With most U.S. companies now having reported their 3rd quarter financial statements, it shapes up to be another astonishing jump in corporate growth. Sales growth is up again, with the average American company reporting a 25% jump in sales over last year. This means 75% of all stock market companies are improving top-line corporate growth.
Pent-up desire to spend by consumers, rising wealth and savings, low-interest rates, easy access to credit, and now the fear of missing out on rising asset prices has produced an overheated corporate economy. Add to that the recently legislated federal infrastructure spending-action, and there are all the conditions for rising commodity prices and inflation.
Inflation Directly Impacts Corporate Growth
Commodity and labor costs are rising at a faster rate than product prices, so the only direction for the gross profit margin is down. Evidence accumulated during the recent financial statement update shows that companies are, in fact, passing on rising costs as higher product and service prices. This is seen by both the S&P 500 and the Otos Total Market Index gross profit margin rising. After a 4-year almost steady decline, a solid rebound marks the 1st increase since 2019.
Your Portfolio Attributes Speak Numbers
It is important to be scrupulous around the growth attribute of companies in your portfolio. With share-price indexes back to all-time highs, it is important to sell stocks of companies with falling growth. Review your portfolio, and sell stocks of companies with lower sales growth and falling profit margins.
In November, the broad market index was down slightly while long treasury bond yields dropped to 1.7%, lifting long treasury bond prices. Stocks have been flat relative to bonds, and the gap between corporate growth and inflation has never been higher.
Share Performance Is A Function Of Relative Growth
Historically, in periods of rising growth, shares of stable growth companies perform poorly even with a high growth rate. In the recent 3rd quarter, the gross profit margin was up on average but with a smaller proportion of companies achieving this improvement. So, make sure all your stocks have rising profit margins.
Some of the remarkable improvement in growth attributes is the result of the virus impact that makes an easy comparison and maybe some pent-up demand as people postponed purchases during the lockdown. These attractive growth stocks will dissipate in the coming quarters.
FED's Response
Evidence emerged recently that U.S. policymakers will go to even more extraordinary lengths to sustain the value of assets. The unusual gap between bond yields and inflation must fall. The proper policy now would be to increase interest rates and restrict lending to cool an overheated economy and prevent rising inflation from becoming rising inflation expectations.
However, no such policy can emerge before the mid-term U.S. elections. That makes for another year of fuelling inflation.
That translates into a portfolio strategy for a more volatile market, with the stock market still near an all-time high. You must focus on sell decisions, particularly companies with stable or falling growth.
Average Sales Growth Is Over 25%
It will be difficult to sustain the rising-sales-growth attribute among our portfolio of companies in the coming quarters. Sales growth is over 25% now, the highest we have ever measured from U.S. companies. Sales growth must fall in the future. As stated above, 3/4 of U.S. companies recorded an improvement in the recent period. That is still a large majority of companies but down from 83% in the prior period.
With overall growth high and rising, it is important for portfolio companies to accelerate faster. That requires operating and/or financial leverage. That is why, at least for as long as the acceleration persists, your portfolio of companies should also have leverage.
Sell Bonds
It is the bond market that faces a sustained decline. Review your retirement accounts now and sell all fixed-income investments. Rising inflation expectations cause the wage-price spiral that has been so difficult to control.
It has been decades since markets have experienced anything resembling a tight money policy. The Long Treasury Bond yield, now 1.7%, peaked at 17.2% in March 1983. At the time, evident consumer-price inflation was 15% (up 5 percentage points in the prior 9 months), and the real interest rate of 2.2% predicted that inflation would fall.
CPI Is Now 6.2%
Furthermore, consumer price inflation is 6.2%, up 5 percentage points in the past 9 months, but real interest rates are at an all-time low of -4.5%. This simply predicts that inflation will rise.
Despite All Distortions
Corporate growth has never been higher or rising at a faster rate than it is now. The challenge is to manage portfolios through falling growth and rising interests that are now undoubtedly ahead. Make sure that the attributes of your portfolio are at least as good as the market average.
Capital markets are likely to become more volatile, but a sustained stock-market decline is unlikely. Our best strategy response now is to sell all bonds and insure an equity portfolio of companies with rising growth attributes.