* Pricing power key for investors faced with rising inflation
* Commodity prices have recovered sharply
* Food prices: reut.rs/2jLZacs
* Euro area inflation: reut.rs/2jM8e1e
* Margins under pressure: reut.rs/2inrgWr
By Vikram Subhedar and Kit Rees
LONDON, Jan 13 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 U.S. 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
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
"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
"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," Greetham said.
Upbeat results this 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
Bank of America Merrill Lynch analysts, led by Angus Tweedie, expect the
slide in sterling to squeeze UK consumer budgets in 2017 and also push costs
higher, particularly for apparel retailers sourcing clothes from abroad.
Next week, sales updates from the likes of H&M, Burberry
and JD Wetherspoon will keep the European retail sector in focus.
Analysts have consistently cut forecasts for gross margins for several
consumer-focused industries in Europe over the past few years. Autos, travel and
tourism and restaurants and bars saw the sharpest cuts, according to Thomson
Reuters data. More recently, tobacco companies have suffered cuts as
health-conscious consumers change habits.
"Companies selling direct to consumers will get squeezed," said Charles
Glasse, a portfolio manager at Waverton Investment Management, which ran some of
2016's best-performing funds, according to Lipper data.
Instead, areas where companies face limited competition, whether by industry
or geography, tend to fare better in times of rising inflation.
"These tend to be in sectors that are a little less exciting and not very
well-known, such as industrial gases or chemicals," Glasse said.
As investors gear up for the corporate earnings results due over the next
four weeks, they are likely to be particularly cognizant of rising costs and
margin pressures as above average valuations leave little scope for
"Whilst a pick-up in inflation will flatter some, many companies will have
to deal with more expensive inputs - an issue they have not seen for some time,"
said Derek Stuart, manager of the Artemis UK Special Situations Fund in his
outlook for 2017.
(Graphics by Vikram Subhedar, editing by Larry King)