Corporate profits

A good read on inflation for corporate profits

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Thursday May 13, 2021

It’s all about demand.

Inflation data released on Wednesday left markets scared.

Consumer prices rose at the fastest annual rate since 2008 in April, according to the latest data from the BLS, news that pushed stocks down with the S&P 500 (^ GSPC) falling 2.1% on the day .

The simplest reading of the market’s reaction to this data is that higher inflation will lead to earlier rate hikes from the Fed and, everything else, higher rates are worse for stocks. This leaves the most successful stocks – in this case technology stocks – the most vulnerable. But thinking about the “why” behind the April price increases, it becomes less clear that this data is so reflexively negative for the stock market. Janney’s Chief Fixed Income Strategist Guy LeBas said on Wednesday that this data is yet another reflection of what we have covered in recent editions of the Morning Brief: growing demand.

“There just isn’t a good historical analogue for basic CPI printing today in the post-70s era,” LeBas said. “I can tell you what this represents is that consumer demand is rebounding faster than the economy can create supply in the short term. Well thing for corporate profits.

The main sources of the price increase in April include the used car market, out-of-home accommodation and air fares. Hunting consumers looking to move more and travel is a simple reopening theme.

And as the Bank of America Global Research team said in a note on Wednesday, “The more persistent sources of inflation were weaker. Rents and REL were both 0.2% mo , which is relatively in line with the recent trend “. The company added that “healthcare inflation was stable as the momentum from the stimulus measures at the start of the year waned.”

Rising prices in sectors of the economy that have been severely affected by the pandemic while housing and healthcare costs remain low, is exactly what Fed officials mean when they say inflationary pressures are likely to be “transient”.

At the end of 2020, we argued that the reason for the market rally in the midst of a global pandemic was due to the same factor that in the long run still drives stock prices – higher profits. The ability of companies to exert operational leverage after a recession and to increase prices in a high demand environment are two positive dynamics for companies today.

May the inflationary backdrop of today should Boosting future earnings growth does not, of course, mean that investors should or should or will integrate this dynamic. And as Wednesday’s action made clear, the market’s interpretation of the most recent inflation data is that higher rates will come sooner than expected.

Wall Street economists in our inbox on Wednesday also seemed to agree that even higher inflation readings would arrive in the coming months.

As these reports pile up, questions about whether the Fed will keep its cool and still label these inflationary pressures as “transient” will only intensify. How the market handles these data points is one to guess.

But at least for a month, a jarring inflation report still fits perfectly with an economic theme that couldn’t be clearer: this is a demand-driven recovery.

Through Myles Udland is a journalist and presenter for Yahoo Finance Live. Follow him on @MylesUdland

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