Overflowing cargo ships, snarled production lines, copper above $10,000 and a start to earnings season that’s smashing records.
As developed economies reopen and the newly vaccinated embrace their pre-Covid ways, the global rebound is proving vigorous but messy. For equity investors, the most pressing question is whether the return of inflation spoils returns and eats into corporate profits.
Accelerating prices -- and fears the U.S. Federal Reserve will tighten policy to tame them -- top the list of money-managers’ concerns, according to Bank of America Corp.’s monthly investor survey. Almost half of those polled by UBS AG predict inflation will quicken over the coming three years.
“All materials are going up,” said Nico Delvaux, chief executive officer of Assa Abloy AB, whose products range from automatic doors to biometric readers and e-passports. “Our previous guidance of fully compensating for raw material inflation is not the case anymore.”
While inflation has become a popular buzzword in financial circles, there’s little sign that higher prices are having much of an impact outside of a few pockets of the economy. Price metrics are also being temporarily impacted by so-called “base effects.” Year-over-year increases appear large because they are being compared to the very weak inflation prints seen at the start of the pandemic.
Fed officials anticipate that any surge in prices will prove temporary, but others point out that pent-up demand, rising materials costs and more federal spending could lead to sustained price pressures. In the euro-zone, the economy has tipped into a double-dip recession and an inflation measure excluding volatile items such as food and energy fell to 0.8% in April.
Against that backdrop, stock pickers are negotiating a patchwork of potential winners and losers.
Gold, Autos
Carmakers such as Honda Motor Co. and BMW AG have been forced to halt production due to chip shortages. Unilever PLC, Henkel AG & Co KGaA and Reckitt Benckiser Group PLC may come under pressure as they struggle to pass on higher prices to buyers of their consumer staples, Bernstein strategists say.
But for Evolution Mining Ltd., inflation is good news. The gold it produces is used to hedge against price growth, Bryan O’Hara, general manager for investor relations, said on an analyst call.
The prospect of higher fuel demand in the U.S., China and Europe is also a boon for oil majors: Total SE and Royal Dutch Shell Plc gained on Thursday after reporting better-than-forecast profits.
And it’s not just the oil giants. A record number of companies are besting consensus estimates in both the U.S. and Europe, JPMorgan Chase & Co. analysts said Friday.
But as the earnings beats are unveiled, inflation talk is everywhere.
On investor calls with top executives of S&P 500 companies the word was referenced twice as frequently as last quarter, according to transcript analysis by Bloomberg. Google Trends show the number of searches for “inflation” was the highest since 2004 in the U.S. in March.
The danger is that price growth becomes entrenched, ultimately halting the record run for equities. At the same time, stocks are seen as better placed to handle inflation, compared with other asset classes like bonds, which offer fixed returns.
“Massive fiscal stimulus and pent-up demand, as well as higher corporate taxes, rising wages and de-globalization, could shift medium-term inflationary dynamics upward,” Barclays strategists led by Emmanuel Cau wrote in a note to clients.
For now, investor optimism about the reopening dominates, and U.S. stocks hit another record high on Thursday. The companies wrestling with the rising input costs strike a warier note.
“Palm prices are upwards to 40% to 50% year on year,” Srinivas Phatak, chief financial officer and executive director at Hindustan Unilever Ltd., said in an earnings call on Thursday. “And if you actually have to cover the margins you can simply do the math.”
Shares of Clorox Co., which makes household cleaning products from bleach to cat litter, tumbled on Friday after cutting its 2021 earnings-per-share forecast. Higher costs for commodities, manufacturing and logistics were to blame, the company said.
Others are passing on the costs to shoppers. Church & Dwight Co., which owns brands such as OxiClean, Arm & Hammer and Trojan condoms, said in an earnings call that it will be raising prices. Kraft Heinz Foods Co. said it’s winding down promotions for hot dogs and cream cheese.
At what point does inflation flash danger for equity investors?
UBS says the optimal rate for stocks is “below but close to 2%.” Credit Suisse strategists say equities can handle up to 3%. The European Central Bank predicts inflation will peak at 2% at the end of this year, before slowing to 1.2% in 2022 and 1.4% in the following year.
Should inflation prove to be more than just a fleeting symptom of the economic revival, the recent past has some gloomy lessons.
With prices soaring in the 1970s, the S&P 500 Index posted an annualized real loss of about 1.5% per year, according to Dimitris Valatsas, chief economist at Greenmantle LLC.
“It’s commonly assumed that equities are a good inflation hedge,” he said. “History suggests this is not always the case.”
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Read more articles by Nikos Chrysoloras, Abhishek Vishnoi
