Behind stock market’s ordeal are cracks in profit foundation

Bloomberg

Package maker Sealed Air Corp fell the most in six months after saying higher raw material costs would crimp the bottom line. A few days earlier it was rising freight outlays at Fastenal Co., where $1.1 billion of market value was erased. On October 9, paint maker PPG Industries Inc. mentioned rising expenses. The shares cratered.
From railroads to retailers, signs of price pressures are starting to show at US industrial companies, contributing to the worst October start for the S&P 500 since 2008. Equities have had their three worst sessions since April in space of eight days, narrowly escaping a fourth straight down week thanks to a rally.
An earnings season everyone hoped would restore order has instead sent signals that the future is murkier than bulls realized, particularly on the inflation front, where many of their nightmare scenarios reside.
“That doesn’t necessarily mean that we fall into a recession, but it should slow growth,” said Matt Maley, equity strategist at Miller Tabak & Co. “That is not good for a stock market that had been priced for perfection just a few weeks ago.”
It’s not that earnings are weak. S&P 500 companies are on pace to expand profit by 20.7 percent in the June-September period and are headed for the biggest annual increase in eight years. The problem is the high hopes built into stock prices. Any sign rising costs are eroding the bottom line are ringing alarm bells for investors who have pushed stocks up 50 percent over 30 months. “This leaves little room for a hiccup in the economy,” said Chad Morganlander, portfolio manager at Washington Crossing Advisors. “The environment is changing and yields are at the highest level they’ve been in a decade. This confluence of factors isn’t a good one.”
Concerns like these may seem overstated in an economy where unemployment is at a 48-year low and consumer confidence a two-decade high. But investors with a sense of history are aware readings like these are more common at the end of rallies than the beginning.
Throw in President Donald Trump’s trade war, currency weakness in emerging markets and a still-hawkish Fed, and it’s a recipe for turbulence. The Cboe Volatility Index has averaged 17.2 in October, up 33 percent from the previous month. Among the casualties:
Sealed Air fell more than 8 percent. The Charlotte, North Carolina-based maker of Bubble Wrap cited higher-than-expected raw material and freight costs, along with currency headwinds, in guiding earnings lower. Fastenal slid 7 percent on Oct. 10. The Winona, Minnesota-based industrial supplier has been investing to ward off an incursion by Amazon.com and mentioned higher freight and wage costs in missing gross margin forecasts. PPG Industries tumbled 10 percent on Oct. 9. The Pittsburgh-based coatings maker said rising expenses and soft demand from China cut third-quarter earnings.
In a flat week for the S&P 500, old economy stocks bore most of the losses. Energy shares slid 1.9 percent, commodity producers lost 1.4 percent, and industrial companies fell 1 percent.
The S&P 500 Industrials Index is down 3.6 percent in 2018, compared with a 3.5 percent gain in the full index. Active manager ownership of in the group was at the lowest level since 2008 in August, Bank of America’s data show. Tighter margins go hand in hand with a market villain already on bulls’ radar, rising interest rates, themselves a consequence of a strengthening economy and eight Federal Reserve interest rate hikes since 2015. While not a margin story per se, nowhere is the specter of rising borrowing costs more pronounced than in homebuilder stocks.