Market trends

The cost of inflation and price increases: A market analysis

AlphaSense

|

May 28, 2021


A hand popping a balloon with a money sign on it
A hand popping a balloon with a money sign on it

As the stock market continues to rollercoaster through the first half of 2021, there seems to be a looming issue on the minds of many analysts, brokers, researchers, reporters, the media, and companies.

Inflation

General Inflation, wage increases, price increases of supplies and materials, and rising labor costs seem to be behind numerous fluctuations in the stock market. Still, it has been challenging to make sense of how companies and sectors are specifically being impacted. Adding to the uncertainty is companies’ forecast in the face of inflation. Are general fears substantiated or unwarranted? We dove into the AlphaSense platform to get some answers.

We found over 210,000 documents from the start of the year mentioning inflation – that number balloons to 250,000 when also looking at “labor costs,” “wage increase,” or “price increases.” Drilling even more profound, we see that nearly half of those documents have been published since April, a 35% increase over the last 24 days.

Across company docs, the focus is even more pronounced, with 66.37% more documents published in the last 24 days on the same topics.

Across these topics, there were a few key questions we wanted to see answered from company outlooks and transcripts.

  • How will inflation (and what kind of inflation) affect the company?
  • Will price increases within a company’s supply chain significantly impact a company’s financials?
  • How worried should we be around inflation?

We checked in on the banking, capital markets, Equity REITs, and insurance companies to see what they had to say.

Banking

SEB A. S.E. | Nordic Outlook Press Release

…in the U.S., the focus of attention in financial markets is now shifting from large stimulus measures to overheating risks. An inflation impulse is on its way, but we do not believe it will be long-lasting. This will enable the U.S. Federal Reserve to hold off on raising its key interest rate until 2023, but the Fed will again take the lead in the normalization process.

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Low-inflation environment tested in the U.S. amid “green” spending.

Overheating risks from massive U.S. fiscal stimulus packages will put the low-inflation environment to its biggest test in decades. One risk scenario is that the U.S. labor supply will not respond to increased demand and that this will be combined with rising inflation expectations. Our central scenario is that the upturn in inflation will be moderate. High household savings in the 37 advanced economies of the Organisation for Economic Cooperation and Development (OECD) will provide a buffer as stimulus measures are gradually withdrawn, while unevenly distributed income and wealth will remain a risk. Looking ahead, there are new arguments for expansionary measures linked to reforms that will improve the supply side of the economy and green sustainability.

J.P. Morgan | Announcement of Final Results

Outlook

…The very significant stimulus packages passed by central governments, most notably in the U.S., in addition to record levels of household savings, should help to boost economic recovery further. Set against this optimistic scenario are the fears of the return of inflation, high or excessive debt levels, and recurring trade tensions…

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Outlook: weathering the economic uncertainty

We continue to believe that economic growth will be above trend for the rest of the year, initially powered by the U.S. recovery but with growth picking up across other regions in the middle of the year. In addition, we expect inflation to be volatile but ultimately contained while monetary policy remains accommodative. We, therefore, maintain our risk-on view. However, we seek to express it more nuancedly, reflecting the themes of higher yields, cyclical earnings recovery, and above-trend growth.

Home Bancshares Inc | Q1 2021 Earnings Call

John W. Allison
Co-Founder, Chairman, President, CEO & Executive Officer

Well, from an asset quality perspective, I always keep an eye on our hotels. But the information coming on our hotels is much improved from where it was. So I’ve pushed that off the side. I do worry about inflation. I think inflation’s here, Will, and worry about the dollar’s devaluation; I’m scared to death that’s going to happen. I listen to a guy who I’ve done pretty well with on investing. And he says it’s coming, and he says it’s going to be quick and severe….he said, if you got cash, get rid of it. That concerns me; the dollar’s buying power goes down, and inflation goes up, and we have to fight that battle.

…I think the Fed has done an excellent job, and I believe they are trying to make piles to go ahead and do it….But I don’t think — I don’t believe they are not looking where I’m looking. So the thing that bothers me the most is the inflationary side. But that could be good, too. A little inflation doesn’t hurt us all. And then a little kick-up in rates wouldn’t hurt us. But, I mean you got — you think about it, you tie up your money — you tie-up, we got $2 billion, we tie it up in 1.25 today or 1.30 or 1.40 today, and the 10-year goes to 3% by the end of the year, and you look so stupid. You think, why did I do that? What happened? 

Capital Markets

Manning & Napier Inc | Q1 Special Call

Habibe Hakiqi
Senior Analyst

Yes. From an inflation standpoint, a little bit of inflation can be good for the economy. I think rising inflation is hard to argue that it’s perfect for various asset classes. Whether we’re talking about equities or bonds, or real estate, I believe rising inflation does not help. I think equities are an advantage in a hedge relative to fixed income in terms of inflation. So that’s the net benefit. I believe in terms of how the expectation of rising inflation impacts our day to day and our investment process; I think we’re trying to…look at each company and look at their ability to offset some inflationary costs, whether it’s inflationary pressure, whether it’s from a cost perspective or look at their power to increase their ability to increase pricing. We try to handle how much of a hurdle inflation will be on the fundamentals of the business and what that means from a valuation perspective.

So again, we’re trying to sort of look at it individually. I think more broadly, we have been attempting to take specific actions that hedge against inflation. I would know the recent investment in gold as a way to sort of offset some of the risks around rising inflation. Still, we also have a very decent energy chunk, where commodities have historically served as a hedge against inflation. So net-net, I think from an equities’ perspective, we’re managing that, but we’re also taking a more active stance.

FS KKR Capital Corp | Q1 2021 Earnings Call

Daniel Ryan Pietrzak

Managing Director

… in the future, we believe the coming quarters will be marked by continued improvement in free cash flow growth across many sectors, offset only partially by the effects of expected higher near-term inflation. Over the immediate term, while we continue to believe that modest inflation is healthy for the overall economy, we believe inherent structural forces, including technology and demographic trends, will help balance longer-term inflationary pressures.

Equity REIT

W.P Carey Inc | Q1 2021 Earnings Call

Jason E. Fox

CEO & Director

In addition to accretive acquisitions, a meaningful contributor to our future growth comes from the rent increases built into our leases, a significant portion of which is tied to inflation.

Given renewed expectations for higher inflation, I’ll take a moment to provide a little extra detail on our rent escalations. Leases generate 99% of our ABR with some form of built-in rent increases. In addition, 61% of ABR comes from leases tied to inflation. So if we enter a period of sustained inflation, we remain very well-positioned for it to flow through as incremental rent growth.

Of our leases with rent increases tied to inflation, the majority, representing 38% of total ABR, is based on uncapped CPI, with the largest category being those tied to U.S. CPI. The other 23% of ABR tied to inflation includes leases with floors and caps, which we refer to as CPI-based. The average floor is around 1.5% on an annualized basis within this category, and the average cap is approximately 3%.

In an inflationary environment, if our 3% caps become relevant, it would likely mean that we would be achieving substantially higher same-store rent growth than we are today. For now, however, the floors continue to be more relevant than the caps as drivers of annual growth in our leases.

Finally, 35% of ABR is generated from leases with fixed rent increases, where the average increase is approximately 2% on an annualized basis.

Rent increases generally occur annually, so over time, they will flow through to rents. Given the profile of our rent escalations, we believe we are one of the best positioned net lease REITs for inflation.

Welltower Inc | Q1 2021 Earnings Call

Shankh S. Mitra
CEO, Chief Investment Officer & Director

Yes, Jonathan, there’s no question that you will have labor cost inflation. I do not believe that problem will be as acute as you have seen last five years when all the — frankly speaking, all of our portfolios, given where the locations are, regardless of local regulations, have moved at or above that $15 type of numbers. So you have seen a very significant increase in labor costs. Will you see labor cost inflation? Absolutely. But I think you will also see margin expansion from, as Tim talked about previously, we believe that you will see the margin expansion going back to the historic margins level. So it’s a yin and yang.

I will tell you one thing, though. I would highly encourage you not to look at one quarter or one month of labor costs and projects there. This is a lot of noise and volatility around the fact that many people have received the stimulus check, which has impacted the short term. We do not believe that will be sustained as this sort of — this dries up. However, you are correct that labor cost inflation will remain, but it will not be what you see in other sectors, because what you see in different sectors such as lodging and all the sectors, they have laid off all their employees, the shutdown. That was the case. For us, our communities have never shut down. Because to take care of our residents, and that continues. So is it — are there no issues? Not, will remain so. I would also encourage you to think about the potential immigration changes that are — we hear about. I know it less — probably less than you do, but that also has an offsetting impact. So it’s a long-term problem, but just understanding the demand-supply of labor related to the demand-supply of people and how that impacts people’s other choices at home will all come into place. 

INDUS Realty Trust, Inc | Q1 2021 Earnings Call

Michael S. Amazon
CEO, President & Director

…we see strong demand and rent growth in all of our markets. At the same time, a substantial increase in demand has created some pressures, notably in the availability and pricing for crucial construction inputs. The most significant of these is the availability of steel bar joists to support our buildings’ roof structures. Recent pricing for steel bar joists is up materially, and lead times have increased from 12 to 14 weeks to now up to 25 weeks. Other construction inputs, such as PVC piping and certain petroleum-related products, and even the cost of overhead warehouse doors, amongst others, also have seen significant price increases.

While the strong growth in the industrial sector does have this added cost, we are fortunate that tenant demand is strong, and we expect rising rents will offset much of the impact of these input price increases.

We currently estimate that the input cost inflation I described before, with steel being the most significant factor, creates an approximate $6 to $8 per square foot increase in total project costs.

Using our current market rent assumptions, this increase in cost is not expected to have a material impact on the stabilized cash NOI yields for our development portfolio, which we continue to forecast to be between 6.1% and 6.6%. However, while we are hopeful that these cost increases and availability issues resolved more quickly than we have budgeted, the situation remains fluid. Therefore, we will continue to actively monitor the potential impacts on our projects’ timing and yields.

Insurance

Markel Corporation | Q1 2021 Earnings Call

Thomas Sinnickson Gayner
Co-CEO & Director

I would expect that the actual inflation taking place on the ground is more than what the headlines would report. So all of the managers who live and eat and sleep and breathe these businesses every day, they’re doing the best they can to control their costs, to get their supply chains humming and working, and make sure that they’re charging appropriate prices to earn a reasonable margin of whatever product or service they’re providing.

That’s true every day. That’s true in the public securities portfolio of the companies we look at. And we’re looking for the same kind of behavior from the managers of our businesses at Markel Ventures as we expect from the managers of the publicly-traded companies that we’re investing in. And that doesn’t change whether inflation is low or high, but I don’t want to be caught asleep at the wheel and not aware of the heightened sensitivity and focus that I think should be applied to that line of thought these days.

And to sum it up, and I think I mentioned it in the comments, we believe the dumbest thing you could do right now is to lock in low, long-term rates of return. So we don’t plan to be geniuses or the most intelligent people in the room, but we try not to be the dumbest. So as long as we don’t do stupid things, the good things compound.

Intact Financial Corporation | Q1 2021 Earnings Call

Isabelle Girard
Senior Vice President of Personal Lines

So on the pricing side, as Patrick mentioned, we’re working very closely with the claims team and making sure that in our overall profitability assessment of our book, we reflect the projected trends we think we’ll have in terms of inflation in costs. And that’s precisely why, in the past, we’ve put some measure and action plan around our pricing to make sure we would cover inflation.

So as we are sitting today, we have tempered our rate momentum because of the temporary reduction in driving. But as soon as we see that the level of driving is picking up, we’ll get back to our rating strategy and make sure that we’ll cover the inflation in cost we project.

Charles J. G. Brindamour
CEO & Director

So the severity of inflation we’ve observed for several years, Brian, is fully baked in, in our rate position and our rate adequacy. So we’re temporarily reflecting a drop in frequency, but we’ve done that in a way where we can revert to pre-COVID rate levels without too many obstacles as driving returns back to normal. And I think our stance on severity has been quite cautious.

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