Inflation, Earnings, and a Little Bit of Perspective

Inflation is still with us... But it's not as bad as it seems... Inflation, earnings, and a little bit of perspective... Learning from the earnings, which are up, up, up... Will the bull market end?... Greg Diamond's historical perspective...

In case you hadn't noticed, inflation is still here...

But, of course, you noticed... Car-rental prices for leisure travel were up 43% in October compared with October 2020, according to the Federal Reserve Bank of St. Louis... The average cost of a gallon of regular gas, according to the American Automobile Association, is up 62% over the past year ‒ to $3.42 per gallon... The list could go on.

And then there's "shrinkflation"... the practice of manufacturers reducing the size of everything from Cocoa Puffs to ketchup to toilet paper but charging the same price.

And sure enough, inflation data released today show the Consumer Price Index ("CPI") rose at an annualized rate of 6.2% in October, compared with 5.4% in September. On a month-over-month basis, the CPI was up 0.9%, compared with 0.4% in September.

It's the highest rate of inflation since November 1990... when George H.W. Bush was president, people talked to each other over landlines, and the Nasdaq Composite Index ended the month at 359.10. (Yesterday it closed at 15,886.)

In today's Digest, I (Kim Iskyan) will see how these inflation numbers and the latest super-high earnings results will combine to play out over the next few months... and how history can provide any perspective.

Inflation has been stickier than the Federal Reserve anticipated...

For months, the Federal Reserve and other senior U.S. economic officials have said that multidecade highs in inflation are simply "transitory." Like a drifter on a freight train, inflation is just passing through. As the Financial Times explained...

The data reinforce the view that inflationary pressures are proving far more persistent than initially expected – a growing risk the Federal Reserve acknowledged last week...

As we've written, inflation has been fueled in recent months by a perfect storm of kinks in the global supply chain that have constrained the supply of goods... higher labor costs due to not enough workers... and "treat yourself" post-pandemic demand bolstered by COVID-19 stimulus.

But there are reasons to think that inflationary pressures may be easing...

As Stansberry Newswire editor C. Scott Garliss explained in today's morning market snapshot...

Wall Street money managers invest in anticipation of future economic activity... And right now, they see signs supply-chain problems are incrementally easing.

For example, the Baltic Dry Index, which measures demand for capacity to ship dry goods – often raw materials – has fallen roughly 50% since recent highs in early October. That makes sense... Shipping rates are falling, and available ship storage capacity is rising.

And meanwhile, as we wrote on Monday, several global automakers have indicated that they expect semiconductor supplies to increase... the shortage of which has been a big bottleneck for cars, as well as everything else – from cellphones to cars to football helmets – that uses microchips.

What's more... the Fed's preferred inflation measure isn't as alarming...

When we're talking about inflation, the most common metric is CPI, which captures changes in what households spend. But core personal consumption expenditures ("PCE"), which the Fed focuses more on, excludes food and energy prices, and isn't rising as quickly.

As Scott explained...

There are data included in PCE that may not affect CPI. But typically, PCE tends to run below the levels seen in CPI. And while the numbers like we saw today can get the media excited, following the central bank's preferred gauge gives us a more accurate indication of what they're thinking and how they might act.

And as of the end of October, core PCE was running at an annual rate of 4.4%. That's still high... but it's well below the 6.2% widely reported in the news today.

That doesn't mean – at all – that we're out of the inflationary woods. But it suggests the Fed probably isn't as concerned about rising inflation as the headlines suggest.

Switching gears... earnings season is almost over...

And it's been a very active season... Companies – and the economy – have earned a solid "A"... but they have gotten a little help from their friends.

Four times a year, the thousands of publicly traded companies release earnings results for the previous quarter. When viewed as a whole, these earnings announcements – required by the U.S. Securities and Exchange Commission ("SEC") to be submitted within 45 days of the end of the previous quarter – are a report card on the trajectory of the economy.

Earnings releases, and comments by management that accompany them, reflect the challenges and opportunities facing companies in different sectors. And, of course, earnings are the undeniable evidence about the success (or failure) that firms have experienced.

Earnings themselves – how much a company makes in net income – are important. No matter your preferred way of valuing stocks and markets, profitability is at the center of the equation.

You see, when you buy a stock, you're getting a small slice of a future flow of earnings. If earnings rise, the value of that slice increases in value... and vice versa.

So when earnings overall are weak, it's difficult for share prices to rise in value. But when earnings increase, the wind is at their back.

And right now, that wind is more like a Category 5 hurricane.

Earnings are up 39% compared with the same period last year...

This is where the help from friends comes in – because that's a lot more than the 27.5% increase that Wall Street analysts expected when the third quarter ended.

Remember... higher earnings are good. But in terms of how the market reacts, it's performance relative to expectations that plays a major role in the share price. If expectations were that earnings in the third quarter would be up, say, 59% but increased by "only" 39%... well, that would be a disappointment, and share prices would likely fall.

But that's not generally the case. In the latest quarter, 81% of companies in the S&P 500 Index that have reported earnings beat consensus expectations.

That's a lot. But it's not unusual. In quarterly earnings over the past year, 84% of companies have reported earnings results that were higher than expected.

Let's ask the obvious question... why are earnings forecasts so wrong?

You'd think that stock analysts whose jobs it is to predict company earnings ‒ which become the "expectations" investors focus on ‒ would wonder why they're consistently underestimating corporate earnings... and try to improve their record.

After all, for weather forecasters or football odds compilers – or almost anyone other than a stock analyst – to be so wrong nearly all of the time would be career-ending.

Big public companies are enormously complicated. A dizzying array of factors lead to earnings... like the economic environment, a fickle consumer, competition, costs variations, labor cost, etc.

As a result, many stock analysts take their cues from a company's senior management – who, after all, know more than anyone else about the inner workings of their operation – to help fine-tune their final expectations report.

But it's in the interest of senior company managers to underpromise and overdeliver... And surprise, when the final quarterly numbers are reported, the company beat expectations.

The stock rises... which, at least in the short term, is good for shareholders.

In the bigger picture, the results – rather than expectations – tell us where we are...

So let's take a look now that most companies have reported. Overall, third-quarter 2020 earnings for the companies that make up the S&P 500 were down 8.2% ‒ a modest drop, given COVID-19 lockdowns were still somewhat in place ‒ compared with the same period in 2019.

What that means is that in the third quarter of 2021, overall S&P 500 earnings are up around 25% compared with the same period in 2019.

That's not just a recovery... It's robust economic growth. It's what you might see in an emerging market – but not in the world's largest economy.

Does this bull market ever end?

That, of course, is the question on everyone's mind... Despite strong earnings and seemingly endless good news, history suggests that stocks will stop going up soon – by February or March, to be exact.

Ten Stock Trader editor Greg Diamond applies technical analysis to stock and market movements... That is, he looks at past price changes and uses them to predict where the market is going.

As Greg wrote in his most recent update earlier this week...

I say it often – be unbiased and let the price action guide you.

One of the measures that Greg has noticed in recent months is the similarity in how the Nasdaq 100 Index – the biggest stocks of the Nasdaq Composite Index – moved in the period from 1998 to 2000 and how they're moving today.

And, as you can see in the two graphs below, the comparison is almost eerily similar...

As Greg told me this morning...

This is a roadmap for what is to be expected. And it's been nearly a perfect correlation historically, so why would it stop now?

It suggests that the current bull market in stocks – and everything else – has room to run... but the clock is ticking, as it was back then.

Of course, as always, we'll be sure to alert Digest readers to all the critical developments in the weeks and months ahead. But you can do something else today to make sure you're prepared for whatever happens next...

You see, Greg will continue to track these market shifts and more on a daily basis in his Ten Stock Trader service. Every Monday morning, he sends a weekly outlook on what's happening in the markets directly to subscribers' e-mail inboxes... And throughout the week, he delivers timely trading alerts to help subscribers take advantage of opportunities when he sees them.

So with that in mind, you owe it to yourself to learn more about Ten Stock Trader. Get started here.

New 52-week highs (as of 11/9/21): Analog Devices (ADI), Applied Materials (AMAT), Asana (ASAN), Atkore (ATKR), AutoZone (AZO), Best Buy (BBY), CoreSite Realty (COR), Denison Mines (DNN), Eagle Materials (EXP), Flowers Foods (FLO), Freehold Royalties (FRU.TO), W.W. Grainger (GWW), Ingersoll Rand (IR), ProShares Ultra Technology Fund (ROM), First Trust Cloud Computing Fund (SKYY), Teradyne (TER), Trex (TREX), and Valmont Industries (VMI).

Today's mailbag features observations from a couple of subscribers on two recent Digests from our colleague Dan Ferris. If you haven't already, you can read Dan's essays here and here. Then, share your thoughts with us at feedback@stansberryresearch.com.

"[We did] as you did... buy used, three to four years out of date, pay cash, get a dependable vehicle, plan to run it into the ground (with periodic maintenance of course), plan on 300,000 miles or more. After all, a car is just transportation, unless your ego can't handle it.

"We bought one car used. After we drove it to 250,000 miles, the speedometer went out. My wife drove it around Chicago for two years, going with traffic of course. Then, we got it fixed and drove it another 50,000 miles. At that point, my son bought it from us, and he drove it for another five to six years. At the end of that time, he sold it to another party. During that time, outside of the speedometer and a couple of other minor items, that dependable car kept right on moving. We easily drove it 400,000-plus miles if we combine our miles with our son's miles.

"From the same vehicle manufacturer, I purchased a new car (ignoring rule No. 1 above), drove it for 300,000 miles and decided to sell it. I got it detailed, and it looked terrific. But I did sell it to a young student just going off to college. One problem during that time... one of the windshield wipers decided to quit, [but] not a significant item at all.

"We have been steady customers for that vehicle manufacturer ever since. Our latest was a three-year-old, low-mileage SUV from the same manufacturer." – Paid-up subscriber Fred R.

"Hi Dan, Tesla is an amazing story. Of course you are right that it is absurdly overpriced. More than a year ago and $1,000 per share ago (from the $1,200 high last week) I was telling friends that the company was valued at over $1 million per car produced, even though it lost money on each car it made. Everyone always doubted that and said, 'Then where do they get all the money?'

"It's so hard to explain... I have never seen anything like it. How can you explain how many thousands or millions of investors can be so wrong, as well as banks and other institutions that perpetuate this fantasy? How long can it continue?

"It's to the point that I want to root against the company, even though the technology will undoubtedly help everyone at some point, whether directly or by influencing competition to get better.

"Anyway, keep up the insightful writing." – Paid-up subscriber Rick V.

Happy investing,

Kim Iskyan
Ashton, Maryland
November 10, 2021