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 2.9% year over year in June, above 2.8% recorded in May and in line with market expectations. It also marked the highest inflation rate since February 2012. A jump in oil prices plays a huge role in boosting inflation this year.
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.
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 announced tit-for-tat tariffs on $50 billion of each other’s goods. President Trump now plans to slap tariffs on an additional $200 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 (read: Beyond China, These Asia ETFs to Feel the Heat of Trade War).
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 rates.
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 2.7% (read: Winning & Losing Sector ETFs From June Jobs Data).
Against this economic backdrop, Goldman's strategist explains that “the market generally rewards companies with high margins when the outlook for corporate profitability weakens.”
Below we pick a few sector ETFs that are likely to offer higher or almost the same net margins offered by the S&P 500 (11.8%) for the Q2 earnings season (read: 2 New Sector ETFs that Soared in Q2).
Technology Select Sector SPDR Fund (XLK - Free Report)
The sector is expected to produce 20.6% margins in Q2, per the Earnings Trends issued on Jul 11. It has been outperforming margins of the S&P 500 by a wide margin for past several quarters. The fund has a Zacks Rank #2 (Buy).
Financial Select Sector SPDR Fund (XLF - Free Report)
The expected margin for the sector is 18.5% for Q2. It has also been outperforming margins of the S&P 500 for past few quarters, though degree of outperformance has been lesser than technology. The fund has a Zacks Rank #2.
Invesco DWA Consumer Staples Momentum ETF (PSL - Free Report)
The sector has been trending higher than the S&P 500 on the margin front for the past few quarters, though by a smaller margin. It’s projected margin for Q2 is 12.8%. While rising rates and higher raw material costs bode ill for the space, trade war tensions and a still-steady margin data deserve investors’ close attention for the space. The fund has a Zacks Rank #3 (Hold) (read: Consumer Staples ETFs Riding High on Trade War Fears).
Invesco S&P 500 Equal Weight Materials ETF (RTM - Free Report)
The expected margin for the sector is 11.7% for Q2, slightly lower than the S&P 500. The fund has a Zacks Rank #2.
Want key ETF info delivered straight to your inbox?
Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>