Common stocks are supposed to be hedges against inflation, according to Finance 101, because corporations typically pass along higher costs to customers by increasing selling prices. But if they can’t, companies must absorb the higher expenses, hurting profit margins.
Inflation’s impact on earnings was Topic A here a week ago, as producer prices raced ahead of consumer prices, putting margins in the tightest vise since the stagflationary 1970s.
No wonder it also has been top of mind for corporate executives. Based on second-quarter transcripts, “inflation” was mentioned by 44% of companies on earnings conference calls, according to a report by FactSet earnings analyst John Butters. That was the most since 2010, MarketWatch reported.
(ticker: FDX). Its shares slid more than 8% Wednesday after a big earnings miss, owing to rising labor costs outpacing strong revenue. That was the stock’s biggest one-day hit since March 16, 2020, when it plunged more than 15% in the teeth of the pandemic-induced market meltdown, when the economy was severely contracting.
This time, FedEx reported earnings of $4.37 a share for its first fiscal quarter ended Aug. 31, well short of analysts’ consensus estimate of $4.88, itself barely above the year-earlier $4.87. The company blamed the disappointing numbers on a $450 million rise in operating costs “due to a constrained labor market.” To compensate, FedEx said that it will increase its shipping rates by an average of 5.9%, effective Jan. 3. Nevertheless, the company lowered its earnings outlook for fiscal 2022 to $18.25-$19.50 a share from its June forecast of $18.90-$19.90.
FedEx’s squeeze is anything but unique, our colleague Al Root writes. Costs are surging throughout the supply chain, with the producer-price index for intermediate goods (those with some processing) up 23% in the year ended August, more than twice the 10.5% jump in the PPI for finished goods.
With third-quarter results only a few weeks away, the key question is whether even more companies will be facing margin squeezes as costs outpace price hikes.
At least they’re starting from a peak in profitability, judging from the latest quarterly results. “Reported EBIT [earnings before interest and taxes] has jumped by over 30% in the U.S. and over 55% in Europe,” Société Générale global quantitative research head Andrew Lapthorne writes in a research note. Strong sales growth has outstripped cost increases, lifting U.S. profit margins to records and improving even depressed European margins, he adds.
But is that as good as it gets?
“Profit margins act as shock absorbers,” Lapthorne continues. “If businesses can absorb price shocks and business disruption in their P&L [profit and loss statement] instead of passing along problems onto customers, then logic has it that short-term profitability would be hit, but bigger issues, such as the need for policy tightening, [are] reduced. It is clear that, on aggregate, profit margins are healthy enough to absorb some temporary pain, but it will be interesting to see what path the corporates take: to defend margins and risk inflation taking hold [or] allow profits to suffer awhile?”
That’s what investors are listening for on those earnings calls.
At his press conference this past week, Federal Reserve Chairman Jerome Powell couldn’t duck the question about the investment and trading practices of central bank officials. As previously reported, the presidents of the Dallas and Boston district banks owned and traded securities in 2020 that were directly affected by the Fed’s massive, unprecedented purchases that extended into corporate and municipal bonds.
Powell addressed his own muni-bond holdings, which he said were purchased long before the Fed’s entrance into that sector. He added that he would hold them until maturity and not trade them. But he didn’t mention the Fed presidents’ activities in securities such as real estate investment trusts that invest in mortgages, or leveraged closed-end funds that invest in bank loans or other speculative-grade corporate securities. Both are directly affected by Fed monetary-policy decisions.
Powell has asked for a re-examination of the investment strictures for Fed officials. Obviously, financial-related securities should be off-limits. So should anything else that might be affected by policy decisions.
What might that be? I’m reminded of a conversation years ago with a longtime commercial real estate developer, who said he didn’t worry about a downturn in the property market. “Greenspan will just cut rates,” he said of the Fed chairman at the time, and shore up prices. Given the vast influence of monetary policy on a broad swath of investments, the central bank must avoid even the slightest appearance of a conflict of interest. That arguably would cover even more than the publicly traded securities that have been the focus of recent revelations.
Write to Randall W. Forsyth at [email protected]