By Callum Keown
U.S. stocks edged lower early on Monday ahead of key inflation data and earnings reports later in the week.
Fears over rising COVID-19 cases and vaccination problems, after a Chinese government official said the effectiveness of its vaccines was low , has put equity markets under pressure.
However, the partial reopening of the U.K. and upbeat comments from Federal Reserve Chair Jerome Powell provided some positivity. Investors will also be awaiting consumer price data on Tuesday and earnings from major banks JPMorgan Chase /zigman2/quotes/205971034/composite JPM +1.22% , Goldman Sachs /zigman2/quotes/209237603/composite GS +0.97% and Wells Fargo /zigman2/quotes/203790192/composite WFC +0.94% later this week.
After a delay on Friday, the U.S. Labor Department said the producer-price index, a key measure of inflation, rose 1% in March — the biggest annual increase since 2011.
In our call of the day , Goldman Sachs strategists said higher inflation was on the cards in the coming months, which could boost companies with high pricing power.
“‘Don’t fight the Fed’ is a quip investors have learned to ignore at their peril. What the central bank wants is usually what it gets, sooner or later,” the strategists said, noting that the Fed’s intervention a year ago sparked the 80% rally that has lifted the S&P 500 /zigman2/quotes/210599714/realtime SPX +1.29% to an all-time high. The index has rallied 10% year-to-date and now trades at Goldman’s midyear target of 4,100 — the bank’s end-year target implies a gain of 5%.
The Fed now wants higher inflation, they said. The investment bank’s economics team expected inflation readings to climb in the coming months, peaking at 2.3% in April, before sitting below 2% until 2023.
When it comes to the impact on stocks, Goldman said it was all about margins, adding that some companies were protecting margins by passing higher costs along to their consumers.
The strategists, led by David Kostin, said companies with low pricing power have historically outperformed when S&P 500 profit margins are expanding. In contrast, companies with high pricing power have “sharply lagged” during the past year. However, rising inflation could mean that is about to change, and companies with high pricing power are set to benefit, the strategists said.
Goldman screened for stocks with high pricing power — high and stable gross margins relative to sector peers. The screen produced 55 stocks, including videogames company Activision Blizzard /zigman2/quotes/200717283/composite ATVI +5.62% , tobacco giant Philip Morris /zigman2/quotes/201611010/composite PM +0.38% , consumer-goods companies Colgate-Palmolive /zigman2/quotes/200774077/composite CL -0.54% and Procter & Gamble /zigman2/quotes/202894679/composite PG -0.98% , and drug manufacturer Zoetis /zigman2/quotes/207603157/composite ZTS +0.39% . Technology companies, such as Aspen Technology /zigman2/quotes/201282485/composite AZPN +2.32% , Adobe /zigman2/quotes/200389143/composite ADBE +2.29% and Oracle /zigman2/quotes/202180826/composite ORCL -0.89% , and retailers Etsy /zigman2/quotes/202790087/composite ETSY +0.34% and Dollar General /zigman2/quotes/200691429/composite DG +0.02% also featured.
Separately, with first-quarter earnings seasons getting under way next week, Goldman expected aggregated sales growth of 5% and earnings per share (EPS) growth of 19%. But that won’t matter much, its strategists added. “The trajectory of the economic recovery will continue to make backward-looking metrics less relevant for the forward-looking market,” they said.
The next issue dominating investor discussions is President Joe Biden’s plan to boost corporate tax to 28%, Goldman said. The full adoption of Biden’s proposals would see 2022 annual S&P 500 EPS growth of 12% fall to just 5%, they added.
Higher producer prices are positively linked to S&P 500 earnings, according to this chart from Jeroen Blokland, senior portfolio manager at Robeco Asset Management.
U.S. stocks /zigman2/quotes/210599714/realtime SPX +1.29% /zigman2/quotes/210598365/realtime COMP +1.90% eased lower early on Monday, with the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.78% slipping 67 points, or 0.2% in early trading. European stocks also fell , while Asian markets slipped overnight as investors monitored rising coronavirus cases and slow vaccination rollouts.