Equity Strategy: Who could get hurt from the rollover in corporate pricing power?

Speaker - Mislav Matejka, CFA, Head of Global Equity Strategy

As inflation rates are moving lower, taking out last year’s spike, the question is what the impact of this will be on corporate profitability. After all, instead of being hurt from higher input costs, it appears that most companies benefitted over the past two years, due to better mix and stronger pricing. European topline growth was a very high 14% in 2021, and as much as 24% in 2022, compared to historical median of 6%. 2022 EBIT margins for Europe are 330bp above 2019 levels. Defensives such as Healthcare, Staples and Utilities are the only sectors that are lower. There is a risk of reversal, especially if final demand stalls, potentially if PMI softness continues, and as supply chains have normalized. There is a very strong correlation between PPIs and global earnings delivery. Now, the latest oil rally could mechanically lead to stronger PPIs again. Historically though, when Brent moved up due to supply constraints, topline and margins of other sectors would not benefit, there would be demand destruction. Pent-up demand is behind us, as well as the ample post-COVID consumer liquidity, companies might not be in a position to pass on rising input costs as easily any more. In the report, we assess sectoral impacts, together with our analysts. We find a number of sectors to be at risk of a reversal in pricing power, such as Food and General Retail, Autos, Semis, Hotels, Airlines, Luxury/Sporting Goods and Construction Materials. On the other side, Insurance, Staples, Healthcare and Utilities could be less affected. Big picture, we see the Growth-Policy tradeoff as challenging into year-end. This is especially as the market is pricing in a no-landing scenario, with VIX at lows, credit spreads tight, and, until recently, a big rally in Cyclicals, but on the other side, the market expects 80bp of easing in 2H of next year, just ahead of US elections. This is an unlikely combination. We believe that Defensives will be having a bid into year end. We reiterate last week’s closing of two years’ worth of shorts in Real Estate, and advise tactically less negative call on China and on commodities – Mining (N) and Energy (OW), as they did poorly in 1H – CSI to bounce vs SPX and SX5E.

 

This podcast was recorded on 25 September 2023.

This communication is provided for information purposes only. Institutional clients can view the related report at https://www.jpmm.com/research/content/GPS-4519132-0  for more information; please visit www.jpmm.com/research/disclosures for important disclosures. © 2023 JPMorgan Chase & Co. All rights reserved.