Inflation haunts stock traders in blockbuster earnings season

Bloomberg

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 US 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 falls to 0.8% in April.
Against that backdrop, stock pickers are negotiating a patchwork of potential winners and losers.
Carmakers such as Honda Motor and BMW have been forced to halt production due to chip shortages. Unilever, Henkel AG & Co KGaA and Reckitt Benckiser Group 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 US, China and Europe is also a boon for oil majors: Total SE and Royal Dutch Shell gained 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 US and Europe, JPMorgan Chase & Co. analysts said. 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 US 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-globalisation, may 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 US stocks hit another record high. The companies wrestling with the rising input costs strike a warier note.
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 annualised 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.”