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Even 'less robust' Q3 earnings may still impress amid inflation, supply woes

·Editor focused on markets and the economy
·3-min read
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This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Tuesday, October 12, 2021

'Unprecedented' inflation doesn't necessarily spell doom

On Wednesday, JPMorgan Chase will serve as the firing pistol on the third quarter (Q3) earnings rush. Investors are struggling to untangle the Gordian knot of supply chain bottlenecks, labor shortages and resilient demand conspiring to drive up prices in a big way, as Yahoo Finance's Brian Sozzi explained on Monday.

With people spending as much as they ever have — and paying more for the privilege — corporate America’s balance sheet is likely to reflect some of the ravages of rising inflation that McCormick (MKC) CEO recently called “unprecedented.”

The big questions are by exactly how much — and whether it will be enough to derail a bull market already showing signs of wear.

“We think earnings growth will be strong again this quarter,” explained LPL Financial Research strategist Jeffrey Buchbinder. “But those looking for massive upside surprises and big increases in estimates will probably be disappointed" as the heady crosswinds of labor, supply and prices keep growth in check.

According to Credit Suisse, pricing power and operating leverage are being systematically underestimated, and profit margins may still have some life in them given strong pandemic-era demand.

In a note on Monday, the bank’s analysts estimated that “economic headwinds will mitigate the benefits from pricing power and operating leverage, leading to less robust surprises in 3Q" — but robust nevertheless, Credit Suisse noted. 

"Early reports — 21 thus far — corroborate this view, surprising by just 4.4%. Margins are contributing half of these surprises," the bank noted. Meanwhile, earnings per share growth is expected to check in around 27% — well below Q2’s 88% surge. 

However, Credit Suisse suggested the slowdown was mostly “the result of normal cyclical forces and more challenging comps rather than supply issues." Bearing that in mind, there are a few reasons to believe that headwinds facing publicly traded companies may be less severe than advertised.

In his summary of Q3 results, PepsiCo (PEP) CEO Ramon Laguarta said that consumers were “looking at pricing a little bit differently than before ... as consumers are shopping faster in store and they might be paying less attention to pricing as a decision factor and they might be giving more relevance to the brands or brands that they feel more a bit closer to or more close.”

Laguarta suggested buyers were “more emotionally attached to our brand. So we're seeing less elasticity and we're adjusting our models as we go.”

Brand loyalty and emotional attachment matter a lot — both for customers hungry for pre-pandemic normalcy, and the companies trying to provide it for them. 

That is particularly true for beleaguered consumer staples, where Q3 earnings growth is inching higher — up 3.04% from 1.96% just a month ago, according to S&P Global Market Intelligence data, even as overall growth edged lower.

Even amid rising stagflation fears and the COVID-19 Delta variant, Sam Stovall at CFRA Research reminds us that slowing from historically elevated levels needn't be the end of the world.

“Digging a little bit deeper, we see that in addition to all sizes and styles in the S&P 1500 recording Q3 EPS increases, so too should eight of 11 sectors, with industrials, materials, and real estate on top,” Stovall wrote on Monday.

Although housing and other consumer segments are seen posting “the worst returns,” energy, commodities and chemicals should see a boost from inflationary trends, he added. And despite sticker-shock from higher prices, even long-suffering sectors like leisure and hospitality should benefit, Stovall said.

“With some indications of strong pent-up demand amid the vaccine rollout, we think Q3 marked some notable strides for the broader leisure and hospitality-related industries in the relatively early stages of recovery from the pandemic,” the analyst wrote.

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek

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