Investment grade credit fundamentals remain healthy, but supply chain issues are contributing to the overarching inflationary environment, with different impacts across sectors.

Despite inflationary headwinds, investment grade companies have largely maintained strong credit fundamentals, supported by robust consumer demand and burgeoning economic growth. However, we believe future earnings upside is likely to be limited due to persistent supply chain issues, which are expected to endure through the first half of 2022 and, in some cases, even longer. At the sector and issuer levels, strong brands with pricing power continue to win, and smaller players with less operational excellence, limited product diversity, weaker brands and/or more commoditized products that have lagged in innovation continue to underperform peers.

Across sectors, companies are responding to cost increases by raising, or attempting to raise, prices to consumers. However, the ability of companies to do so varies by sector and company, often dependent upon brand-specific factors. We are also observing companies pursuing additional mitigation strategies such as cost-saving programs and an emerging focus on supply chain management.

The most affected sectors include Consumer Products and Food & Beverage. Freight and transportation are an increasing pain point, and margins have been impaired as price and cost increases have a timing mismatch. On the Retail side, mass-merchant retailers with procurement prowess are positioned to win in the omnichannel environment, but smaller companies or those with less brand power should continue to struggle. Diversified Manufacturing has been facing similar issues with raw material and transportation price hikes, with cost pressures of as much as 50% since July due to raw material price escalation, supplier price and logistics costs increases, and chip shortages. All sectors are implementing diverse mitigation strategies, most notably pricing, supply chain management and supplier diversification, and increased investments in innovation.

The semiconductor supply chain issues that have impacted the Technology sector continue to have trickle-down effects on the Automotive and Diversified Manufacturing sectors, with Technology maintaining relatively healthy margins but facing tension from wage inflation due to the constrained talent environment in software and IT services. Within the Automotive sector, newfound pricing power has enabled companies to upcharge on used cars with a sectoral shift from new to used. Distinctively, Chemicals and Packaging have experienced mixed inflation and supply chain impacts by subsector and business model, which is expected to persist over the next few quarters with predictions of supply chain issues easing sooner, assuming limited event risk.

Overall, our focus remains on investing in sectors and companies that are best positioned to manage through a rising cost environment.