Morgan Stanley: Lower inflation has an unusual downside for companies reporting earnings right now, but these 11 stocks will be able to survive and th

Reduced inflation benefits customers, yet adversely affects businesses, eroding their sales. According to Morgan Stanley, the upcoming earnings season will unveil the companies that will witness a decrease in revenue. However, there are 11 stocks that can successfully preserve their profit margins amidst the current decline in inflation.

Investors were delighted when inflation unexpectedly showed a decline in the June CPI report. It is not surprising that they reacted positively because a decrease in inflation appears to be advantageous for those concerned about an economic downturn.

As expressed by Kamakshya Trivedi, a prominent figure in Goldman Sachs overseeing global FX, rates, and EM strategy, in a recent message to clients, it is crucial to acknowledge that in this particular period, the primary emphasis of policies is on rectifying excessive inflation and guiding it towards the desired target. Consequently, the most conceivable explanation for a recession would be that the Federal Reserve would need to curtail another economic revival drastically in order to tame inflation.

While investors express frustration towards the rise in inflation, companies have come to perceive it as a fortunate occurrence. They have cleverly responded by adjusting the prices of their products and services in line with the inflation rate, thus enjoying the advantages of increased revenue.

However, as inflation diminishes, their ability to set prices is also decreasing. As the earnings season is currently in progress, investors have the chance to examine the details and determine the extent to which lower inflation is impacting sales across the market. This also allows them to identify which companies are successfully preserving their profit margins in the midst of disinflation.

The period of rapid inflation has transformed into a downward trend in inflation.

In a message to customers on July 24, Mike Wilson, the chief US equity strategist at Morgan Stanley, acknowledged that his previous prediction in October about the peak of inflation turned out to be incorrect. Since then, the market has experienced a significant increase, and Wilson expressed his astonishment at the prolonged upward movement in the markets, which exceeded his expectations.

However, it seems that inflation has now reached a critical stage. Wilson actually thinks that inflation is declining more rapidly than what most people expect, and this could have negative implications for companies disclosing their second quarter earnings this month.

According to Wilson, the primary element that has prevented sales growth from dropping to zero for numerous companies this year is the price. If this ability to set prices were to decrease, it would have a significant negative impact on sales.

In the years of the global health crisis, businesses managed to increase their prices in sync with the escalation of inflation. They capitalized on the reduced supply caused by production disruptions, combined with the additional funds in people's pockets from economic relief measures. This phenomenon was notably evident among companies involved in manufacturing and producing goods, as they experienced a significant surge in sales while customers remained confined to their homes and limited their expenditures on services.

Nowadays, though, inflation is decreasing. This implies that the businesses that hiked prices are now facing a difficult situation - especially the companies operating in the communications services, consumer discretionary, and technology industries.

According to Wilson's statement, we believe that in order for these stocks to continue to gain momentum, it is necessary for the projected sales figures to increase. This is the crucial aspect that should be closely monitored when they release their reports.

However, Wilson is not especially optimistic about their likelihood of success. He foresees disinflation eroding sales during this earnings season and is ready for letdown.

In his blog post about the ongoing earnings season, he mentioned that the current anticipations for the second quarter are for zero percent increase in sales. However, there is a projected decline of 9% in earnings per share due to stagnant ability to increase prices and the presence of delayed and increased costs.

11 stocks that have the potential to combat the effects of inflation

Fortunately, Wilson alongside a group of analysts compiled a roster of stocks that are anticipated to defy the disinflationary pattern.

After examining the market's highest valued 1000 stocks based on market capitalization, Wilson filtered the list by targeting stocks that fall within the upper 40% in terms of both free cash flow yield and operating margin. Subsequently, he exclusively picked stocks that are recommended with an overweight rating by analysts at Morgan Stanley.

According to Wilson, below are the 11 stocks that are anticipated to demonstrate robust FCF yields and favorable operational margins throughout the earnings period. Furthermore, the accompanying information for each stock includes its ticker symbol, sector, industry category, and market capitalization.