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Looking at the Stock Market as a Collection of Businesses

CAMS Weekly View from the Corner – Week ending 5/14/21

May 17, 2021

Per our subject title it may seem we are offering the obvious.  Well of course the stock market is a collection of businesses you may think.  Interestingly, this basic fact seems to get lost in euphoria along the market timeline. Bring enough “good times” market-wise onto the landscape and as sure as night follows day the masses will fall into the predictable stupor that the stock market only goes up because it seemingly has become a magical money tree that only needs shaken a bit to have its bounty poured upon participants. The reality that these are a collection of businesses that experience all the macro and micro challenges of any other you-name-it private business gets lost in the euphoria. Keep in mind though that these are not private businesses but rather publicly traded companies.  With this, their values get bid up or down on a continuous basis.  As shared in a previous edition the recent annual growth rate of the S&P 500 has only been matched one time in the previous 80 years(!) and never exceeded.  This type of a reference point certainly underlines stock market pricing is registering historic enthusiasm. This is an entry into a notable issue for these businesses as a whole and that is they have been bid up to the sky with their valuation levels matching their skyward price trajectory. Business Nirvana Backdrop? When markets price company valuation to historic levels they are simultaneously offering a built-in expectation of near business nirvana.  Think sales rates will be growing fabulously while costs will be subdued producing a perfect environment of tremendous increases in profitability. We certainly are not in a business nirvana environment through the lens of forward profitability.  When market participants are bidding prices and valuation levels to the sky they are inherently expecting tremendous increases in sales and profits. Labor The cost of labor – to the degree they can find employees – is and will be rising further.  Like any market, when demand notably exceeds supply prices rise and the demand for labor currently far exceeds the willing supply of labor.  These businesses, like most private businesses are scrambling to find willing labor.  The result is either to curtail some aspect of sales or to further incentivize labor with higher wages.  Few companies, especially large publicly traded companies, who are always furiously trying to protect their market share, will willingly curtail sales.  Consequently, a logical follow-on offers labor prices will be rising. Input Costs In many aspects of input supply, prices are rising far faster than can be passed onto end customers.  Ending first quarter of this year company conference calls across a wide range of industries were loaded with the topic of notably rising input costs and the expectation of attempting to pass those on, best they can, to their end customers. Some industries are better positioned than others to pass on increased costs to end customers.  At the same time, companies are rarely able to pass on costs to the degree they are incurring them when in a rising labor and input cost environment.  The level of profitability decreases as a result. Inflationary Pass-through Vehicles Generally, businesses are often looked at and have a slang phrase associated with them as inflationary pass-through vehicles.  When in inflationary times this slang phrase becomes more prominent. As stated, some industries/businesses are better positioned to pass on increased costs to their end customers compared to others.  As we move through this inflationary environment the ability of “x” company or industry to pass on costs will be a notable driver of market participants willingness to bid up their stock prices. When the general price inflation backdrop becomes well recognized (i.e. inflationary times) valuation levels go lower around the stock market landscape.  This then places a headwind rather than a tailwind for stock prices generally.  Few people realize how much stock prices are impacted, both up and down, by the willingness of market participant’s to increase or decrease the valuation of the companies they are bidding on in the marketplace. With all of the above digested, stock market investing will become more challenging going forward.  We suspect, as near months unfold, the view of the market as a magical money tree will fade and the realization that these are businesses subjected to the same challenges of any other business will become more appreciated and recognized. With this, the ability of any business to pass through their own inflationary experience to end customers will play a notable role in their attractiveness to general market participants.     I wish you well…

Ken Reinhart

Director, Market Research & Portfolio Analysis

Footnote:

H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.

This commentary is presented only to provide perspectives on investment strategies and opportunities. The material contains opinions of the author, which are subject to markets change without notice. Statements concerning financial market trends are based on current market conditions which fluctuate. References to specific securities and issuers are for descriptive purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. There is no guarantee that any investment strategy will work under all market conditions. Each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. PERFORMANCE IS NOT GUARANTEED AND LOSSES CAN OCCUR WITH ANY INVESTMENT STRATEGY.

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