Large-cap stocks with high market share and strong customer loyalty have passed on price increases
Meanwhile, small and mid-cap stocks struggled to maintain margins due to difficulty passing on prices
If inflation eases, strong performance is expected from small and mid-cap stocks
[Asia Economy Reporter Gong Byung-sun] As the COVID-19 Delta variant spreads, the upward momentum of the S&P 500 is slowing down. However, there is a forecast that if inflation weakens, the earnings of small and mid-cap stocks will improve, supported by margin improvements.
According to KB Securities on the 19th, the market consensus for the U.S. growth rate this year fell by 0.3 percentage points in September, recording 5.9%. The S&P 500, which had risen for seven consecutive months, dropped about 2.12% in September, raising concerns about a correction. In fact, the operating profit margin and net profit margin of the S&P 500 have rebounded rapidly since the second half of last year, reaching historically high levels.
Concerns are growing not only about the delay in economic recovery due to the COVID-19 Delta variant but also about rising costs caused by supply chain disruptions. The Producer Price Index, which shows changes in costs incurred in corporate production activities, exceeded market expectations last month, rising 8.3% year-on-year. Prices increased broadly across goods, services, and construction categories, with the transportation and warehousing services sector showing a particularly notable rise.
Wages are also on the rise. Due to the spread of the COVID-19 Delta variant, economic activities have contracted, and job-seeking activities have been delayed because of government transfer income support, resulting in a shortage of labor supply. So-eun Ahn, a researcher at KB Securities, said, “Industries with significantly higher job vacancy rates compared to the end of 2019 before COVID-19 are experiencing strong wage pressure,” adding, “For example, companies like Walmart and Amazon are offering not only wage increases but also incentives such as tuition support to secure manpower.”
Nevertheless, earnings forecasts for the S&P 500 remain favorable. KB Securities expects the S&P 500’s earnings to slightly decline in the third and fourth quarters of this year but to rise again next year. Furthermore, even if earnings margins decline in the second half of the year, they are expected to remain higher than pre-COVID-19 levels.
This expectation implies that companies are strategically offsetting the burden of rising costs through price pass-through. In fact, the intensity of price increases relative to cost changes among U.S. companies since COVID-19 is the highest since the 1970s.
Looking ahead, if inflationary pressures weaken and price pass-through concludes, an environment favorable to small and mid-cap stocks over large caps is expected in terms of earnings. Large-cap stocks have already actively passed on prices amid inflation, but for small and mid-cap stocks, which found price pass-through difficult, the risk of margin weakening could be alleviated.
Researcher Ahn explained, “Large companies included in the S&P 500 have been able to pass on prices easily by leveraging high market share and strong customer loyalty, but small and mid-cap companies found it difficult to do so, making it hard to maintain margin rates,” adding, “If inflationary pressures ease, the forces that have prevented earnings recovery in small and mid-cap stocks will also weaken.” In fact, during 2011?2012 and 2014?2015, when producer price inflation slowed, small and mid-cap stocks showed relatively strong performance supported by margin improvements.
Demand recovery is also a positive factor for small and mid-cap stocks. Consumers’ purchasing power is improving. Even if prices of goods and services rise, if income rises faster, the burden of inflation on consumers is not significant. In fact, the real hourly wage growth rate adjusted for inflation rose month-on-month in both July and August. Researcher Ahn said, “The calming of COVID-19 spread and normalization of economic activities will also drive demand recovery.”
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