The stock market’s inflation fears are overblown as explosive economic growth is primed to create a perfect ‘mix’ for more gains, says a Wall Street chief strategist

Traders and financial professionals work on the floor of the New York Stock Exchange
Traders and financial professionals work on the floor of the New York Stock Exchange Drew Angerer/Getty Images
  • James Paulsen, Chief Investment Strategist of The Leuthold Group says stock investors shouldn’t fear inflation.
  • Paulsen told investors in a letter that inflation is only a concern for stocks when real economic growth is weak.
  • The strategist said what matters is not either “inflation” or “growth,” but the “mix” of the two.
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The stock market’s inflation fears may be overblown if explosive economic growth comes to fruition to create a perfect “mix” for more gains, according to James Paulsen, Chief Investment Strategist of The Leuthold Group.

In a letter to investors on Friday, Paulsen said that although inflation may be on the rise,  that hasn’t always meant poor returns for the stock market as long as real economic growth is strong.

And with the post-pandemic reopening in sight, many analysts are arguing real economic growth will be impressive in the second half of the year.

In fact, a monthly Bloomberg survey of economists showed annual GDP expectations nearly double to 5.5% from what experts were predicting just two months ago.

In his letter, Paulsen highlighted the two components that have made up nominal GDP since 1950: annual real GDP growth and annual inflation growth.

The strategist illustrated how a perfect “mix” of these components has led to significant stock market gains in the past. He also said that even when inflation rates are high, the stock market has been able to deliver strong returns as long as real economic growth remains strong.

“Regardless of the inflation environment, if real growth is Low, High, or Super High, negative annual market returns are not that prevalent,” Paulsen said.

According to Paulsen, it’s only when real growth slips to the “super low” level that returns begin to fall.

Contrary to popular belief, inflation isn’t always a bad thing for equity markets. According to Paulsen, when real economic growth is “super-high” inflation has “simply not been important.”

Instead, what’s important is the “mix” of annual inflation growth and real GDP growth. 

The strategist said fears of inflation wreaking havoc on the stock market are not “acute,” “because real economic growth is poised to be spectacular, creating a Mix that has historically been supportive for stocks.”

Paulsen did warn that if real economic growth falters going into 2022 and inflation remains high, that could be a recipe “far less hospitable for stock investors.”

“It’s not just inflation; it’s the mix,” Paulsen concluded.

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