Signs Of Inflation

It is earnings season which means I am reading a lot of company earnings reports. One thing that is very noticable is that companies are talking a lot about the increase in their cost of inputs.

• Stanley Black & Decker joins a host of other big-name companies this earnings season announcing price increases due to high input costs.
• Among other inflation comments from earnings transcripts:
• Procter & Gamble (NYSE:PG): “The commodity challenges we face next year will, obviously, be larger next fiscal year.”
• Honeywell (NYSE:HON): Inflation “is taking hold. That — there’s no doubt about it. We knew it. We see it.“
• Kimberly-Clark (NYSE:KMB): “… sharp rises in input costs …”
• Coca-Cola (NYSE:KO): We’re “closely monitoring upward pressure in such inputs such as high-fructose corn syrup, PET, metals, and other packaging materials …”
• PepsiCo (NASDAQ:PEP): There “is certainly higher input inflation, but it’s been factored into the ’21 guidance, notably, in terms of agricultural and packaging …”
• Boston Beer (NYSE:SAM): The “input costs are going up because the phase is still coming into our costs of materials and ingredients and packaging materials.”
• Celanese (NYSE:CE): “I mean, we’re certainly feeling the inflationary factor.”
• Crown Holdings (NYSE:CCK): Delivered “aluminum in North America at round $1.28 a pound versus $0.75 last year at this time, so an increase of 70%.”
• Steel Dynamics (NASDAQ:STLD): “… higher average selling values were offset by significantly higher input costs.”
• Mattel (NASDAQ:MAT): “… despite the cost inflation we’re seeing and the impact it’s having on gross margin …”
• Whirlpool (NYSE:WHR): Our actions “will offset the impact of global supply constraint and rising input costs.”
• Snap-on (NYSE:SNA): We’ve “got material inflation in these numbers.”
• GATX (NYSE:GATX): The “increased price of steel is increasing the cost of a car across the board.”
• Dover (NYSE:DOV): “… I get it that the Fed doesn’t want to recognize inflation. But there is inflation.”
• Sonoco Products (NYSE:SON): “Our industrial segment was hit the hardest with price/cost challenges due to the higher OCC costs.”
• Colgate-Palmolive (NYSE:CL) and Clorox (NYSE:CLX) report earnings this Friday and are also on inflation watch.
  • This list comes from seekingalpha.com – as it was a copy/paste I do not know if the hyperlinks are functional

In looking at some of this inputs themselves, is apparent why companies are seeing their costs increase.

• Lumber increased in price 27% just this past month
• Soybeans, corn and wheat are at multi-years high prices
• Copper, aluminum, lead, zinc, tin, iron and steel are at multi-year highs
• Oil is up more than $100 per barrel over the past year from negative prices and up from $19 to $63 once the short-term negative pricing cleared up

Government economic reports are coming in that show inflation is becoming an issue

• This week’s Chicago Purchasing Managers Index reported that prices paid at the factory gate (cost of production-only and not including transportation, marketing, mark-ups, etc.) surged to a 41 year high, last seen prior to Paul Volker taking over the Federal Reserve to combat the double digit inflation of the 70’s.
• The Atlanta Fed’s sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—increased 3.5 percent (on an annualized basis) in March, following a 2.3 percent increase in February. 
  • The flexible cut of the CPI—a weighted basket of items that change price relatively frequently—increased 21.8 percent (annualized) in March and is up 6.3 percent on a year-over-year basis.
• Core PCE ( the measure of inflation that the Federal Reserve follows) saw the largest month-over-month increase since October 2009

Where is all of this coming from?

• Supply constraints due to covid lockdowns of production and shipping facilities
• Bad planning by miners and millers who did not anticipate the demand
• Increased demand from the housing boom we see
  • People are moving out of the big cities because they can now work from home
  • They seek a home in the suburbs for a better lifestyle instead of a cramped apartment in the city
  • People are moving to southern states for a variety of reasons (weather, taxes, etc.)
• Anticipation of an infrastructure boom coming from increase government spending
• Reduced energy supply due to shut down of pipelines

The Federal Reserve states that this is transitory and will ease after a few months

I can see their point of view to an extent: shipping facilities will come back to full strength and production lines will be fully staffed again. However, we are seeing a secular change in how people work and where they want to live. The tidal wave of people moving from the cities to suburbs and those moving to southern states may slow, but it will not stop anytime soon.

With trillions of government dollars on the table and the plans to undertake multi-year projects means that fiscal stimulus will likely have an impact for an extended time period.

The Federal Reserve has stated that they do not see any sort of increase in over-night interest rates until after 2023. The Chairman also stated that he does not anticipate ending their bond buying activities anytime soon. Both of these monetary stimulus tools will continue to stimulate the economy and fuel the fires of inflation.

My belief is that inflation will go on longer and reach higher than the Federal Reserve wants to admit at the current time.

Investment Strategy

We have not seen inflation of any sort for a very long time. Most people managing investments today were not around in the 70’s and early 80’s to see the devastation it can cause, nor do they understand how to position portfolios to withstand the impact of increasing prices.

Precious Metals, Oil and Commodities (in particular the companies that produce these items) are a necessary component to portfolios. These companies get increasingly higher prices for their production and their share prices increase accordingly. Some of the companies we have in client accounts include:

• Gold and Silver Miners: Newmont Mining, Barrick Gold, Agnico Eagle, Kirkland Lake Mines
• Lumber Company Weyerhaeuser
• Agriculture companies: Deere, Agco, Mosaic, CF Industries, and Nutrien
• Energy producers: ExxonMobil, Conoco-Phillips, Chevron, Devon Energy

Real estate, hard assets, and collectibles all increase in value during times of inflation. Some of the companies we have in client accounts include:

• Real estate companies: Florida landowner and developer St. Joe, Dallas and Atlanta landowner and developer Green Brick Partners, Florida lemon producer and landowner Limoneira

Companies that have the ability to pass along price increases because the buyers need their products:

• Consumer Staples Companies: Hershey, Kellogg, Pepsi, Coca Cola, Procter & Gamble

Given all of the stimulus in the economy, both fiscal and monetary, we should see the economy growing. This means that there are certain investment styles that perform well:

• Value stocks that are cyclical in nature will see their earnings increase as economic momentum builds
• Small Cap stocks that are more domestic-focused than the multi-national companies see greater benefits from a resurgent US economy
• Banks whose earnings go up as bond rates go up benefit from the increased demand for financing
  • Our Blue Chip portfolios are perfectly situated for this type of economy
  • Our Growth/Core/Fully Diversified portfolios have been rebalanced so they are positioned with large exposure to cyclical industries, banks, and small cap companies

Keep watch for updates here on the blog as we navigate the coming challenges posed by inflation. At the current time, the stock market is near all-time highs and not all that worried about the impact of inflation. However, when things change, they change fast. We have to be ready for any sort of correction that might come along.

We are positioned with cash in client accounts that we can deploy into our highest rated companies if we see any sort of pullback in prices from investors fear of ballooning inflation.

—Mark