Three stock rebuttals to the Cassandra inflation case

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(Bloomberg) – Fears of inflation destruction are being felt by Wall Street executives and analysts, but stock investors are relatively optimistic.

Shares of companies with higher pricing power — the ability to pass costs on to customers without hurting the business — are crumbling relatives of their less privileged peers. Meanwhile, S&P 500 stocks with the highest labor costs beat companies with relatively low ones. And operating margins are at record highs.

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This is in stark contrast to the alarm bells that are ringing all over Corporate America. Nike Inc. and FedEx Corp. are among the companies that have had to lower forecasts in recent weeks, thanks to a toxic combination of shipping delays, higher input costs and rising wages. Morgan Stanley warned Friday that the worst is not over, particularly for retailers, as supply chain and freight inflation rise while sales decline.

While stock market leadership shows that inflation is having an impact — energy stocks were the only sector to see gains last month — according to Dan Suzuki of Richard Bernstein Advisors LLC, there is largely no fear as investors choose to focus on growth. .

“The market has been much more focused on interest rates and growth, rather than inflation specifically. The fact that energy stocks rose in double digits while everything else fell tells you that inflation is having an impact,” said Suzuki, the company’s deputy chief investment officer. “It’s just not necessarily something that’s generating a lot of fear for markets right now.”

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price power

That focus on rising interest rates could explain why stocks of tech companies, which in theory have ample capacity to pass costs on to consumers, have underperformed in recent weeks. Ten-year Treasury yields rose to their highest level since June this week, sending risky assets and high-priced technology stocks racing. The Nasdaq 100 plunged for the fourth straight week, surpassing a decline in the broader S&P 500.

Equity baskets tracked by Goldman Sachs Group Inc. show that dynamics spread beyond technology. Companies with higher pricing power — a cohort that includes Colgate-Palmolive, Procter & Gamble, and Dollar General — have outperformed companies with low pricing power, such as Boeing and Disney, since November 2020 last month.

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“I don’t think the market is fully taking into account higher costs that cannot be passed on,” said Chris Zaccarelli, Chief Investment Officer at Independent Advisor Alliance. “Almost every company has reported higher costs in previous conference calls. The belief that costs can be passed on across the board — which I personally don’t believe — explains why companies with low pricing power could perform better when in theory they shouldn’t.”

labor cost

How stock markets deal with rising labor costs is also not intuitive. A Goldman Sachs basket of S&P 500 stocks with the highest labor costs as a percentage of sales beat low-cost counterparts by 8.5 percentage points in the quarter, the best performance since the data began in 2010. the industry away.

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“There is some recognition that there will be near-term risks to revenues from both input and labor cost pressures, as well as supply shortages,” said RBA’s Suzuki. Even then, “some of the most labor-intensive industries outperformed in September, from financial institutions to consumer and healthcare companies.”

The dynamics come down to investors once again charging cyclical names, despite heavy overhangs from staff shortages and rising labor costs, Suzuki said.

Record margins

And even with all the wringing of hands on the damage rising input costs will do to earnings, margins have held up and then some. Operating margins for the S&P 500 came in at 14.4% last quarter, a record high, with companies in many cases even benefiting from the inflation that executives are concerned about.

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The S&P 500’s profit as a percentage of sales has risen more than 91% since their pandemic low to 17.4%, above the previous cycle’s high of 16.4%, according to Credit Suisse data compiled by Jonathan Golub . All sectors have seen margins grow, although financial and cyclical companies outperformed technology companies.

While that margin measure is still below its all-time high of 18.8% in 2007, Golub sees further upside potential. However, Megacap technology has less room to recover, with margins already at record levels.

“TECH+’s EBIT margins declined more modestly during the pandemic (23.6% to 18.9%) and are currently at record highs (24.5%),” wrote Golub, the company’s chief US equity strategist. head of quantitative research. Thursday. “We believe the upside margin for TECH+ companies will be more limited given their lack of operating leverage.”

©2020 Bloomberg LP

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