Unexpected CPI inflation is associated with weaker 1-day U.S. stock returns for low-market-power firms (3.9% decline per 1% surprise) than for high-market-power firms (1.2%) (1977–2022; CPI releases vs. Bloomberg/Haver median forecasts; top vs. bottom quartile markups).
Do stock prices confirm that firms with high market power maintain profitability during times of high inflation because they can raise prices, while those with low market power cannot? In their August 2023 paper entitled "Stagflationary Stock Returns and the Role of Market Power", Benjamin Knox and Yannick Timmer study effects of inflation news on stocks of firms ranked by market power. They define:
Inflation news as the difference between total consumer price index (CPI) releases and the median inflation forecast from Bloomberg back to 1997, and before that from Haver Analytics back to 1977.
Market power as firm ability to set its price above marginal costs (markup), estimated as sales over cost of goods sold multiplied by the output elasticity of inputs (from a production function estimate).
They decompose stock returns into risk premium, risk-free rate and cash flow news components. They designate firms above the 75th (below the 25th) percentile of market power as high-market power (low-market power) firms to assess stock price responses to inflation news. Using total CPI releases, associated median inflation forecasts, accounting data for a broad sample of U.S. common stocks and daily returns for both individual stocks and the broad U.S. stock market during 1977 through 2022, they find that:
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