eating at restaurants. 

High inflation can also lead consumers to trade down even from brand names and premium products in staples and discretionary purchases. Consumers who are used to buying a well-known cereal brand or pasta may trade down to the store brand private label since it's cheaper with matching quality. Consumers who purchase premium drinks may change to non-brand beverages at bars and restaurants. It's a balancing act with consumer staples stocks vs consumer discretionary stocks when balancing a portfolio during inflation. 

High inflation ultimately becomes terrible for all stocks, forcing the Fed to adjust monetary policy by tightening the money supply and raising interest rates. Higher interest rates hurt technology and growth stocks due to the higher financing costs, which causes the stock market to sell off as investors take a risk-off approach and move money into fixed-income instruments like government and corporate bonds. All stocks are affected as they generally link to sell off benchmark indexes. 

If you've paid attention to news reports over more than five years, you'll notice a consistent trend of at least some inflation. While most laypeople assume that inflation is always a sign that the economy is on a downward trajectory, the truth is that some level of inflation is expected annually — and can be a sign of a healthier economy overall. 

In periods of moderate inflation, stocks have historically performed well. Companies can pass on increased costs to consumers through higher prices when the dollar's value is not severely impacted, maintaining profit margins without much complaint from consumers. Additionally, inflation can be a sign of a growing economy, which tends to benefit corporate earnings and stock prices. Investors may view stocks as a hedge against inflation during these periods, as they represent ownership in companies that can adjust their prices and operations to adapt to changing economic conditions.

However, when inflation rises rapidly, it can erode the purchasing power of consumers and reduce corporate profits. High inflation may lead to higher interest rates, increasing borrowing costs for companies and consumers, potentially slowing down economic activity. In such situations, markets may experience volatility and declines as investors reassess the risks associated with inflation.

Inflation has had a historically varying effect across multiple sectors. Some areas where you might want to make special considerations are within the following major stock types and sectors. 

  • Cyclical stocks: Consumer cyclical stocks are shares of companies that tend to be more sensitive to economic conditions. Examples include consumer discretionary stocks representing items consumers tend to not purchase when wages are low and aerospace stocks, which also tend to do poorly when consumers have less discretionary income. During minor inflation and economic expansion periods, these sectors may perform well as consumer spending and business activities increase. As inflation increases, the performance of these stocks also often suffers. 
  • Technology and growth stocks: Tech and growth stocks may be more attractive assets during periods of less inflation. High-growing stocks may face pressure during rising interest rates as investors seek higher yields in other sectors and the security of dividend stocks. Remember this as you create your portfolio composition, and diversify with blue-chip options to balance growth-oriented assets.
  • Bond market: Inflation leads to higher interest rates, as central banks may raise rates to control it. When interest rates rise, the value of existing bonds decreases, leading to potential losses for bondholders. Investors may shift away from bonds during periods of rising inflation. Dividend stocks may see less impact, and investors shift money to assets providing a measurable return now during periods of uncertainty. 

Diversifying your portfolio across multiple industries and asset classes can help you customize your risk and return potential level. 

CPI's influence on interest rates

CPI plays a pivotal role in influencing monetary policy decisions, particularly regarding interest rates and how inflation affects consumer spending. Central banks like the Federal Reserve in the United States or the European Central Bank closely monitor CPI as a key indicator of inflation, and use pricing data to announce inflation data. These central banks also usually target a specific inflation rate to maintain price stability and support overall economic health.

When CPI indicates that inflation is rising above the central bank's target, it can prompt policymakers to introduce measures that have historically reduced inflation. One common tool for doing so is raising federal interest rates. Higher interest rates can help cool inflationary pressures by making borrowing more expensive, reducing consumer spending and business investment. Central banks may also use interest rate adjustments to manage inflation expectations, sending signals to the market about their commitment to maintaining price stability. The goal is to balance fostering economic growth and employment while preventing excessive inflation or deflation.

Changes in federal interest rates have historically resulted in significant effects on inflation and the pricing of consumer goods. One notable historical instance was the "taper tantrum" in 2013, when the Federal Reserve hinted at scaling back its bond-buying program, quantitative easing (QE). 

The Fed had implemented QE in response to the 2008 global financial crisis, aiming to stimulate economic growth and lower long-term interest rates. As the U.S. economy showed signs of improvement in 2013, there was speculation that the Fed might gradually reduce its bond purchases. This expectation led to a surge in consumer pricing, leading to a sharp increase in interest rates, particularly in the U.S. Treasury market.

This anticipation of a reduction in monetary stimulus also had implications for inflation expectations. If the Fed were to taper its bond purchases, some investors worried it might slow down inflation, which was below the central bank's target. 

Inflation expectations play a crucial role in shaping interest rates, and any uncertainty or shift in these expectations can lead to market volatility. The Fed took steps to provide clear communication with investors moving forward to avoid another hit to inflation and consumer pricing.

Sectoral impact of CPI on stock markets

Inflation changes and increases in the CPI can affect different types of companies differently, as factors like inflation and GDP changes may disproportionately affect some industries. The following types of stocks tend to be “winners” in environments where inflation is rising as reported by the CPI. 

  • Mining and materials: During periods of inflation, the prices of commodities are often the first to rise, requiring more resources to create the products that furnish shelves worldwide. Companies in the materials sector, which includes mining and basic materials production, may benefit from increased demand and higher prices for their products. An example of a quintessential materials and mining company is Freeport-McMoRan Inc. (NYSE: FCX)
  • Energy: Energy stocks can also perform well during inflationary periods, as rising prices for oil and gas contribute to increased revenues for companies providing those transportation energy services. Examples of major oil and gas companies include Chevron Corporation (NYSE: CVX) and Exxon Mobil Corporation (NYSE: XOM).
  • Real estate: During periods of inflation, some investors may move their money into hedging assets like real estate. Real estate values and rental income may rise with inflation, benefiting companies in this sector, which can be especially appealing for dividend investors. Suppose you’re interested in creating a dividend income stream and hedging against inflation with a single investment. In that case, you might consider investing in REITs like the ALPS Active REIT ETF (REIT)

Sectors that tend to do more poorly during periods of inflation include the following: 

  • Tech and other growth-oriented stocks: High-growth stocks, particularly in the technology sector, may face headwinds during periods of inflation. Rising interest rates can lead to higher borrowing costs, impacting the valuation of companies with future cash flow expectations.
  • Utilities: Utilities are often seen as defensive stocks, but rising interest rates can negatively impact them. Higher rates make their dividend yields less attractive compared to fixed-income alternatives, which can negatively impact stock prices. 

How to defend your portfolio against inflation

During periods of high inflation, investors tend to take a risk-on approach and invest in growth companies. The stock market tends to rise during rising CPI. However, it ultimately invites the Fed to raise interest rates, triggering a stock sell-off. Diversification and proper allocation are the keys to defending your portfolio against inflation. While there is no perfect defense against inflation in a portfolio, here are some ways to hedge against inflation.

  • Invest in consumer staples stocks: Invest in consumer staples stocks that benefit from high inflation. These include stocks of companies that provide essential goods and services like food manufacturers, grocery stores, utilities, housing, healthcare, personal care product makers and the stores that sell them.  
  • Invest in tangible assets: Invest in tangible assets like real estate and commodities. People still need a roof over their heads, so real estate and housing can be a hedge against rising inflation. Commodities are also a hedge against inflation as prices rise for raw materials.
  • Invest in inflation-indexed bonds: Investing in inflation-indexed bonds like Treasury Inflation-Protected Securities (TIPS) can also help you. These government-issued bonds offer a fixed rate adjusted for inflation as the principal of the TIPS increases. Remember to distinguish these from regular Treasury bonds, like the five-year, 10-year and 30-year fixed. These have a fixed yield and may not keep up with the pace of inflation. The Fed's raising interest rates to combat high inflation can result in higher yields but falling prices for treasuries. 

Strategies for investors in an inflationary environment

While inflation is an unavoidable part of the market cycle, there are a few steps that you can take to manage risk. Start by devoting a percentage of your portfolio to inflation-resilient assets. For example, Treasury Inflation-Protected Securities (TIPS) are bonds designed to protect against inflation. These securities adjust their principal value based on changes in the CPI, providing a potential hedge against rising prices. Investing in TIPS offers a safeguard that can help you hedge against more growth-oriented investments. 

Bonds aren’t the only investable assets that have shown historic resilience against inflation. Allocate a portion of your portfolio to commodities and real assets, as they often correlate positively with inflation. Investments in sectors like energy, metals and real estate can provide a hedge against inflationary pressures, offering stability to your portfolio that balances aggressive assets. Materials, energy and certain parts of the financial sector may also perform well during periods of high inflation. 

It’s also important to employ risk management techniques, such as setting stop-loss orders or using options strategies, to protect against significant market downturns. Understanding your risk tolerance and establishing a disciplined approach to risk management is vital in navigating market fluctuations. Regularly monitor and re-evaluate your investments to be sure that they still align with the goals you have for your portfolio. 

Long-term tailwinds

Hopefully, you now have a better answer to the question, “How does CPI affect stocks?”

Stock markets ultimately run higher in the long term. Remember this historical fact when adjusting portfolios based on the CPI. The near-term effects of a rising CPI can negatively impact the stock market, but that's why the Fed raises interest rates to combat high inflation. The Fed ultimately targets inflation around the 2% range, which is considered the ideal level of inflation. 

As they say, "Don't fight the Fed." It's best to stay the course, have a diversified portfolio of stocks and bonds and adjust the allocation as needed. 

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Sarah Horvath

About Sarah Horvath

  • horvath.sarah17@gmail.com

Contributing Author

Retail, Healthcare, and Real Estate stocks

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Sarah Horvath has been a contributing writer for MarketBeat since 2022.

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