I can't understand what stock indexes really are. What they are representing? As far as I know, they represent relative change (in points) in the prices of shares of a given set of companies. Is that correct? If so, then does this mean that a stock index is directly dependent on inflation? Because inflation causes rising in share prices since the value of a currency is decreasing, so the stock indexes must be rising as well. Is that correct? If so, then the rising of a stock index does not always represent the rising of a given set of companies, but just their prices in inflated currency, and it does not mean when the index goes up, the investor gets a profit (since the purcasing power of the currency went down)? Sorry for the stupid questing, I'm just started learning the basics of economics and investing.
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1$\begingroup$ There is no clear connection between inflation and the stock market. For example, there is substantial inflation at the moment, and most socks declined significantly in the last few months. In the long run, you can expect shares to act as a hedge against inflation. a stock index is just a combination of stocks put together to represents and measure the performance of a specific set of stocks. $\endgroup$– AlexMay 26, 2022 at 17:10
1 Answer
Yes, stock indices and inflation are related.
A stock index is generally calculated based on a basket of stocks. For example, SP500 is calculated based on the prices of about 500 big companies. The movement of SP500 represents the overall price performance of those 500 big companies, which to some extend can be regarded as the broad market. If SP500 declines significantly, that means most companies are having a bad time and the general economy is not good.
During the time of inflation, consumers will cut spending, the federal reserve will raise interest rate to curb inflation, which makes financing cost higher for businesses. Overall, the general economy will most likely not be good and SP500 will not look good either.
There is a component of inflation in the stock price increase. However, based on history, the real return of the stock market is positive. In other words, the nominal return of the stock market exceeds the rate of inflation.
