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Lower inflation could mean companies raise prices less quickly, hurting their sales.
David Becker/Getty Images for Nordstrom Rack
Investors have cheered declining inflation, but there is a negative side to the picture as well. The stock market isn’t likely to be a bed of roses in the near term.
The positive side of the picture, of course, is that as prices rise less frenetically, the Federal Reserve will see less need to keep raising interest rates to rein them in by choking off demand for goods and service. That would be positive for corporate profits, which drive stock prices.
The
S&P 500
is up about 27% from the bear-market low it hit in early October, partly because investors think the Fed is near the end of a series of increases that have lifted the fed-funds rate to above 5% from near zero in March 2022. It makes sense because the consumer price index rose only 3% year over year in June, down from just over 9% in June 2022.
The problem is that more muted inflation means companies will be less aggressive in lifting prices. While a flattening out of interest rates, or even a decline, will eventually allow demand for goods and services to grow, smaller price increases in the near term will limit growth in sales.
That means that sales and earnings could disappoint investors. Companies’ revenues could miss expectations outright, or analysts could lower their forecasts for sales and profits as they see growing evidence of limited price increases.
Recent economic data point to those possibilities. The producer price index, which measures what companies pay for supplies and materials, has been rising less quickly as firms prepare for weakening demand.
According to
Morgan Stanley
,
PPI results like those seen recently have historically correlated with aggregate year-over-year revenue declines of almost 5% for S&P 500 companies. Sales have only dropped about 0.8%, in aggregate, in the second-quarter profit reports that have been issued so far, so more declines could be on the way. Earnings are likely to fall even harder because companies can’t cut costs fast enough to keep pace with revenue reductions.
“Disinflation is now eating into sales growth,” wrote Morgan Stanley’s chief U.S. equity strategist Mike Wilson. He believes aggregate earnings from S&P 500 companies will be lower than Wall Street expects next year, and that the index is likely to fall about 9%.
How far stock prices fall depends on how badly earnings are hurt by the declining rate of inflation, and on how fast sales and profits rebound from any drop. So far, the market has looked through this challenge, viewing it as a blip on the radar.
But the stock market will drop if investors sees the revenue headwind as more lasting. If prices of goods and services fall and then grow only moderately, the market would have to reduce its assumptions about the outlook for sales and earnings unless investors sees reason to expect a substantial surge in demand at some point. Lower earnings mean lower stock prices unless investors are willing to value shares at higher multiples of profits.
The stock market is more complicated than it looks. Nothing is simple.
Write to Jacob Sonenshine at [email protected]
Source: https://www.barrons.com/articles/falling-inflation-sales-earnings-stocks-9a8ef522?siteid=yhoof2&yptr=yahoo