Sceptics of the rally in the US equity market worry that valuations are misaligned in relation to earnings. Valuations have become stretched, they fear.
Last week’s second reading of US GDP for Q2 provided a strong rebuke to the bears. Profits rose sharply, with unit margins hitting a fresh high in $ terms and as a share of GDP.
There is a caveat. Costs have been kept under control. Total unit costs were down 0.21% y/y in Q2. However, prices are rising quickly too. Unit selling prices rose 4.74% y/y.
Margin expansion that is derived from companies simply flexing their muscle, driving prices up quickly (relative to costs) may look good for equities in the short-term.
However, it marks a turning point. It implies that costs are not the primary driving force behind the rise in inflation. A concentration of economic power, in the hands of a few, large corporates has changed the inflation dynamics. That has ramifications for Fed policy.
Summary
- Validating this year’s rally in equities
- Costs under control, but selling prices rise
- How companies respond to rising wages will determine length of bull market
