I started my career in 1980 and back then I wasn’t paying much attention to the historic inflation rates prevailing. Needless to say, US equity investors are experiencing today a challenging investment environment with the fastest rate of price increase ever seen since. However, we think, the JPMorgan American Investment Trust (JAM) is well placed to navigate this backdrop. Our investment process focuses on finding companies with durable franchises that possess the pricing power necessary to be able to withstand periods of high inflation.
In recent decades, inflation has not been a serious concern for US equity investors. Over the last 40 years the consumer price index (CPI) has rarely breached 5% and has come nowhere near showing the massive swings in prices of the 1970s or 1950s. In fact, in 2009 the main worry was deflation, with a crash in oil and commodity prices driving a decline in CPI.
US inflation at its highest level for 40 years
Source: US Bureau of Labor Statistics, Bloomberg, J.P. Morgan Asset Management. Data as of 30 April 2022.
That situation has turned on its head. US CPI soared to 8.5% in April (source: US Bureau of Labor Statistics), its highest level since 1981, far beyond the US Federal Reserve’s long-term target, in part due to a surge in oil and commodity prices in the wake of Russia’s invasion of Ukraine. However, inflation was already rapidly climbing before the war, with the economic re-opening following Covid-19 induced lockdowns causing issues in supply chains for certain goods. At the same time, consumers were ready to spend the money they had saved up during lockdowns on supply-restricted goods. This resulted in inflationary pressures being stoked from both the supply and demand sides.
It is difficult to forecast with any certainty how long this period of high inflation will persist but it is important, as investors, not to ignore it. Inflation erodes the value of cash and, if left unaddressed, would make your savings worth less in today’s terms.
While the value of bonds tend to deteriorate in an inflationary environment, history suggests US equities perform better during periods of moderate inflation. This is because companies tend to be able to pass on some of their rising costs to consumers and maintain a level of profit, which is reflected in the earnings of companies in the S&P 500 Index closely tracking headline inflation numbers.
Exhibit 4 : US inflation and S&P 500 trailing earnings
% change year on year, earnings are last twelve months'earnings per share
Source: BLS, IBES, Refinitiv Datastream, Standard & Poor's, J.P.Morgan Asset Management.
Guide to the Markets - UK & Europe. Date of 20Janauary 2022
However, not all companies will be able to continue pushing their prices higher without undermining demand for the products or services that they offer. To be able to do this, companies need to exhibit strong pricing power. Pricing power is derived from a combination of different factors, most notably significant market share and high barriers to competition. JAM seeks to invest in companies with these characteristics. The trust focuses on companies with durable franchises that can thrive through different types of economic environments.
My co-manager Timothy Parton and I rigorously analyse stocks across the full breadth of the US stock market, tapping into the expert research of J.P. Morgan’s large and experienced team of New York-based stock analysts. The result is a portfolio of mostly large cap companies, which have strong positions in their respective markets, and which have the ability to pass on price increases when inflation rises.
We have several examples in the portfolio of companies with strong pricing power. One of our favourites is agricultural machinery manufacturer Deere & Co, more commonly known as John Deere. Throughout its history Deere has had a strong focus on producing the highest quality products with unmatched customer service that are reasonably priced. It is one of the few companies that does not look to competitors to set the pace for price and instead sets prices based on a balance between its own costs and what is acceptable to its clients. While Deere’s products may be more costly compared to competitors, it’s a price customers are willing to pay due to the quality of the product as well as the company’s customer service.
With its current focus on precision agriculture technology, it is using new technology to increase farmer yields and profitability while lowering the level of traditional inputs needed to grow crops (e.g. land, water, fertilizer). This in turn significantly increases farmer productivity and reduces waste. Through the use of these innovative technologies as well as its progress with machine learning and automation initiatives, Deere has widened its competitive moat relative to peers thus allowing it to continue to sell high quality products and maintain pricing power.
Another example is Illinois-based Packaging Corporation of America. The company is a market leader in box packaging, manufacturing a range of products from small retail packages to large container boards. It has plants that span the breadth of the US, giving it easy access to its consumers.
The proliferation of ecommerce has helped keep demand high for packaging, which has been a boon for Packaging Corp of America. Where the company has had to deal with headwinds such as freight availability and cost, labour costs and higher input costs, it was able to navigate these challenges with price increases and higher production. Both of these changes have led to several hundred basis points of margin improvement.
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