Weekly Investment Update (10/08/2021)
- Labor markets: Expiration of federal unemployment benefits has little correlation to labor force participation rate; wages rising due to demand and supply mismatch; and labor market healthy enough for Fed to taper.
- Company earnings: Third-quarter earnings estimates trimmed due to supply chain disruptions; second-quarter earnings showed that companies can offset higher costs, and 2022 and 2023 earnings assumptions remain higher and unchanged.
- Energy sector: Energy prices hit multiyear highs this week as demand outstrips supply; higher prices should not have a significant impact on the U.S. economy; All Equity portfolio remains modestly underweight versus the benchmark.
U.S. Labor Supply Constraints Pushing Wages Higher; Not Expected to Hinder Fed Tapering Plans
The recession officially ended a year and a half ago, and as we have anticipated and discussed, the labor market continues to recover but at a slower rate than other areas of the U.S. economy. The labor force participation rate has barely budged since June 2020, increasing by just 0.2 percentage points to 61.6% today versus the pre-recession high of 63.4%. We have seen little correlation between the expiration of the additional federal unemployment insurance benefits and the labor force participation rate, suggesting that other factors are playing a larger role in inhibiting people from returning to the labor pool. Some other explanatory variables include people retiring early, ongoing concerns over COVID-19, and childcare constraints. Additionally, while there are a record number of job openings in the U.S., we have seen a greater relative increase in job openings in less urban areas that may also be hampering the recovery process.
Due to the demand and supply mismatch, we have seen many companies increase incentives to attract workers. For instance, earlier this week, Bank of America announced that it had increased its hourly minimum wage from $20, which was enacted last year, to $21 today and will increase this rate to $25 by 2025. Target increased its minimum wage from $13 per hour to $15 in July, and Starbucks raised wages for hourly workers to at least $12 per hour effective this month, after already increasing pay for all baristas by at least 10% in December 2020. Amazon also announced plans to hire an additional 125,000 workers and raised its average starting wage from $17 per hour since May to over $18 today. These headlines suggest that wage pressure may soon begin to affect company margins, and this is something we will be paying attention to in the upcoming earnings season.
Lastly, as the Fed contemplates the start of tapering its asset purchase program, the state of the U.S. labor market remains top of mind for financial market participants. In our view, the labor market is healthy enough to give the Fed the greenlight to begin decreasing its monthly purchases of $120 billion in Treasuries and mortgage-based securities. The Fed’s next policy meeting is scheduled for November 3.
Third-Quarter Earnings Preview — Continued Concerns Over Supply Chain
Next week marks the beginning of third-quarter earnings announcements for companies within the S&P 500. Over the past three months, expectations for third-quarter earnings results have risen, according to Factset. Estimates for third-quarter average earnings increased in July and August but were trimmed in September on concerns that continued supply chain disruptions would drive an increase in input costs, ultimately contracting margins.
It is possible that third-quarter results will end up being similar to the second quarter, when companies showed they had either the pricing power to offset these higher costs or were able to reduce them. In the second quarter of this year, the S&P 500 reported its second-highest net profit margin since 2008, when FactSet began tracking this metric. Although some companies — such as 3M, Sherwin Williams, and DR Horton — have cut guidance for the third quarter as a result of supply chain issues, management teams are labeling supply chain constraints as temporary. End-market demand for most businesses is still strong, and companies have shown previously that they are able to raise pricing or cut costs, benefiting margins.
Analysts have trimmed third-quarter and fourth-quarter earnings this year, but 2022 and 2023 earnings assumptions remain higher and unchanged. Analysts are focused on corporate dynamism and the expectation that companies will be able to navigate this environment while cost pressures eventually subside. Bessemer continues to focus on high-quality companies with scale advantages that are best able to manage higher input cost pressures, providing some measure of stability to portfolios amid these dynamics.
Energy Prices Higher as Demand Outpaces Supply
Several energy prices, including oil, natural gas, coal, and power, hit multiyear highs earlier this week as OPEC+ announced their production plans and the market received news of power rationing and blackouts across the world from China to Europe. Commodity prices more generally have been increasing in recent months, driven by increases in demand from reopening economies that are outpacing supply as producers struggle to increase output to meet demand.
Oil prices moved higher after OPEC+ stuck to its plan to raise oil production modestly and gradually. After lower prices negatively impacted income during the pandemic, OPEC+ producers are benefiting from the revenue boost of higher prices. Meanwhile, natural gas prices soared to record highs after rising demand has been met with supply disruptions, which have led to record-low inventories ahead of the peak winter period. Prices subsided from highs after Russian President Putin indicated Moscow was willing to help stabilize the global energy market.
At current levels, energy prices should not have a significantly negative impact on the U.S. economy, in our view. The U.S. market can increasingly manage higher oil prices given the U.S. economy’s declining energy intensity in addition to the S&P 500’s relatively low exposure to oil-related industries.
The Bessemer All Equity portfolio has increased its energy exposure since the start of the year but remains modestly underweight relative to the benchmark (3% vs. 4% for the benchmark). Portfolio managers generally find limited opportunities in the sector as energy companies tend to be lower quality with higher debt burdens, and their stock performance often closely correlates with crude prices rather than purely idiosyncratic growth drivers that are more within managers’ control.
— Bessemer Investment Team
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