“Pricing power is set to become a alpha generator due to the wide variance in how companies cope with it“– Paul Ebeling
Inflation is bad news for bond investors, as it pares the value of future returns.
For stock investors and traders, inflation is not that bad given the ability of certain companies to make profits from higher prices.
History tells us that there is opportunity in the inflation environment.
Energy shares have been persistent winners during times of high inflation over the past 50yrs our data shows.
Supply/demand imbalances suggest mining shares and fertilizer producers offer better hedges should inflation pressures build.
No matter how optimistic Fed Chairman Powell is about the topic now, inflation will matter again for stocks some 1 of these days.
Just in the last few wks, hawks have observed worrying signs in everything from a global shortage of computer chips to the biggest jump in US producer prices on record.
With the economic outlook brightening, virus cases falling and more fiscal aid/relief/stimulus looming, caution about inflation is brewing.
That means pricing power is set to become a alpha generator due to the wide variance in how companies cope with it.
Our leading indicators suggest that an inflation scare is in the making, and that companies with price flexibility will come out winners.
Our data show that energy stocks have the best track-record during periods of rising consumer prices. In 7 out of 9 cases of high inflation since Y 1972, the industry outperformed the S&P 500 by a median of 14%.
When ranked by investments, cyclical value stocks, companies whose sales are more sensitive to economic swings and usually trade at relatively low valuations tend to do better when inflation runs high
Crude Oil has spiked YTD boosted by confidence in a global economic recovery.
Those bets have been reflected in the stock market, with energy producers including Exxon Mobil (NYSE:XOM) and Marathon Oil (NYSE:MRO). soaring. The industry has led gains in the S&P 500 in Y 2021, climbing 5X more than the equity benchmark.
While inflation’s ramifications for the broader market are not straight up, a deep look shows investors and traders are preparing for inflation by favoring companies with high operating leverage, or the ability to extract profits from revenue.
While both sales and input costs tend to increase when inflation rises, companies with strong leverage potentially offer a safer trade. The reason is because the effect of growing revenue our runs production costs.
Since the start of February, a basket of stocks with the highest operating leverage that strips out industry bias has beaten the cohort of weakest ones by 1.7%, our data show.
The gauge is poised for a 4th month running of outperformance, the longest streak since Y 2013.
Higher input costs such as commodities pose little threat to overall earnings for S&P 500 companies partly because some industries gain as material prices climb and others hedge exposure notes Shayne Heffernan, PhD.
Labor costs, on the other hand, are a bigger headwind, with an increase of 100 bpts in wage growth likely amounting to a 1% reduction in company profits, their estimates show.
Accordingly, we here at HeffX-LTN advise investors to favor firms whose labor costs make up a smaller share of revenue.
Many investors believe the increase in spending will lead to higher inflation and interest rates, which would reduce the value of equity duration and increase the importance of near-term growth.
Historically, inflation has boosted nominal S&P 500 revenues, but weighed on profit margins as companies struggled to lift prices at the same pace as rising input costs.
For our managed accounts we have put together a basket of stocks based on their sensitivity to metrics like fluctuations in copper and food prices. Basic materials, technology and energy shares currently make up 65% of that portfolio.
The group has proved correct by rising with inflation expectations in recent months, the drawback will be poor performance during times of disinflation.
To offset that deficiency, we have designed a strategy that limits the Southside risk while maximizing the Northside.
Investors want the Northside from value rallies and would like to hedge inflation risk, but most find the volatility incompatible with their risk tolerance. Our ‘insurance‘ strikes the right balance for them.
Have a healthy week, Keep the Faith!
Latest posts by Paul Ebeling (see all)
- Commentary: Paul Ebeling on Wall Street - March 1, 2021
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