The impact of changing inflation on stocks depends on the initial level of inflation and the direction of the trend.

The combination that tends to be most favorable for stock markets is when inflation is rising from very low levels (and the risks of deflation are declining) or when high levels of inflation are moderating. As the chart shows, for stocks, bonds, and balanced funds, higher inflation (above, say, 3%) that is rising tends to be the worst-case scenario, while inflation above 3% that is falling is much more benign. 

For stocks in particular, the best returns tend to occur when inflation is below 1% but rising; this is often associated with a recovery from a recession and also with a declining risk of deflation (and, therefore, is not particularly favorable for bond markets).

Stable yields with inflation within the range: the reversal of extremes tends to be bullish