Costs

Whilst ‘The Interview’ may have averted attention for a day or two, the market remains fully vexed on the inflation narrative: how high are yields going, and how quickly can portfolios rotate. It has been the fourth worst start for 30yr Treasuries in the past 100 years. And there are good reasons to vex: employment in February was down almost 10m from the peak, bank loans are edging higher, and consumer net worth has climbed almost 20% to a ready-to-spend it $133 trillion. The surge higher in oil, as the OPEC cartel stay friends, is going to start to bleed into prices, and many food commodities are up 50%. Hence the latest flow data reports more money into equities, more money out of gold. Over the past four months almost half a trillion dollars has found its way into the equity market. It has, though, gone where it’s hot; tech remains in vogue. See the chart of the combined market cap of consumer staples and utilities as a percentage of the S&P. Yes, inflation is heading higher, but it might just be transitory. Some commentators talk about a structural turn, others appear more vexed about the Royals; pointing to recent times when a 3% bond yield was on easy terms with a Fed Funds rate at zero. The base, remember, is low. For companies then, the picture could not be more different to the one they faced twelve months ago as the virus razed economies. Back then, it was about survival. Mothball, retrench, cut costs, and send the bank manager some flowers. For many companies it provided the catalyst for change. And much of this change has been good. More digital adoption, more focus. A company like US Foods, a supplier to the restaurant industry, saw revenues collapse. They too cut costs, and claimed they were permanent. The risk for many management teams who made similar promises, though, is that as demand picks up, bookings flow, and profits surge, the urgency is gone. The bank manager is not needed on speed dial and costs slowly begin to inflate. The benefits are fleeting. For US Foods, CFO Dirk J. Locasio was clear on the recent earnings call. The cuts are permanent and, as restaurants reopen and revenues recover, the business finds itself – post COVID – in a much stronger position: “The actions we took during 2020 have strengthened the future earnings power across our business.” This means sustainably higher margins. And sustainably higher profits. Investors are likely to want other companies to follow suit.

 

The securities mentioned in this blog may be held by funds managed by Majedie Asset Management Ltd.