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July producer prices rose twice as much as expected (1% versus 0.5%) and the core was stronger as well at 0.4% (0.1% expected). Energy was the big factor with a 4.4% rise, the largest since October’s 5.7% jump. Jet fuel jumped 16.8%, gasoline 10.9%, and natural gas 7.4%. Autos rose as well; sellers saw their prices increase as buyers saw a decline in prices. Something of an aberrant situation that helped push the PPI higher overall (core was up 0.2% without the autos factored in).
Whether you keep the autos in or toss them out you have to look at the bigger picture: energy costs are impacting producers, but as of yet they have been unable to pass them through to consumers. Indeed, with this spike in prices producers are seeing faster price increases than consumers. The issue always associated with producer prices is whether they will be passed to consumers. If they cannot do that then producers have to find some way to offset them. Producers can buy additional equipment to improve efficiency (increasing productivity, but that has limits and diminishing returns), get more out of current workers, they can eat the costs, or they can pass them along to the consumer.
Producers have been adding productivity enhancing capabilities ever since the recovery began (productivity over people). There may be more juice to squeeze out of that lemon, but it is getting pretty dry. What we are seeing is eating some of the costs and passing along some of the costs. With producer prices rising faster than consumer prices, however, it is clear there is more eating ongoing than passing along.
With companies purportedly flush with cash this can be absorbed to a certain degree, but as prices continue to rise faster than they are passed along to consumers then profits start to deteriorate. The primary catalyst for the market rally is profits, and one reason the rally has continued is the series of upside surprises in profits even through the last quarter. If the expansion starts to wane the profit erosion accelerates.
This profits pressure has a direct impact upon the market. If profits get squeezed, stocks stop their upside move because price gains are based upon profits growth. If this divergence between producer and consumer prices continues to widen profits will be impacted because the consumer is already adjusting buying habits due to high energy costs. In short, the consumer is not going to tolerate much rise in prices before he or she further alters spending. That leaves producers in a tight position where they can pass on a modest amount of the price rise but not enough if prices continue to rise. If the economy was booming it would have a better chance, but the rising oil prices are already impacting consumption across the board as discussed in the Tuesday report.
Retailers already showing the effects?
Tuesday night we discussed WMT’s guidance and how it saw energy impacting its future sales. Wednesday more retailers were providing guidance, and a lot of it was lower than expected. DKS missed earnings and guided lower Tuesday; ANN, ARO, and FD all lowered guidance today. Consumers are indeed altering their buying habits at $2.55/gallon gasoline. Moreover, retailers are finding themselves having to reduce guidance because of those altered habits as well as the growing price gulf between producer and consumer prices. If they raise prices they will only hasten the slowing consumption. It is an ugly scenario when you cannot push prices through to the end user.
Of course companies have overall enjoyed some excellent returns for the past three years. After falling through the floor in the recession and bust, the recovery has been stronger than expected due to the utilization of productivity enhancing systems. Profits have thus surged beyond expectations. The inevitable result of spiking energy prices is a decline in profits because spiking energy prices do more to damage consumption than they do to increase inflation. Fortunately prices have not hit the choke point where the consumer says ‘no mas.’ Instead they are at a point where the consumer says ‘not today, but maybe next week.’
Whether you keep the autos in or toss them out you have to look at the bigger picture: energy costs are impacting producers, but as of yet they have been unable to pass them through to consumers. Indeed, with this spike in prices producers are seeing faster price increases than consumers. The issue always associated with producer prices is whether they will be passed to consumers. If they cannot do that then producers have to find some way to offset them. Producers can buy additional equipment to improve efficiency (increasing productivity, but that has limits and diminishing returns), get more out of current workers, they can eat the costs, or they can pass them along to the consumer.
Producers have been adding productivity enhancing capabilities ever since the recovery began (productivity over people). There may be more juice to squeeze out of that lemon, but it is getting pretty dry. What we are seeing is eating some of the costs and passing along some of the costs. With producer prices rising faster than consumer prices, however, it is clear there is more eating ongoing than passing along.
With companies purportedly flush with cash this can be absorbed to a certain degree, but as prices continue to rise faster than they are passed along to consumers then profits start to deteriorate. The primary catalyst for the market rally is profits, and one reason the rally has continued is the series of upside surprises in profits even through the last quarter. If the expansion starts to wane the profit erosion accelerates.
This profits pressure has a direct impact upon the market. If profits get squeezed, stocks stop their upside move because price gains are based upon profits growth. If this divergence between producer and consumer prices continues to widen profits will be impacted because the consumer is already adjusting buying habits due to high energy costs. In short, the consumer is not going to tolerate much rise in prices before he or she further alters spending. That leaves producers in a tight position where they can pass on a modest amount of the price rise but not enough if prices continue to rise. If the economy was booming it would have a better chance, but the rising oil prices are already impacting consumption across the board as discussed in the Tuesday report.
Retailers already showing the effects?
Tuesday night we discussed WMT’s guidance and how it saw energy impacting its future sales. Wednesday more retailers were providing guidance, and a lot of it was lower than expected. DKS missed earnings and guided lower Tuesday; ANN, ARO, and FD all lowered guidance today. Consumers are indeed altering their buying habits at $2.55/gallon gasoline. Moreover, retailers are finding themselves having to reduce guidance because of those altered habits as well as the growing price gulf between producer and consumer prices. If they raise prices they will only hasten the slowing consumption. It is an ugly scenario when you cannot push prices through to the end user.
Of course companies have overall enjoyed some excellent returns for the past three years. After falling through the floor in the recession and bust, the recovery has been stronger than expected due to the utilization of productivity enhancing systems. Profits have thus surged beyond expectations. The inevitable result of spiking energy prices is a decline in profits because spiking energy prices do more to damage consumption than they do to increase inflation. Fortunately prices have not hit the choke point where the consumer says ‘no mas.’ Instead they are at a point where the consumer says ‘not today, but maybe next week.’
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