Stocks rose on Friday after a brutally volatile week as investors began to accept the reality that rates are going up. Inflation numbers out on Friday confirmed what the Fed Chairman told us earlier in the week…inflation continues to rise.
“It’s not personal, it’s just business.” I have written about it many times in many different settings, but in light of recent events, I want to highlight once again as we wind down earnings season and prepare to close out a very challenging January for investors. Now, you all know that I love to bring economics into my writing and investment management. One of the big economic themes in the past 12 months has been supply and demand. Supply has been squelched and demand is hot which, in economics 101, always leads to price increases. Price increases as in, you know, inflation. Inflation has, indeed, become the bogeyman that has been exacting fear over the markets throughout 2021, and that fear reached a high note in the early days of this month making it a memorable one…for those who relish discomfort. Inflation is a growth killer because when it gets too extreme, consumers simply stop purchasing. That is a technical way of looking at it, and it is factual. However, there are societal consequences that are far more powerful than the potential for reduced consumption. When families begin to feel the pinch in the purse, things can go from ugly to very ugly, very quickly. Can’t afford the gas to get to work? Stop working? Can’t afford healthcare? Stop… being healthy? Can’t afford healthy food? Stop eating healthily, or worse yet…go to bed hungry? Can’t afford rent? Become homeless? Now, I know that those are some extremes, and I know that if you are reading this market note, you are not likely to be in one of those unfortunate categories, but I am sure that you, like me, have felt a bit of that over the last year. It is important to remember that many people around the country are facing those inflationary pressures and that those extremes are very much on their minds. Inflation has caused bloody revolutions and has indeed, led countries to war. The point here is that inflation has implications that go far beyond economic theory. That is precisely why the Fed, in its inflation fighting capacity, is a very important player in keeping the peace…so to speak. The problem with that is that the Fed can only fight inflation using crude tools like rate hikes which serve to exact further pain on consumers in order to incent them to reduce demand. Believe it or not, there is some controversy amongst mainstream economists on whether there is even a direct relationship between higher interest rates and consumption. Many believe that it is fear, rather than the rate hikes themselves that cause consumers to pull back on their inflation-stoking consumption. Seems rational. Speaking of rational, what is it that actually causes prices to go up? That is not a trick question. Companies set prices, not economists. So, why would a company raise its prices if it knew that higher prices would cause customers to ultimately buy less? Because, in most cases, they have no choice. We look at two types of inflation, consumer inflation and producer inflation. Those are tracked through the CPI (Consumer Price Index), and the PPI (Producer Price Index). The PPI, also known as factory gate price inflation, tracks the prices of raw materials and services paid by producers. In other words, those are the costs and expenses required to get the products onto the shelves for us to buy. If those costs go up, companies’ margins, or profitability, goes down. Have you seen what happens to publicly listed companies who announce that they have experienced margin pressure? I know you have, and it is usually not good for shareholders. So, it is only rational to assume, that rational companies will raise their prices in order to maintain their margins…and not upset their shareholders. PPI was somewhat subdued in the month leading up to the pandemic, even declining in September and October of 2019. When the pandemic hit, producer prices plunged, and in 2021, the recovery year, they spiked up by +13.3% in November and pulled back in December to close out the year with a +12.2% growth. What that means in practical terms, is that companies were spending +12.2% more to produce goods in December than they were a year earlier. Can you imagine a company announcing that its profitability was -12.2% lower than it was a year prior? There are some signs of hope, which can be found in the month over month changes in PPI. Those numbers appear to be trending lower, and if the trend continues, there is hope that companies may ultimately slow down the price hikes...reduced consumer inflation. For now, however, given the choice between accepting lower profitability and hiking prices, rational companies will always choose to raise prices. Listening closely to recent earnings announcements, many companies have and will continue to do just that until input costs (producer prices) pull back. It is here and it is not going to go away so easily. It’s just business.
WHAT’S SHAKIN’
Align Technology Inc (ANR) shares are trading higher by +1.36% in the pre-market after Morgan Stanley initiated coverage with an OVERWEIGHT rating. The maker of Invisalign dental braces has lost -11.7% in value over the past 12 months and is expected to announce earnings this upcoming Wednesday. Potential average analyst target return: +53.4%.
Citrix Systems Inc (CTXS) shares are lower by -3.36% in the pre-market after the company is reportedly nearing a $13billion sale to Elliott Management and Vista Equity partners who will take the company private. The per-share announced price is below Friday’s close. Potential average analyst target return: -7.4%. WHY IS THIS NEGATIVE. Because the current price of the stock is above the average 12-month price target set by analysts. Though this may be interpreted as the price being overvalued, it does not mean that the stock cannot continue to climb.
VF Corp (VFC) shares are lower by -1.52% in the pre-market after beating EPS and Revenue estimates in last Friday’s announcement. Forward guidance was weaker which caused many analysts to immediately lower price targets. In fact, 19 out of the 22 analysts have lowered their price targets in the past 30 days. The stock traded lower by -6.52% in Friday’s session. Dividend yield: 3.18%. Potential average analyst target return: +19.1%.
FRIDAY’S MARKETS
Stocks rallied on Friday as investors swooped in to buy stocks put on sale earlier in the week. The S&P500 rose by +2.43%, the Dow Jones Industrial Average climbed by +1.65%, the Nasdaq Composite Index jumped by +3.13%, the Russell 2000 Index advanced by +1.93%, and the S&P500 ESG Index added +2.59%. Bonds were higher and 10-year Treasury Note yields pulled back by -3 basis points to 1.75%. Cryptos were higher by +6.57% and Bitcoin rose by +4.44%.
NXT UP