Plenty of bears remain skeptical about the U.S. market’s stellar rally since October 2022. One reason for their gloom is they’re overlooking an economic elixir on the horizon that will help fix inflation and boost profit growth. That secret ingredient is productivty, and we are about to see a boom in it.
The boom is key to understanding why you should consider staying in stocks and adding on weakness.
First, a quick primer. Labor productivity is output per hours worked. Productivity growth happens when output increases more than hours worked. It’s natural to think this happens because people work harder. But that has little to do with it.
Instead, productivity goes up when companies invest more in technology and equipment that make it easier for workers to produce more. That investment is happening now in a big way, which is how we know productivity is about to rise by a lot. This will make all the difference for growth, earnings and stocks.
“Productivity improvement could usher in the next phase of earnings growth,” says Bank of America strategist Savita Subramanian. That’s because it boosts profit margins. The other big benefit is it puts downward pressure on inflation. When productivity rises, companies feel less pressure to pass on increases in their own costs. This cools inflation, and it will ease worries the Fed will hike the economy into a recession.
Here are the four main reasons why a productivity boom is on the way, and 14 stocks that will benefit.
1. AI boom: Whenever a new technology arrives, it’s tough to see through the hype. But generative AI seems like more than hype. Almost half of companies surveyed by CNBC recently say that AI is their top priority for tech spending over the next year. AI budgets are more than double the second-biggest tech spending area, cloud computing. It is no mystery why. AI has the power to do a lot of things more efficiently than people — like routine research, writing and code writing. So, AI will boost productivity.
A straightforward way to invest in AI is to own shares of Nvidia
NVDA,
because it makes some of the most widely used chips in the space. Yes, Nvidia shares are up a lot and look pricey. But game-changing tech companies always look expensive until they grow into their expensive valuations. That’s happening with Nvidia.
AI-linked demand drove the huge increase in second quarter sales projections to $11 billion in sales vs. the $7.2 billion analysts had penciled in. Bank of America reiterated its “buy” rating after the stock popped on robust first quarter earnings, and upped its price target to $450 from $340. Goldman Sachs reiterated its buy rating on July 10, and raised its price target to $495 from $440.
AI also helps code writers handle the more routing parts of their jobs. This will help Accenture
ACN,
develop apps for customers, one reason why Bank of America analyst Jason Kupferberg favors the stock. And since AI helps companies collect and process data faster, it stands to help boost profits at Thomson Reuters
TRI,
which has been investing heavily in AI, says B of A’s Heather Balsky.
2. Wage inflation: U.S. manufacturing wages rose 4.9% year-over-year in May, and are up 19% from pre-COVID levels. This is going to drive up productivity. Wage inflation typically induces companies spend more on tech and new equipment to boost efficiency. Historically, productivity has increased two years after wage inflation. Companies are talking more often about automation. This confirms they are putting money into it. In short, a real capital spending or “capex” cycle is here.
3. A new capex cycle: U.S. capex spending was up 14% year over year in the first quarter, following 18% gains in the prior quarter. Companies have announced $600 billion in large projects since the start of 2021, triple the normal amount, notes Bank of America. This follows a decade of underinvestment. The upshot: Technology and equipment are old, so the burst in spending is going to have a big impact.
Besides the pressure to offset wage growth, companies are spending more to “re-shore” manufacturing because of the recent supply chain debacles, and the growing geopolitical tensions with China. U.S. companies are also motivated by incentives to build domestic factories in the CHIPS and Science Act, the Inflation Reduction Act, and the Infrastructure Investment and Jobs Act, notes Ed Yardeni of Yardeni Research.
“If the US manages to skirt a recession, it will be due in good part to the massive capital spending and building related to these plants,” Yardeni says. He notes that nonresidential construction is booming, particularly factories. It rose to a record $189 billion in April (annualized and adjusted for seasonality). That is a 152% increase over the past twenty-four months, as this chart shows.
Capex cycle stock plays
The obvious go-to group here is companies that provide automation equipment. They are already reporting the highest revenue growth rates since 2011. Sales at these companies are 35% above pre-COVID levels, notes Bank of America analyst Andrew Obin. Obin singles out Emerson Electric
EMR,
and Fortive
FTV,
Others to consider include Rockwell Automation
ROK,
Honeywell International
HON,
and Schneider Electric
SBGSY,
In addition, restaurants have high labor costs, so their profits have been hit by rising wages. During 2021-2022, food service wages rose 23%, compared to 10% for the private sector overall. This gives restaurant chains a big incentive to invest in labor-saving technology. Both Starbucks
SBUX,
and Chipotle Mexican Grill
CMG,
have been investing heavily in automation, so they should see a nice payoff in profit margins, says B of A’s Sara Senatore.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned NVDA and SBUX. Brush has suggested NVDA, SBUX and CMG in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks
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This story originally appeared on Marketwatch
