Stagflation on the Way?

By John Stewart, chief investment officer at Farmers Trust Co.

Earnings Season Kicks Off with Big Banks

CANFIELD, Ohio — The large money center banks kicked off the second quarter earnings reporting season this past week. Names like JPMorgan, Bank of America, Citigroup, and Goldman Sachs all reported their sales and profit figures for the quarter ending June 30.

Despite the fact that most of the numbers reported by these banks surpassed analysts’ estimates, the stocks traded mostly lower in the wake of the news. Why? For a couple of reasons.

First of all stock prices care more about the future than the past, and loan growth at the big banks seems to be slowing quite significantly. In addition, longer-term interest rates have been trending lower for the past couple of months, and that is likely to negatively impact the profitability of the loans these banks are able to make going forward.

The rise in the overall stock market has obviously foretold what is sure to be a very strong quarter for earnings growth. However, it will be important for earnings expectations for the third and fourth quarter to continue to move higher in order for stocks to continue moving in the right direction. The good news is that the probability of this occurring is quite high.

Featured Insight: Beware Cheap Stocks with High Growth Expectations

Although many “investors” these days seem entirely unconcerned with the price or valuation they’re paying for stocks they purchase, the discerning investor typically likes to find companies that are trading at an attractive price relative to some fundamental metric like earnings per share.

At the same time, most investors like the prospect of a company that is expected to grow its sales and earnings power over time.

While this is an entirely reasonable approach to evaluating the merits of a particular company’s stock relative to its peers, it is important to tread very carefully when something appears too good to be true.

One big red flag investors should pay attention to is when a company’s estimated earnings growth exceeds its ratio of price-to-earnings. For example, if you’re paying $10 for every dollar of earnings power for XYZ stock while analysts expect XYZ earnings to grow at 15%, there is likely an unknown risk factor that makes this opportunity appear unusually attractive.

Always remember, there are no free lunches when it comes to investing.

Looking Ahead: Stagflation on the Way?

Economic growth has surged so far this year coming out of last year’s pandemic induced coma – that’s certainly no secret. What also isn’t a secret is that we’ve seen inflation rates rise at levels above anything we’ve been used to for the past couple of decades.

As long as economic growth continues at a relatively brisk pace, people are willing to put up with some modestly higher inflation. What causes concern is when growth slows while inflation remains hot. This is what we call “Stagflation.”

We’re starting to see some signs that this may in fact be happening. If things continue in this direction, Growth stocks and defensive sectors like Utilities and Real Estate are likely to outperform Value stocks and cyclical sectors like Financials and Industrials.

Copyright 2022 The Business Journal, Youngstown, Ohio.