The negative relationship between inflation and Maltese stock returns : an analysis

Abstract

PURPOSE: This study sought to analyse the relationship between inflation and Maltese stock returns and identify causes of such relationship using monthly data comprising of 139 observations. Additionally, the study sought to compare the results of the Maltese stock market with previous empirical evidence from developed and developing economies.

DESIGN: A mixed-research design was adopted to attain the objectives of the study. The quantitative method involved a series of statistical tests so that the final multivariate time series model – a vector error correction model, was fitted to the data. Research efforts were corroborated through the findings from the qualitative method which involved 8-semi-structured interviews with local experts on the subject matter.

FINDINGS: Stock returns are positively influenced by stock returns of the previous month and negatively influenced by inflation where the inflation factor takes 3 to 4 months to impact stock returns. Additionally, short-term interest rates and money supply seem to contribute indirectly to the negative inflation-stock returns relationship since both variables are statistically significant in explaining inflation. Long-term interest rates and industrial production variables are statistically insignificant in explaining both inflation and stock returns. The key message from the interviews, the Maltese investors’ mentality of high dividend pay-out and capital preservation was stressed by all interviewees.

CONCLUSIONS: Investors should incorporate inflation, short-term interest rates and money supply when making an investment decision. Additionally, policy makers should exert smooth and positive influences on the economy so as to reduce volatility in the Maltese stock market and in turn increase investors’ confidence.

VALUE: The study contributed in enriching the current limited literature on the Maltese stock market and hence adding value to local financial advisors when giving investment recommendations. Moreover, the study gave additional value to macroeconomics finance literature by providing several recommendations to investors and policy makers.