A sturdy economic system, with earnings nonetheless sturdy however inflation sticky, creates a difficult narrative for energetic buyers. To see the influence of upper inflation and better rates of interest on firms, simply take a look at the earnings launch for CarMax this morning. Earnings and income in its newest February quarter missed estimates and it pushed again its objective of promoting two million vehicles by 2026 to someday between 2026 and 2030. What did CarMax blame? “We imagine automobile affordability challenges continued to influence our fourth-quarter unit gross sales efficiency, with ongoing headwinds because of widespread inflationary pressures, increased rates of interest, tightened lending requirements and low shopper confidence,” a press release stated. Total, it is a very powerful atmosphere for small cap shares, speculative know-how (suppose Cathie Wooden/ARK), REITs, and utilities. For instance, increased charges are usually dangerous for REITs beause REITs depend on debt financing. Rising charges enhance borrowing prices, and better borrowing prices cut back revenue margins. However long-term, the consequences may be extra refined. For instance, if charges go up as a result of financial progress is robust, REITs can profit long-term. It is often additionally dangerous for utilities as a result of when charges rise: Treasury bonds change into extra enticing because of increased yields. Greater charges additionally imply elevated borrowing prices for utilities, which carry numerous debt as a result of they use numerous capital. If utilities cannot cross on the upper prices, their shareholders endure. Some sectors do properly with rising charges The reflation trades means a newfound concentrate on cyclical shares that carry out finest when the economic system turns up, similar to power, supplies and hospitality. The issue is, power and materials shares have already been rising because of increased oil and a nonetheless sturdy economic system. Power is the second finest performer amongst S & P sectors year-to-date, up 17%. Communication companies, led by an enormous transfer in Meta , is the chief, up 18%. Different potential beneficiaries of upper charges with a robust economic system are defensive shares, which are usually much less rate of interest delicate, like Kroger or Walmart . One other potential beneficiary is insurance coverage shares. Life insurance coverage firms, for instance, take the premiums they get from clients and make investments them in bonds. When charges go up, they get extra yield from these bonds, which generates extra funding revenue. Key’s sturdy economic system and continued job progress If that adjustments, particularly if the job market weakens considerably and we nonetheless have inflation increased than fascinating, that can be stagflation, and that can be a a lot larger downside for the markets. The bottom line is that the economic system has to remain sturdy, which is able to assist prop up earnings. Earnings have remained steady on the sturdy economic system. First quarter estimates have been regular prior to now few weeks, with the S & P 500 anticipated to see features of 5%, based on LSEG, and full yr progress in 2024 up 9.8%, little modified from the 11% acquire anticipated on January 1st. All of this adjustments if the economic system, and notably jobs, flip south. Job progress contracting alongside sticky inflation means “stagflation” and if the market involves imagine that could be a possible situation, neglect it. The S & P 500, which closed Wednesday at 5,160, can be within the mid-4,000s in a short time.