Too many investors are missing a very simple, but very important, dynamic at the heart of the current macro-micro nexus.
Resilient earnings are in part a function of elevated revenue, and elevated revenue is synonymous with inflation. Policymakers need inflation to recede. So do politicians. Something’s gotta give, as they say.
That “something” is probably going to be profits. If the “Greedflation” continues, it may be the end of capitalism, according to SocGen’s Albert Edwards, but it may also be the end of presidencies and congressional tenures. While politicians are generally fine with corporations helping to install them in office, they aren’t especially amenable to a situation where decisions made in corporate boardrooms undercut reelection bids.
On Monday, Edwards’s colleague Andrew Lapthorne touched on this touchy topic.
“Inflation comes from companies putting up prices of the things they sell, and it is fair to say that while margins have come under pressure, double-digit sales growth has more than compensated and is still running near 10% ex-energy in the US,” Lapthorne wrote, calling that “clearly inconsistent” with the Fed’s inflation-fighting efforts.
The visual illustrates the point, and as Lapthorne’s chart heading suggests, this is the furthest thing from complicated.
Of course, companies’ capacity to raise prices is enabled (or not) by consumers’ willingness to pay up. And in that regard, bottom-up consensus seems to believe the consumer isn’t tapped out.
Although analysts expect non-financial profits to fall in the US and Europe, bottom-up consensus forecasts “do not appear consistent with either a recession or inflation reverting back to the 2% target,” Lapthorne went on.
As it turns out, the industries where analysts see the strongest profit growth around the world in 2023 are concentrated in Consumer Discretionary. Juxtapose that with expected declines in Energy and Basic Resources, where last year’s windfalls will be a tough act to follow.
“So, despite the low headline number, the bottom-up consensus estimates envisage a transfer of wealth away from input prices to consumption,” Lapthorne wrote, summarizing. It is, he said, “simply a reverse of what happened last year.”
If consumption does indeed hold up, pricing power might too. And inflation could therefore remain stubborn and hard to dislodge.
I would make a small riposte to Mr. Lapthorne’s statement. The goods companies sell are made from many inputs: materials, labor, and capital. At their basic source, all materials that end up in goods, start their lives in the ground or the air and proceed from there to the commodity marketplace where they are used to produce intermediate goods to go into final goods. The companies that sell us stuff have only limited direct influence on commodity prices or quantities. Their demand can push on prices, but when that happens commodity producers will push more material into the markets and force the price down. Commodities are costs to goods producers who will do anything they can to drive those prices down. Labor is also a commodity, as is money and as costs, both these commodities will be under pressure from final goods producers trying to save money. Substitution of many types helps control these costs. Companies will use AI, robots and other technologies to replace labor and/or to increase productivity. They will also substitute cheaper materials (plastic for metal), use less (4 mil steel instead of 5 mil steel, a 20% reduction in tonnage, for example), and so forth. At least half our industries have achieved 95% or more customer penetration. They can’t increase the amount of their product they sell so they start trying to raise prices but that idea bumps up against the budgets of their customers who like the companies they buy from, see goods prices as costs, not revenues. They have the same motives as the companies, keep costs down. The truth is that the last thing companies want to do is raise prices because it annoys the heck out of their customers. The Fed isn’t really needed here, just patience.