If you’ve tracked the news over the past few weeks, you’ll have likely noticed that inflation chatter has picked up.
Even if you haven’t, you only need to travel to your nearest gasoline station or food store to see that prices are rising. Take corn, for example. With the price up some 80% since the start of 2010, it’s triggered a spike in food costs – a trend that was partially responsible for the Middle East protests. Nestle and Cadbury are selling air-filled chocolate bars thanks to cocoa’s three-decade high.
Those prone to panic have been busy stocking up on gold, shotgun shells, canned food and copies of The Overton Window.
But how worried should we really be? True, the Federal Reserve has pumped a massive amount of cash into the economy, which traditionally means inflation. However, most of it is sitting on banks’ balance sheets. So how much inflation is actually occurring?
Measuring inflation is a bit like deciding which Beatles album is the best… there’s no definitive answer.
Fortunately, the current earnings season will provide some decent clues on just how much prices are rising…
The “Core” Flaw
The shortcomings of the Consumer Price Index (CPI), the government’s official inflation gauge, are well documented. Because it’s subject to so many judgment calls and adjustments, the index radically understates inflation.
The most reported number is the headline “core” inflation rate – one that excludes energy and food prices in order to “smooth out volatility.” Yep, that makes perfect sense, since most Americans don’t travel anywhere and grow their own food!
The Massachusetts Institute of Technology (MIT) offers another inflation gauge – its “Billion Prices Project,” which scours the prices of five million goods sold through 300 online retailers to generate a daily price index. And the latest reading indicates that inflation is much higher than the CPI.
The trouble is, it doesn’t account for healthcare or energy prices either and there’s a question over whether the online market really captures the typical buying habits of American consumers.
Instead, other methods offer a better idea of inflation…
One Way to Truly Gauge Inflation
Corporate profit margins are at 8.2%, near an all-time high.
Great, right? Well, the positive vibes are tempered when you learn that this was largely due to cost-cutting – a classically unsustainable method of boosting profits in the short term.
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Last week, my colleague Louis Basenese nailed it when he claimed that sales numbers will affect stock prices more than earnings results this earnings season.
The other part of the story is that not only will companies need to grow sales to boost profits and margins, they’ll also need to control their operational costs. To simplify the accounting equation: Profits = Sales minus Costs.
This is a crucial factor in diagnosing the true state of the economy. However, it’s tough to tell which companies which companies are affected by inflation the most. For example, if an airline can pass on fuel costs through surcharges or has its fuel purchases well-hedged, then inflation won’t play as much of a role in its margins.
Certain companies do provide good overall inflation indicators, though. And here are three big names to watch for this earnings season:
- McDonalds (NYSE: MCD): Reports April 21. Although the company hedges most of its costs, it will experience volatility from higher beef prices. And when most of your marketing is based around “The Dollar Menu,” raising prices isn’t easy. “The Dollar Fifteen Menu” doesn’t have the same ring.
- Whirlpool (WHR): Reports April 27. The company expects an unfavorable impact from commodities costs that could total between $250 and $300 million for the year – and won’t be able to raise prices to cover the expense.
- GAP Inc. (NYSE: GPS): Reports May 20. Cotton prices are on a tear and apparel producers across the board are reluctant to raise prices. With Gap’s widespread operations in the United States and around the world, its results should show what’s going on across the industry.
Ahead of the tape,