Soaring producer prices can reduce profit margins and inventories
Starve a cold and feed a fever, or is it the other way around? I never remember, so I eat, just to cover my bets. But in more severe cases, you need to know the right prescription for the disease.
The way we’ve all learned to diagnose the economy is that rising prices are a sign of a boom, with demand exceeding supply. We are now facing the flip side, with limited supply and unable to meet demand in the short term. As a result, rising prices are slowing growth.
This produces a phenomenon well known to commodity players – the destruction of demand – as higher prices ration scarce stocks among those willing to foot the bill. So soaring energy costs in the UK and continental Europe are straining the chemicals, fertilizers and metals industries. At the same time, China is limiting metal production to reduce pollution, in part to purify Beijing’s acrid air ahead of the Winter Olympics, just as the government miraculously did for the summer games. of 2008. The combination of Chinese production cuts and soaring electricity costs in Europe is helping to send aluminum prices to record highs.
Rising costs, combined with the scarcity of resources, both material and human, could hurt business results. Stephanie Pomboy once again warns her MacroMavens customers that producer prices far exceed consumer prices; the producer price index reached a record level of 8.3% in August compared to its level of the previous year, against 5.3% for the consumer price index. “The result is an implicit margin squeeze like we’ve only seen once before – during the 1970s, when Nixon severed the dollar’s link with gold and imposed wage and price controls. over 90 days. Let’s not forget, it was not a happy time for corporate profits! His last missive notes.
But even during the stagflation of the 1970s, the growth in real workers’ wages remained above prices, Pomboy adds. On the other hand, wage gains are now lower than prices, with a real fall of 0.6%. This will likely limit the ability of consumers to absorb the higher costs that businesses hope to pass on, dealing “an even more pernicious blow to margins today.”
And this real drop is based on government price readings that consumers doubt, and not without reason. As previously reported, the latest calculation of ‘homeowners’ equivalent rent’, the largest component of the CPI, shows it up 2.6% from last year, a figure that is far behind the surge. house prices.
But two economists from the Federal Reserve Bank of Dallas predict that rents will catch up, as our colleague Lisa Beilfuss recently reported. And consumers in the latest University of Michigan survey say high prices for homes, cars and durable goods have pushed buying conditions to near-worst levels in survey history.
Despite the likely tightening of margins, analysts remain optimistic about the earnings outlook. FactSet expects third quarter earnings to be 27.9% higher than the depressed comparable period 2020 results. Looking ahead to 2022, when comparisons won’t be so easy, consensus is calling for strong 9.3% increase.
At the moment, the financial markets are mainly focused on the Federal Open Market Committee meeting which will end on Wednesday. Fed watchers widely see the panel paving the way to start slowing its purchases of $ 120 billion monthly securities, with an actual announcement expected after the November 2-3 meeting.
Fed Chairman Jerome Powell will likely try to separate the decline in bond purchases from a possible hike in the target federal funds rate from the current 0% to 0.25% range. JP Morgan chief US economist Michael Feroli writes that he expects the FOMC’s new dot plot to show a median expectation for a take-off in 2022.
Tax and spending measures are also at the forefront of Congress. While the tax proposal that emerged from the House Ways and Means Committee last week was less draconian on investors than feared, the overall package is expected to be scaled back from the $ 3.5 trillion sought by the White House. And all of this risks getting mixed up in debt ceiling negotiations, potentially upsetting the markets. (See Streetwise for more on this.)
With all of these things looming, the stock market ended the week on a negative note. In particular, the
S&P 500 Index
closed a hair below its 50-day moving average, which virtually all market trackers, human or computer, are watching closely. Is this the trigger for the long-awaited correction or a retreat from the uptrend?
It’s harder than feeding a cold.
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Write to Randall W. Forsyth at [email protected]