Higher inflation is resetting the gravitational pull on stock valuations

Stock market valuations are under downward pressure even as prices remain high, because inflation is resetting the gravitational pull on asset prices. The Core Personal Consumption Expenditures Price Index rose 3% year over year in February 2024. The Consumer Price Index reached 3.3% in March 2024 as energy prices spiked due to the war in Iran. Inflation expectations for 2026 now stand at 2.7%, up from prior projections. Futures traders no longer expect Federal Reserve rate cuts in 2024 and now price in a chance of a rate hike. Higher inflation and elevated interest rate expectations increase the risk-free return from Treasury bonds. Investors demand higher returns from risk assets like stocks to justify holding them over safer alternatives. Since corporate earnings cannot adjust instantly, investors bid down stock prices to achieve higher expected returns. The stock market has experienced significant volatility amid the Iran war. While valuations remain fairly elevated, the logic of asset pricing has not changed. Higher interest rates mean lower valuations. Jamie Dimon and Warren Buffett both identify rising interest rates as a gravitational force weighing on all asset prices. Persistently higher inflation could keep asset prices lower for longer, reshaping long-term investment returns.