S&P 500 firms have discussed inflation a record number of times this quarter amid a 900% surge in mentions, BofA says

• Companies are increasingly flagging concerns about costs pressures stemming from inflation, Bank of America said Monday.
• Labor-related inflation has been cited the most in the consumer discretionary and industrials sectors, the most labor-intensive sectors in the S&P 500 index.
• Companies have posted record-high net margins of 13.1% in Q2 but those rates look set to moderate.

Nearly unprecedented corporate earnings growth has propelled the S&P 500 to record highs during 2021. But Bank of America says companies in the index are getting increasingly concerned about the effects of inflation.

Discussion of inflation on second-quarter earnings calls hit a record high, the investment bank said in a Monday client note. Inflation mentions rose 900% on a year-over-year basis, in line with the growth seen in the first quarter, BofA said.

In highlighting accelerating inflationary pressure, some companies expect cost pressure to outstrip pricing power in the near term. Inflation rates have climbed in recent months as the world's largest economy continues to recover from the recession it fell into during 2020 because of the coronavirus pandemic.

The increase in inflation mentions comes as companies have posted record-high net margins of 13.1% during the second quarter, excluding the financial sector, ranking the period among the best macro environments for margins since 1978.

"However, we are starting to see the good inflation environment turning into a bad inflation environment with many companies citing accelerating cost inflation, particularly around wages," said Savita Subramanian, head of US equity and quant strategy at Bank of America. She said in reflecting this risk, consensus margin expectations have moderated to 12.6% in the third quarter and to 12.5% in the fourth quarter.

Labor-related inflation mentions soared by 117% year over year compared with 12% in the previous quarter, suggesting increasing wage pressure. Companies outpointing supply chain inflation more than doubled compared with 17% in the first quarter. Most of the mentions about inflation have come from the materials and staples sectors, and labor inflation was most cited in the consumer discretionary and industrials sectors, the two most labor-intensive sectors in the S&P 500 index.

In another cautionary point for markets, BofA said corporate sentiment scores have dipped from a record high set last quarter, which could indicate a peak in sentiment as companies face concerns about inflation and the Delta variant spearheading a pickup in COVID-19 infections.

BofA said S&P 500 companies are beating per-share earnings expectations by 15%, at $52.29 a share, with 90% of second-quarter earnings reports already handed in. The S&P 500 has run up by 18% so far in 2021 but BofA's year-end target of 3,800 suggests a pullback is in store for the benchmark.

For small-cap companies, which are even more sensitive to labor-market inflation than large-caps, margins have expanded in the second quarter, with further upside through the end of the year. But a continued acceleration in inflation poses a risk, the bank said.