Fed chairman Jerome Powell is sounding the alarm on wage inflation.
Salaries have picked up some steam as the labor market has strengthened and the U.S. joblessness rate has fallen to lows that last prevailed in the 1960s. Powell has said that he has been surprised the uptick in wages hasn’t been stronger considering how far unemployment has fallen. Still, wages are beginning to rise.
At 3.8%, the jobless rate is down substantially from its post-crisis peak in 2009 of 10%. It’s also below the 4.5% level that policy makers have said is a level sustainable in the long-run. Central bank officials say the unemployment rate may even sink as low as 3.5% by the end of 2019, according to their median forecast from June 13.
“It’s a bit of a puzzle,” Powell said, while noting that he expects wages to continue to go up as the labor market tightens.
As wages gain, not all companies will see their profits prosper. For labor-heavy companies like McDonald’s (NYSE: MCD), profits may fall under the pressure of necessary wage hikes in order to retain and attract talent in a wage inflation environment.
“Reflecting the tight labor market, the leading signal from survey data suggests that wage growth should soon accelerate above 3% from its current pace of 2.6%,” said Goldman Sachs strategist Ben Snider. “When wages rise faster than prices, margins suffer. Investors should focus on sectors and stocks least exposed to this risk.”
Goldman developed a list of 50 companies that are more likely to triumph in such an environment given their relatively low labor costs, with their stocks outperforming the broader market. This basket of 50 stocks is already beating the market at large.
“Our basket of stocks with Low Labor Costs has outperformed the S&P 500 by 21 percentage points since breakeven inflation began to rise in early 2016, and has continued its outperformance so far in 2018 (7.0% vs. 4.9%),” Snider said.
Of the 50 companies, these 4 stocks are ones to keep an eye on.
Under Armour (NYSE: UAA)
After a miserable two year run, Under Armour is back in the game and is up 57% year-to-date – though it’s still far below the stock’s 2015 highs.
While domestic sales are still lagging, the growth in international sales is impressive with the company posting growth of 27% last quarter. The company has also finally stopped losing money and is now back to break even. UAA also suggested in its last earnings call that it would meet its 2018 guidance, which knocks a big hole in the bearish thesis for the athletic shoe and apparel giant.
In a smart move, the company is also diversifying away from basketball with a recent shoe collaboration with Dwayne “The Rock” Johnson. A few years ago, Under Armour rode the Steph Curry mania to fantastic results, but it was risky to have so much of the company’s growth prospects coming from just one star athlete.
The Rock, as a former wrestler, is an athlete, but he’s also an actor, director, and has even hinted at a possible presidential run. His star power opens Under Armour up to a consumer set that the typical basketball or football endorsements wouldn’t, and his first batch of shoes sold out in under an hour demonstrating that the demand is strong for his product line.
Under Armor’s new president, Patrik Frisk, is also solving one of the company’s biggest issues—inventory mismanagement—starting specific initiatives aimed at cleaning up the process. Initiatives that appear to be paying off.
Earlier this month, Jefferies analyst Randal Konik noted that the company is slimming down its inventory levels, which will in turn, fatten up the company’s margins. Konik said, “Under Armour fundamentals are poised to inflect, with the top line accelerating and margin erosion lessening, supported by progressively cleaner inventory.”
As the company continues to diversify its endorsements and correct its inventory issue, investors could see significant growth ahead for Under Armour.
Gilead Sciences (NASDAQ: GILD)
Right now, Gilead is an attractively priced biotech stock whose worst days may soon be behind it.
Gilead is several years into a major plunge in sales for its hepatitis C virus (HCV) product, with the company’s CFO—Robin Washington—stating during the company’s Q1 conference call that “2018 is a trough year for us on which we can grow.”
While HCV will continue to be a part of Gilead’s business—with sales expected to stabilize later this year—it will be a smaller part of it. The story for Gilead now is on its other products and its upcoming pipeline.
Included in that pipeline is the company’s new “megablockbuster” HIV drug, Biktarvy. The drug is anticipated to be the most successful HIV treatment ever, which is a triumph considering Gilead’s past successes in treating the disease.
Gilead also picked up the drug Yescarta with its acquisition of Kite Pharma. Yescarta is a CAR-T therapy that uses the body’s own immune system to treat lymphoma patients who have not responded to other treatments or who have relapsed after a minimum of two years with other types of treatments.
Currently, Gilead has minimal oncology revenues, so this new therapy—and any others in the pipeline—will be majorly disruptive in the pharma market.
Synchrony Financial (NYSE: SYF)
Synchrony is an interesting player in the financial sector. The company focuses on Credit Services and is rated a buy by 16 analysts who cover the stock, with a $43 price target – 26% higher than Thursday’s close.
The bank makes money in an unusual way. It’s a private-label card issuer and acts as the bank behind many of the store credit cards offered by some of the largest retailers in the country, including Walmart (NYSE: WMT), Gap (NYSE: GPS), Lowe’s (NYSE: LOW), JCPenney (NYSE: JCP), and others.
These partnerships mean Synchrony has a massive outside salesforce (retail employees) working to push its credit cards to new customers. The company gets a healthy spread on the balances, strengthened by the high interest rates charged on store cards.
Activision Blizzard (NASDAQ: ATVI)
The gaming industry has been hot lately, and one of the standout performers in the sector is Activision Blizzard.
Best known for its Call of Duty, World of Warcraft, and Candy Crush franchises, the stock is up 20% year-to-date, and up over 200% in the last three years.
What’s promising about the company is that it isn’t just reliant on one game. In total, ATVI boasts 8 franchises that have generated more than $1 billion in sales each. And other games may be in the pipeline with Activision’s Overwatch League potentially the next billion-dollar franchise.
Overwatch League reportedly sold a total of 12 teams in its e-sports franchise to an array of traditional sports team owners and some big-wigs in the video game industry for $20 million each earlier this year, amounting to $240 million for the League’s first season. And Activision is expecting the League to expand to 28 teams in the future.
The League has been a big hit with fans as well, drawing in 400,000 viewers for its premiere, and averaging 80,000 to 170,000 viewers per broadcast on the Amazon-owned e-sports streaming platform, Twitch.
While there have been some concerns about the rise in popularity of Tencent’s (OTC: TCEHY) free game, Fortnite, the company recently announced that it would counter the threat by adding a new mode to its Call of Duty game. The battle royale mode, which Activision is calling Blackout, will be available in the soon-to-be-released Call of Duty: Black Ops 4.
Despite the Fortnite threat, ATVI reported record returns in its latest earnings. Revenue and earnings per share both grew 14% year-over-year. Activision also reported record revenue, net bookings, earnings per share, and operating cash flow.
The full list of Goldman Sachs’ Low Labor Costs basket of 50 stocks is below: