Inflation Hits the Headlines

As I discussed in recent posts and podcasts, I began noticing a growing number of companies reporting rising costs and pricing power in Q2 2017. At that time, I wasn’t sure if these trends were temporary or sustainable. In my Q2 2017 quarterly update I wrote,

“Despite reports of tame consumer and producer inflation, many businesses reported cost pressures and pricing action in Q2. I’m not certain if or when these increases make it into the government data, but I listed dozens of examples of cost and price increases in my quarterly management commentary. Although inflation isn’t spiking higher, it was definitely noticeable in Q2 and certainly isn’t dead.”

By the end of 2017, it was becoming clear to me that the uptick in corporate costs and pricing was not temporary and was in fact a new trend. In my Q4 2017 quarterly update I wrote,

“Rising costs, especially wages, are becoming increasingly noticeable. Frequent discussions on strategy to pass on price increases. In addition to labor, freight and commodity increases mentioned frequently. The shift from deflationary tone (2015-2016) to inflationary (2017-2018) is becoming more evident with costs and wages accelerating in Q4. Based on results and outlooks, this trend does not appear transitory.”

Evidence of rising inflation continued to build in Q1 2018. I wrote several posts discussing these trends, including a post that included a long list of company-specific examples (Inflation Subsiding or Accelerating). I also participated in an hour-long podcast with Jesse Felder, specifically devoted to inflation (podcast link). More recently, as I plow through Q2 2018 earnings reports and conference calls, I continue to notice and document numerous examples of rising corporate costs and price increases.

In summary, the bottom-up data I’ve accumulated over the past several quarters supports my belief that the disinflationary environment (most noticeable in 2015-2016) has passed and has been replaced with rising rates of inflation. And while the shift in narrative from deflation to inflation has been slow to develop, it appears others, including the media, are beginning to take note and are currently reporting on the change in trend. In fact, last week I noticed several articles highlighting inflation.

The first article, “Kraft Heinz Tops Estimates with Higher Pricing, Shares Surge” discusses packaged food companies and how they’ve been forced to raise prices to offset rising costs. While there is often a lag, recent price increases appear to be sticking for many businesses, restoring profit margins and earnings growth. As a result, investors are celebrating and rewarding companies with the ability to pass on price increases. While pricing power is certainly a positive business attribute, I can’t help but wonder if the broader implications of price increases – as it relates to interest rates, balance sheets, and required rates of return – are being ignored (good topic for future post).

Another article published last week, “Inflation, Gas Prices, Tariffs, Squeeze Consumers”, documents rising corporate costs and how inflation is influencing consumer behavior. The article provides several examples of recent corporate price increases and inflationary pressure, stating,

“Procter & Gamble…said Tuesday that Pampers prices will increase by an average of 4 percent in North America, while the Bounty, Charmin and Puffs brands could see 5 percent increases. Gas prices have already surged more than 24 percent in the past year. Rent and other housing costs were up 3.4 percent in June compared to a year earlier, and auto insurance has jumped more than 7 percent.”

And while I don’t rely on government data to form my macro opinion, for those who do, the article states,

“The consumer price index, the government’s primary measure of inflation, rose 2.9 percent in June from a year earlier, the fastest increase in six years.”

In effect, the government’s inflation data and my bottom-up assessment are in agreement – inflation has arrived.

And finally, the title of the Bloomberg article, “How U.S. Companies are Coping with Inflation and Scarce Labor” caught my attention yesterday. While I thought the title was a good summary of my recent posts on inflation, I was less enthusiastic about the article’s assertion regarding the sustainability of current trends. Specifically, the article states inflation “may prove to be temporary.” While this could prove to be true, I currently see little evidence suggesting inflationary pressures are subsiding. That said, the article did provide a quote from Clorox’s CEO supporting its view. Specifically, Clorox’s CEO stated he “expects increases in transportation costs to ease to a mid to high-single-digit pace from high double-digit.”

While I agree high double-digit increases in transportation costs should moderate (mainly due to comparisons), high-single-digit increases remain above average and inflationary. Unless the Federal Reserve can print 50,000 truck drivers in the near-future, (also known as QT – Quantitative Truckers 🙂 ), I’m not expecting elevated transportation costs to subside in the near-future.

As I sort through Q2 2018 operating results and conference calls, I’m growing increasingly confident in my belief that there has been a shift in inflation psychology. There appears to be a growing understanding between businesses that price increases are necessary. In effect, pricing requests have become more acceptable and in many cases expected. And as businesses discover price increases are sticking and becoming more acceptable, it’s logical to assume managements will be more comfortable requesting further increases. In fact, I’ve noticed several instances of companies announcing multiple price increases over the past year (pricing decisions are typically limited to once a year). And finally, with tariff concerns increasing, several executives stated they are prepared for further increases in costs and pricing. Based on management commentary, I suspect a growing number of corporations will use tariffs to justify additional price increases.

In summary, the rising trend in corporate costs and pricing I began noticing and documenting in 2017 continues today. How long current trends persist remains uncertain, but to claim the uptick in inflation is temporary seems premature. In fact, based on recent corporate operating results and outlooks, I believe inflationary pressures will remain elevated in Q3 2018. Given the tightness in many areas of the economy and labor market, I expect pricing pressure to persist until asset inflation or demand subsides. In the meantime, I will remain alert for signs that market participants are beginning to recognize inflation and its growing threat to elevated asset prices.

As last week’s articles on inflation illustrate, the inflation narrative appears to be in transition and is gradually becoming more aligned with my bottom-up analysis and views. I’m beginning to wonder if the market’s inflation recognition moment I’ve been expecting is a process, not an event. If so, I believe the process has begun and its momentum is building.