Market Comment May 2021 - A New Season - Let's not spoil the party!





First-quarter earnings season is in full swing and the news is very good. So far, expectations of a swift and impressive rebound from the pandemic have been amply fulfilled. For the roughly 50 % of companies in the S&P 500 that have reported their first-quarter results, this is shaping up to be a lavish earnings season. Earnings per share is on course to be up 33.8 % from the first quarter of last year, the highest annual increase in a decade. This would owe much to the low base set in the first three months of last year, but it is still extraordinary. Financial markets, ever the killjoys, are now fretting about a substantial rise in inflation, even though there is little evidence of that currently. The rise in commodity prices has become one of the most-cited headwinds according to the comments of CEOs and CFOs which so far suggest that the risk of inflation is rising. Central banks had warned that there will be an increase in supply-chain cost but that this increase would only be temporary as the economy returns to full productivity. After all, production capacities which have been idled during the pandemic will come back on stream without the need, for now, to build new ones. Consumers have been put on notice to expect higher prices for goods ranging from toilet paper to washing machines to restaurant burritos, in several recent announcements that underline inflationary pressures across the global economy. Executives at Coca-Cola, and appliance maker Whirlpool, as well as household brand behemoths Procter & Gamble and Kimberly-Clark, all told analysts that they were preparing to raise prices to offset rising costs. Investors are also concerned about higher inflation but not sure if it will materialize. If the market were really pricing sustained inflation above the Fed target through next year and beyond, yields would be meaningfully higher. Volatility in financial markets has hit the lowest levels since the pandemic rocked stock and bond prices last year, a sign that investors bet on tranquility and ride a wave of optimism about the US economic recovery. On the other side of the Atlantic, IG Metall, Germany’s biggest union, last week accepted a 2.3% increase to wages in a key industrial region. The deal was well below the union’s demand for a 4% wage rise and is significant as it provides a benchmark for its workers in the rest of the country. This illustrates that, for the time being, a price-wage spiral looks highly unlikely in an economy, which remains weighed down by restrictions to contain rising coronavirus infections. Fed officials view the inflation risks as ‘broadly balanced’, with policymakers pointing to forces that could push price growth in either direction. The central bank targets average inflation of around 2 %, although it is willing to allow an overshoot to achieve full employment. Consumer prices increased at a year-on-year rate of 2.6% in March, this rapid increase was fueled by a large rebound in energy prices. The ‘core’ measure, which excludes both food and energy, rose a more modest 1.6%. Corporate margins will reveal whether there really is overheating in the economy, and whether it will manifest itself in persistent inflation, or in pain for the corporate sector. In the U.S., where companies have found it much easier to jack up profitability, margins have already completed their recovery from Covid. If profit margins were to fall, this would reflect increasing pricing pressures, and an inability to pass on costs — in other words, rising costs might manifest themselves in lower profits for companies, rather than higher prices for consumers. For now, economies are gradually easing out of the pandemic and growth will be higher than anything we have seen in decades. This bodes well for companies, employment and … (no, I will not mention the ugly T word – more about taxes next time). Enjoy the good news for now.

May 1st, 2021

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