In this week’s update, CIO Tom Weary, CFA®️, discusses continued worries over inflation after an unexpectedly large jump in April’s Consumer Price Index (CPI). He also shares earnings from The Walt Disney Company, Alibaba Group, Air Products & Chemicals, and more.

Transcript

Hi, I’m Tom Weary here at Reilly Financial Advisors with your Weekly Market Update.  We had another big week for earnings reports from our companies, but before turning to those let’s take a quick look at the latest reading on inflation, a data point that made headlines this week.

Wednesday’s headline that the CPI jumped 4.2% from a year ago is grabbing attention.  There are three reasons I think that we need not be alarmed by this number.  The first is something called base effects, meaning that the latest CPI measures prices in April versus April 2020 when the nationwide overnight lockdown caused a widespread collapse in prices.  The lower base makes the year-over-year comparison appear inflated.  This will resolve over time.  The second reason is pandemic dislocation.  The biggest factor in April’s CPI increase was Used Car Prices.  This is driven by pandemic-related issues such as low supply just as demand increases with people returning to work but not wanting to take public transportation, along with lower new car supply due to the global chip shortage.  There are numerous examples of temporary bottlenecks across supply chains which are causing price pressures as the economy re-opens.  The third thing to keep in mind is embedded expectations.  Inflationary expectations are rising somewhat but do not appear to be embedded in consumer psychology yet.  Some pundits are beginning to talk about a wage/price spiral, but that will likely prove short-lived.  What happened with the pandemic lockdowns and policy response appears to me to be analogous to open heart surgery.  The government had to “stop the patient’s heart” at the outset of the pandemic, “keep the patient alive” through historic monetary and fiscal stimulus, and then “revive the patient” through a massive vaccination program enabling gradual re-opening of the economy.  The events of 14 months ago hardly resemble a garden variety ‘recession’ or ‘bear market’.  They were shocks to the system.  We are witnessing temporary dislocations in a complex economy.  GDP growth and inflation will surge this year but likely prove to be transitory.  Were inflationary expectations to become embedded, the Fed has more than enough tools to rein them in again.  Given the enduring deflationary forces of technology, demography and debt, the Fed is likely to welcome a little boost to inflation.

Core Portfolio holding Air Products and Chemicals, the industrial gases company, reported a fiscal second-quarter profit that came up short of expectations, while sales beat forecasts, as the COVID-19 pandemic and a severe winter storm in the U.S. Gulf Coast weighed on results. Net income for the quarter was $473.1 million, or $2.13 a share, versus earnings of $477.8 million, or $2.15 a share, in the year-ago period. Excluding nonrecurring items, adjusted earnings per share rose 2% to $2.08, below consensus of $2.12. The company said it estimates COVID-19 reduced adjusted earnings by 10 cents to 15 cents. “Adjusted earnings improved over the prior year, we continued to improve pricing, and we again generated strong cash flow,” said Chief Executive Seifi Ghasemi. Sales grew 12.9% to $2.5 billion, above consensus of $2.3 billion, while cost of sales increased 19.5%. For 2021, the company expects adjusted earnings of $8.95 to $9.10, surrounding the consensus estimate of $9.02. The stock has rallied 14.6% over the past three months, while the S&P 500 has gained 8.3%.  Let’s hope that continues.

Alibaba reported a surprise net loss during its fiscal fourth quarter—the result of a fine levied by Chinese regulators amid a crackdown on big technology companies.  It also reported its first loss from operations since going public.  The red ink stemmed from a fine, imposed in April, over allegations that the company had abused its dominant market position.  CEO Daniel Zhang said in the earnings release that the company hit one billion annual active consumers globally during the 2021 fiscal year.  “We remain very excited about the growth of China’s consumption economy, which is benefiting from the acceleration of digitalization in all aspects of life and work,” Zhang said.  For the total core commerce segment, revenue was up 72% year over year.  Sales in the cloud-computing business jumped 37% year over year. Digital media and entertainment sales were up 12%, while the catchall segment for innovation initiatives and other operations saw 18% growth.  One analyst commented that the company’s overall growth prospects “remain intact across all business segments.”  Let’s just hope that the Chinese government doesn’t slap the company with any more fines.

After the close on Thursday, the Walt Disney Company reported earnings of 79 cents per share, well above estimates of 27 cents, but investors were disappointed by the number of Disney+ streaming subscribers coming in at only 103.6 million versus the 110 million expected.  Revenues were also light at $15.6 billion versus $15.9 billion expected.  The pandemic continues to have an effect, continuing to disrupt film and television operations while having an impact of $1.2 billion on the Parks and Experiences division, which suffered an operating loss of $406 million.  The company stated that they are focused on re-opening the parks and ramping up studio production.  The light at the end of the tunnel is getting closer, but we aren’t there just yet.

This week we heard from a couple of our European-based Consumer Staples companies.  Ahold Delhaize, the Dutch parent company of U.S. grocery chains Giant and Stop & Shop, reported strong results with earnings 16% above estimates.  The company raised their outlook for the year, saying they expect underlying earnings to grow in the low to mid teen range versus 2019 and online sales to grow over 40% versus the prior year.  In an update to investors, Diageo, a Defensive Portfolio holding, said it expects organic operating growth of at least 14% for fiscal 2021, which ends June 30. The world’s largest spirits maker also said it has restarted its share buyback program.  The company’s performance was boosted by strong demand in the U.S., where more people bought alcohol to drink at home. That trend continued into the second half of the calendar year, while the reopening of countries around the world has seemingly improved performance in recent months.  Cheers!

On Wednesday, Lumentum, a leader in lasers used in 5G telecommunications and facial recognition on smartphones, reported earnings inline with analysts’ estimates for $1.40 but sales of $420 million came in $14 million below expectations.  CEO Alan Lowe stated “Out of an abundance of caution, we deferred $14.8 million of revenue due to delays in 5G deployments in China, which decreased our reported revenue accordingly. Despite the lower revenue, due to the strength of our financial model we achieved approximately 50% gross margins, and strong operating margins and earnings, both of which were within our guidance ranges.”  However, he also lowered his guidance for the year.  Investors were not pleased, taking the stock price down over 15% on the news.  Companies failing to beat expectations are severely punished these days.

Simon Property Group reported earnings of $1.36 per share, beating consensus forecasts by 40 cents, while the mall operator’s revenue was slightly above estimates. However, Simon also cut its full-year profit forecast and said occupancy levels would not return to 2019 levels until 2022 at the earliest.  CEO David Simon said profitability and cash flow growth improved as shopper traffic and retailer sales increased amid leasing momentum grew across its portfolio.  The recently acquired Taubman Realty Group portfolio is seeing similar results, he said.  Occupancy was at U.S. malls and premium outlets was 90.8% on March 31, 2021, down from 91.3% at Dec. 31, 2020.  It looks like things might be stabilizing at the shopping malls.

So, what does it all mean?  An unexpectedly large jump in April’s Consumer Price Index caused quite a kerfuffle amongst the punditry this week, but not so much in the bond market.  Bond investors are very sensitive to whiffs of inflation, and yet as you can see in this chart of the yield curve, long term interest rates moved up less than 20 basis points, or two tenths of a percent, at the long end.  And rates remain nailed to the floor on the short end.  As we see in this next chart of the yield on one month Treasury bills, short term rates have been waffling around zero, often slipping into negative territory, for several months now.  So, fixed income investors don’t seem too concerned about inflation getting out of control.  We’ll keep an eye on how things develop for you.  So, please, sit back, relax, and join us again next week for the RFA Weekly Market Update.

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