Producers Look to Pass on Rising Costs to Consumers

Today’s news starts with inflation information. Inflation numbers were released for China and the United States. China reported that inflation on the producer level hit a 26-year high to 13.5%. In contrast, the U.S. Producer Price Index came in at 8.6% on Tuesday. One of the largest impacts of China’s rising prices was rising energy costs.

China also reported that consumer prices rose 1.5% reaching a 13-month high. Rising costs in food and fuel were big drivers. However, China uses price controls and subsidies to reduce consumer prices. This means Chinese companies may have to take the brunt of the costs which could reduce their profitability. Chinese price controls on commodities and raw materials could also result in shortages for the country as foreign producers may funnel products to other countries willing to pay the higher prices.

The U.S. Consumer Price Index (CPI) came in much higher than expected at 0.6% instead of the 0.4% forecasted for the month of October. Annual inflation was expected to be at 5.8% but was actually 6.2%. Core CPI was up 4.6%, but inflation was pretty much hotter across the board. The 10-year Treasury Yield (TNX) rallied 1.49% on the news in premarket trading.

The CPI reported a 30% increase in energy prices. Oil had already rallied on Tuesday after the API Weekly Crude Oil Stock report came in much lower than expected. Later today the Energy Information Administration (EIA) will provide its short-term energy outlook. The White House is already getting pressure to release strategic petroleum reserves to help curb prices.

In light of the inflation news, Friday’s Michigan Consumer Sentiment report may garner more attention as investors look to see what consumers’ thoughts are on rising inflation and how it might affect their behavior.  

Stock index futures were a little soft before the announcement and were a little moved on the news.

Outside of the CPI report, a couple of stocks were making moves. DoorDash DASH rose 17% in premarket trading after reporting plans to buy Finnish company Wolt for $8.1 billion. Wolt operates in 23, mostly European, countries. The news appears to have investors shrugging off the company’s miss on earnings.

RingCentral RNG is also up ahead of the bell. The company rose more than 25% on better-than-expected earnings and revenue. RingCentral announced a partnership with communications company Mitel. Barron’s reported that RingCentral will pay $650 million to acquire Mitel’s intellectual property and patents related to network and call management, security, and infrastructure.

The electric vehicle IPO, Rivian RIVN is expected to start trading on Wednesday. The company has backing from Amazon AMZN and Ford F. Its electric pickup came to market in September beating both General Motors GM and Tesla TSLA.

Before investing in an Initial Public Offering, be sure that you are fully aware of the risks involved with this type of investing. There are a variety of risk factors typically associated with investing in new issue securities, any one of which may have a material and adverse effect on the price of the issuer’s common stock.

Cryptocurrency broker-dealer Coinbase COIN was down nearly 10% in premarket trading after missing on top and bottom-line numbers. The company reported lower trading volume and fewer users as reasons for the miss.

Vaccine maker BioNTech BNTX dropped 4.85%, despite beating earnings and revenue estimates. The company lowered guidance on the sales of its COVID-19 vaccine. BioNTech partnered with Pfizer PFE on the vaccine, so the news prompted a 1.78% drop in the stock on Tuesday.

Passing on Prices

When considering the PPI and CPI reports, it appears that producers are pushing more and more of their rising costs on to consumers. This could mean that November’s CPI numbers could be higher still. Many companies have already issued warnings about rising prices.

Last week, Mondelez MDLZ announced earnings and told investors that prices on its products include snacks like Oreo and Chips Ahoy! cookies, Ritz crackers, Toblerone chocolate, and Sour Patch Kids will rise about 6% to 7%. Last month, Unilever (UL) told investors it plans to raise prices on products that include Dove soap, Lipton tea, and Klondike bars about 4%. McDonald’s (MCD) also announced last month that prices would increase about 6%.

Disinflation vs. Deflation

Despite the quickening of inflation, the global economy has experienced mostly disinflation and deflation over the past 10 years. Disinflation is a slowdown in rising prices, and deflation is the falling of prices. For the most part, the CPI has risen over the last 10 years but at a slow rate. The Fed normally wants to see inflation rise at 2% per year. However, this hasn’t happened for many reasons. Let’s look at three. 

First, globalization and freer trade provide increased supplies and cheaper labor.

Second, globalization means more participants and more mindpower, and therefore increased ingenuity. So, more and more people are finding new and efficient ways to mine, drill, and harvest raw materials. For example, producers can get more utility out of a barrel of oil today than they could 30 years ago.

Increased mindpower ties closely with the third reason I wanted to highlight—technology. Cars and machines run more efficiently and longer without breaking down, harvesting machines get more out of each shovel or pipe, and refiners can get more of the raw materials—and all of these segments create less waste. Additionally, technology provides better and faster computers, TVs, phones, and so on. Back in the day, my family had to spend $12 to rent a VCR and a couple of movies for a night. Today, we have access to hundreds of movies for $12 a month not including internet costs. Mom popped popcorn on the stove and melted butter; today, I can have kettle corn popped in the microwave with very little effort and mess.

These lower costs have provided an environment that has allowed businesses to flourish. It’s difficult to say if this means commodity prices will eventually catch up, but right now people are already coming with new ingenious ways to solve the current inflation problems.  

CHART OF THE DAY: NOT SO HOT COMMODITIES. The S&P GSCI Index ($SPGSCI—candlesticks) attempts to track all commodities. It has fallen 9.56% over the last 10 years. Oil prices (/CL—pink) have fallen 13.82% over the same time. The lower price of raw materials has helped the S&P 500 (SPX—blue) gain 285.41%. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results. 

Shrinkflation: Despite disinflation, there are ways that retailers and producers try to hide price increases. One way is through shrinkflation. Shrinkflation occurs when the company changes the amount of product it sells instead of raising prices. For example, a box of cereal could have 19 ounces of cereal, but as production costs rise, the company reduces the weight sold to 17 ounces. The price could stay the same, but the consumer just gets less product.

The CPI does adjust for shrinkflation because it measures price per weight or per volume. So, while it may go unnoticed by shoppers, at least until they have to keep going back to the store for the same thing, it’s accounted for when tracking inflation.

Skimpflation: Another way businesses attempt to deal with rising inflation, particularly service-oriented businesses, is through skimpflation. This occurs when you pay the same price for a product or service but get lower quality. Some examples include less cleanliness, broken drive-thru intercoms, broken ice cream machines, cutting out shuttles to parking lots, taking longer on deliveries, or being on hold for hours. The quality of service declines despite paying the same price. 

However, in today’s environment, it’s difficult to differentiate skimpflation from labor shortages or supply chain problems. Some businesses just can’t deliver the service they’d like because of factors outside of their control.

Stagflation: Stagflation doesn’t describe a way in which businesses adjust to inflation; instead, it is a business condition where inflation is rising despite slow or negative economic growth. The United States experienced stagflation toward the end of the 1970s. Inflation grew despite a stagnating economy.

Many economists and analysts were worried about stagflation during the pandemic because supply lines had stopped and made it harder to get products to market. The lower supply trying to meet demand resulted in increasing prices. Additionally, large amounts of the monetary and fiscal stimulus were putting money in the economy, but fewer people were working and producing the goods and services. So, demand was still high, despite few people producing products.

Fortunately, the economy appears to be getting back to normal and supply lines are opening. So, while higher inflation is a problem today, many people are getting back to work. In fact, there are numerous jobs open that aren’t being filled.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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