‘Good’ inflation or ‘bad’? Investors are scared because they can’t tell difference just yet

The stock market is generally expected to benefit from inflation, but a long-predicted surge in U.S. prices rattled investors in the past week. A closer look at the historical record might indicate the source of concern, according to one Wall Street analyst.

For equities, there is “good” inflation and “bad” inflation, said Nicholas Colas, co-founder of DataTrek Research, in a Thursday note. Good inflation lifts corporate earnings as long as employment remains high; bad inflation causes recessions, undercutting corporate earnings.

“Markets are volatile because they’re not sure which sort of inflation we have at present, or what (if anything) the Federal Reserve may do to bring inflation down,” he wrote.

Stocks fell sharply on Wednesday after data showed the U.S. consumer-price index, or CPI, rose by a hotter-than-expected 4.2% year-over-year in April. Equities bounced Thursday and Friday, but suffered weekly losses, with the Dow Jones Industrial Average DJIA, -0.16% down 1.1% and the S&P 500 SPX, -0.25% retreating 1.5% after closing at records on May 7. The Nasdaq Composite COMP, -0.38% fell 2.3% for the week.