Inflation and cross-sectional stock response - It is complicated

 What is the relationship between inflation shocks and equity prices? This simple question is addressed in a new paper from a group of Fed economists, see "Inflation surprises in the cross-section of equity returns". The equity response to inflation surprises is clearly negative. The response to a positive inflation shock is stronger than a negative shock. The inflation shock is significant when there is a change in monetary expectations. The response will vary cross-sectionally with firms that have low leverage, large market cap, high market beta, low book-to-market, and low market power having stronger inflation response. However, the results are sensitive to the timing of how you measure the inflation effect since inflation announcements come out before the market open. There is the return pre-announcement, post-announcement until the open, the open, and the period until close. 

The sensitivities generally make intuitive sense. For example, if you have less market power, you cannot pass along price increases. Lower levered firms will not get a bump like those firm who are large net debtors. High beta firms will be more sensitive to shocks. Positive inflation surprises are not the same as negative surprises. The sensitivities have also changed through time. Most important, the responses to inflation shocks are not all the same. There can be considered inflation sensitive and insensitive equity buckets.

Don't ask whether stocks are sensitive to inflation. Ask which stocks are sensitive.