Return of inflation puts focus on pricing power

Rising commodities prices leave firms in Europe’s retail, travel and leisure sectors among those most vulnerable

Rising prices of commodities from vanilla to oil are stoking inflation expectations and turning investor attention to profit margins at companies, especially in consumption-related industries, that may struggle to pass on rising costs to consumers. The so-called “reflation trade,” which has lifted US and UK stock markets to record highs, began in earnest last quarter, as bond yields rose on bets that more spending on infrastructure would spur economic growth.

A recovery in metals prices and the rallies in agricultural commodities, however, mean that input costs for a range of European companies are rising for the first time in three years.

That leaves sections of the market at risk, especially with valuations now above their long-term averages.

In the UK, a slide in sterling since last June’s Brexit referendum is expected to hit consumer spending this year, putting further pressure on margins.

That leaves companies in Europe’s retail, travel and leisure sectors among those most vulnerable, analysts and investors say. Intense competition in a bid to keep customers will make it harder for them to raise prices and absorb higher costs.

Real squeeze situation

“The closer you are to the consumer, then you are in a real squeeze situation,” said Trevor Greetham, head of multi-asset at Royal London Asset Management, drawing parallels with a similar situation in 1994 when commodity prices surged. “The closer you are to the shovels, the closer you are to the commodity end, you can pass it on. If you’re a mining company, or an oil producer, this is what you do, you pass on price rises.”

Upbeat results last week from UK supermarkets and retailers sent shares soaring.

The numbers caught investors off guard, though the outlook remains tough, according to some of the top-ranked analysts covering the sectors.