Determining when (or even if) US corporate profits will suffer a deeper contraction entails making some assumptions about pricing power.
One extraordinary aspect of the pandemic-era economy was consumers’ willingness to absorb price increases. The C-suite had no difficulty passing on higher input costs in an environment where household balance sheets were bolstered by stimulus and government transfers. Even where the consumption impulse waned, savvy management teams pursued price-over-volume strategies to keep profits high. In short: Inflation was a boon.
The flip side finds sales growth decelerating with inflation, creating a “be careful what you wish for” dynamic for investors ready to celebrate evidence of moderating price pressures. Some cost increases for businesses are permanent — think wage hikes. As top-line growth inevitably cools, sticky cost pressures will erode margins. PPI is your best leading indicator for this.
“While many equity investors were cheering the weaker-than-expected PPI release last week, we would caution to be careful what you wish for as we think these data portend a sharp drop in revenue growth over the next four months,” Morgan Stanley analysts led by Mike Wilson said Tuesday.
The figures above admit of no ambiguity. This relationship is very strong, and there’s no evidence whatsoever to suggest it won’t hold going forward.
Notwithstanding companies’ efforts to cut costs, management’s capacity to mitigate the impact of falling sales growth is limited by the perceived necessity of labor hoarding and, in some industries, by a burgeoning “Keeping up with the Joneses” dynamic vis-à-vis A.I. spend. The read-through: Crimped profits.
And don’t take PPI’s word for it, ask import and export prices.
Again: There’s no ambiguity there at all.
“Revenue growth looks primed for disappointment in the very near-term due to fading pricing power,” Wilson emphasized. “With supply chains catching up to softening demand, we think it’s likely that bloated inventories across the economy will now lead to the order cancellations and price discounting that change the trajectory of revenue growth expectations provided by company guidance,” he went on, before suggesting that if the signal from PPI, export and import prices is any indication, “that moment should be imminent, not later this year, or in 2024.”
I took a quick look at the S&P1500 (S&P 500+400+600). Excluded the 15% of these 1500 names that have no reported inventory (financials, utilities, etc). One can doubt how meaningful “inventory” is for DAL or LLY or GOOG, but anyway they’re included in this slap-dash look.
Average 2023 invtry/sales (2022 invtry/2023E sales) is 14%, or +66% higher than the three-year average for 2017-2019 invtry/sales which is 9%. That’s simple averages, not cap-weighted.
Sectors with the most increase in I/S from 2017-2019 to 2023 are Technology (+90%), Industrials (+46%), Healthcare (+44%). Sectors with the least increase are Consumer Cyclicals (+12%), Non-Energy Materials (+16%), Energy (+19%, but probably not a meaningful metric), Consumer Non-Cyclicals (+30%).
Excess inventories is not going to trouble the mega-caps aka the new defensives. The 10 largest market-cap names either have no reported invtry (META, V, UNH), a decrease in I/S (AAPL, AMZN, TSLA), or I/S isn’t meaningful (MSFT, GOOG). The only exception there is NVDA.
…interesting and helpful, … thanks…
I broke the data down by industry sub-sector and market cap. One pattern I’m seeing is that within each industry, the increase in I/S slightly tends to be larger in mid-cap (10-50BN) and small-cap (1-10BN) than in large-cap (>50BN). It is not a strong pattern, but is discernible. Makes sense – the small guy gets stuck with the excess.
the next moment of truth will come in about 4-5 weeks with earnings reports. we’ll hear what the companies have to say. i don’t see a reason for a meaningful selloff before then. does market go much higher before then? don’t know. but i am not going to get off the train until we drop below the 50sma
The moment of truth might be ambiguous. S&P500 consensus EPS for 2023 and for 2024 has flatlined (neither falling nor rising) during the last couple months, after falling steadily since spring/summer 2022. Since 2024 estimates are still higher than 2023 estimates, the rolling S&P500 consensus EPS for “next 12 months” has started moving up, after falling steadily since summer 2023. Suppose things stay this way – no change to annual estimates but the calendar continuing to roll forward. I wonder if that will be positive or negative, after a run such as we’ve had?