By now, the year 2018 can easily be accredited to price inflation. U.S. economic growth, oil price movement and trade tensions have made this possible. But this may not mean good news for the future stock market performance.
Fear not. Goldman Sachs has suggested a way out. David Kostin, the company’s chief U.S. equity strategist recommends investors to “focus on stocks with high and stable gross margins” to wait out the likely volatility. Let’s delve a little deeper.
Inside Threat of Inflation
Consumer prices in the United States grew 2.8% year over year in May, above market expectations of 2.7%. It also marked the highest inflation rate since February 2012. The Fed also upped PCE inflation expectations in its latest June meeting. Expectations were upped from 1.9% to 2.1% for 2018 and 2.0% to 2.1% for 2019 but were kept intact at 2.1% for 2020.
Not only in the United States, an uptick in inflation has been noticed across the pond too. The ECB is satisfied with the pace of inflation. The annual inflation rate in the Euro Area rose to 1.9% in May of 2018 from 1.2% in April and beat market expectations of 1.6%. A jump in oil prices plays a huge role in boosting inflation this year.
However, it does not end here. There is more to come on the inflation front as President Trump enacted import tariffs on China and many other countries on a wide array of goods, including key metals like aluminum and steel. This in turn will likely result in higher inflation in the United States.
China tariffs are especially mammoth in scale. The two countries imposed tit-for-tat tariffs on $34 billion of each other’s goods on Friday. Tariffs on another $16 billion worth of Chinese goods are expected to be enacted in two weeks. And if Beijing continues retaliation, President Trump has threatened additional tariffs on $500 billion in Chinese goods.
Since many items used by consumers on a day-to-day life are sourced from Chinese or Hong Kong based companies and factories, import duties will put an upward pressure on prices.
Companies’ Profitability at Stake?
Apart from inflation, rising interest rates and wage growth are the other deterrents to U.S. companies’ profitability, per Goldman Sachs. The Fed has turned hawkish this year with an expectation of a total of four rate hikes. This led the 10-year U.S. Treasury bond yields to reach the 3% mark in the first half of this year. On the other hand, over the year, average hourly earnings increased 2.7%.
Against this economic backdrop, Goldman's strategist explains that “the market generally rewards companies with high margins when the outlook for corporate profitability weakens.”
The strategist found the case coming true for the Russell 1000 index. Stocks in the top quintile of each of their sectors with stable gross profit margin levels have outperformed low gross margin stocks by 14 percentage points so far this year, as quoted on CNBC.
Below we have highlighted five stocks that have average operating as well as net margins (five-year) greater than the median S&P 500 and the medium-industry (a combination of related medium groups creates a sector). These stocks have a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Cheniere Energy Partners LP Holdings LLC
The company owns and operates a liquefied natural gas terminal. It comes from atop-ranked Zacks Sector (top 5%). Its five-year average net margin is 69.32% and operating margin is 73.10%.
Facebook Inc. (FB - Free Report)
This social-media giant comes from a top-ranked Zacks industry (top 45%). Its five-year average net margin is 27.16% and operating margin is 29.30%.
The Buckle Inc. (BKE - Free Report)
It is a leading retailer. It hails from a top-ranked Zacks industry (top 35%). Its five-year average net margin and operating margin is 12.42% each.
Intel Corporation (INTC - Free Report)
It is one of the world's largest semiconductor chip maker and belongs toa top-ranked Zacks industry (top 4%). Its five-year average net margin and operation margins are 19.22% and 21.62%, respectively.
It is a worldwide provider of advanced technology services to Fortune 1000 companies, as well as to government entities. Its five-year average net margin is 18.22% and operating margin is 24.16%. The company hails from a top-ranked Zacks industry (top 41%).
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