The Threat to the Market No One Is Talking About

Companies in the S&P 500 reported a record net profit margin of 11.6% in the first quarter of 2018.

It’s the highest net profit margin for the S&P 500 since financial data firm FactSet began tracking it in the third quarter of 2008.

But clouds may be on the horizon.

That’s because a new concern is cropping up in their earnings calls: rising costs.

There’s no shortage of examples from last quarter…

  • “We expect steel and other commodity costs to be a headwind all year.” That came from Caterpillar, a farming and construction equipment manufacturer.
  • Soda and snack maker PepsiCo is feeling rising costs, too. “Our expectation is that we will continue to see some levels of gross margin compression from inflationary input costs.”
  • Same with Tyson Foods, the owner of popular brands such as Hillshire Farm and Jimmy Dean. It said, “Increased freight costs affected all four segments,” and “We are seeing increased labor costs.”
  • We’re seeing comments like this from various companies.

    Hershey, UPS, and Procter & Gamble, to name a few, made similar comments.

    And it points to one thing: rising inflation.

    In fact, as I’ll show you in a moment, input costs are rising at their fastest level in six years.

    Longtime readers know we’ve been warning about inflation since the beginning of the year.

    That’s why we’ve recommended that readers should look for safe stock market income opportunities. But first, let me show you the devastating impact inflation can have on your finances.

    Inflation Destroys Your Buying Power

    It’s been a long time since the U.S. has seen any substantial inflation. The last inflationary period was between 1965 and 1982.

    In the years leading up to 1965, inflation remained well below 2%. But by 1969, inflation was over 5%. By 1974, it was over 10%. And by 1980, it reached close to 15%.

    Inflation that high can wreak havoc on your finances. It’s like a hidden tax on your buying power.

    In other words, as time goes by, you can buy less and less with the same amount of money.

    Let’s see how that worked out over the last inflationary period.

    For example, let’s say you had $100,000 in savings at the beginning of 1965. That $100,000 would buy you $100,000 worth of goods at that time.

    But how much is it going to buy you in the future?

  • By 1969, that same $100,000 worth of goods would cost you $116,000.
  • By 1974, it would cost you $156,000.
  • By 1981, it would cost you $288,000.
  • It’s clear that inflation destroys your buying power over time.

    And the signs today are pointing to rising inflation ahead.

    Wholesale Prices See Their Biggest Rise in Six Years

    The comments from the companies mentioned above all highlight rising input costs. These are the costs that go into the production of goods and services for consumers.

    They’re measured by the Producer Price Index (PPI), which is released by the Bureau of Labor Statistics every month.

    Many are familiar with the CPI, or Consumer Price Index. The CPI measures the prices of consumer goods purchased by households.

    The PPI is a bit different. It measures prices at the wholesale, or producer, level.

    In other words, it’s a measurement of the cost of raw materials to companies that produce goods. And the PPI just had its biggest increase in over six years.

    Here’s why that’s significant. Those higher input costs will result in higher product costs. And that means you’ll be paying more in the future.

    It’s part of what we call Income Extermination. That’s the combination of rising interest rates and rising inflation that destroys the wealth of retirees and savers.

    Two Steps to Beat Inflation

    First, you want to identify and remove red flags from your portfolio. Red flags are investments that are vulnerable to Income Extermination.

    At the top of this list are long-term and high-yield bonds.

    The last time we saw this lethal combination of rising rates and inflation was in 1981. The bond market fell 19% that year.

    The next step is to identify the right investments.

    You want investments in which real capital appreciation will exceed inflation. That way, you maintain your purchasing power.

    At The Palm Beach Letter, we like to buy high-yielding closed-end funds (CEFs) that are trading at a discount to their assets.

    That’s our favorite strategy to beat Income Extermination.

    CEFs are an investment structure with shares traded on the open market. They’re similar to exchange-traded funds (ETFs)… But there’s one main difference: CEFs do not issue shares daily.

    That means CEFs can trade on the market at prices different from the value of their assets, called the net asset value (NAV).

    When a CEF trades for less than its NAV, you can buy it at a discount. This means you could buy, for example, $1 worth of assets for 90 cents.

    Since adding CEFs to the PBL portfolio in 2016, we’ve averaged realized gains of 18.4%, which beats the S&P 500 by 16.5% during that span. And the yields collected over that time were an average of 300% greater (or more) than the S&P 500’s.

    If you’re a PBL subscriber, can view our buyable CEF recommendations right here…

    And if you’re not a PBL subscriber, we recently showed you our three-step strategy to find your own quality CEFs right here…


    Greg Wilson
    Analyst, The Palm Beach Letter