Viewing Inflation Through Two Important Lenses

We’re All Feeling The Effects Of Inflation At The Moment

– and hoping it will peak and level off soon. Though it’s an uncomfortable experience, to say the least, looking at it from different perspectives can help to give us a broader understanding. At Arbor Capital, we view inflation through two lenses:

  1. How are broader economic indicators trending?
  2. What are companies we own stating about inflation?

Let’s take a look at both.

How are broader economic indicators trending?

For broader economic indicators, we look at the Consumer Price Index (CPI) and Producer Price Index (PPI) trends. Looking at Producer Price Index data serves as a leading indicator for the Consumer Price Index. Simply put, if producer costs are increasing by 5% year-over-year and those cost increases are sticky, we would expect the price to consumers to increase by roughly 5% so the company keeps gross margins stable. That makes sense, right?

In the U.S., PPI for the 12 months that ended in May 2022 was 10.8%, compared to an 8.6% increase in the CPI. In Europe, the EU PPI was up 31.4% year-over-year through March with the next report in June. PPI was up 8.1% year-over-year in May. Looking forward, we would expect either (1) the CPI to continue to rise and consumers absorb even higher prices, or (2) the CPI to remain at current levels or fall, meaning companies take a hit to margins and earnings as they cannot pass along cost increases without losing sales volume.

What are companies we own stating about inflation?

What companies say is anecdotal, but at scale due to their revenue and market reach. From a consumer perspective, each Costco earnings call provides information related to the company’s own cost increases for what it purchases. For the last 5-6 quarters, expected cost inflation year-over-year has continued to increase. Their current cost inflation is expected to be 7% year-over-year compared to 4.5%-5.0% six months ago. Companies like McDonald’s with its dollar menu, and Camping World with its used RV business, are preparing for consumers to trade down to lower-priced products due to continued inflation.

Addressing Wage Inflation

Simply put, wage inflation is an issue. MSC Industrial struggles to hire for its sales department. JPMorgan struggles to hire the tech people it needs to code software. And, these are just a few examples. So, it is not just worker shortages that are visible at your local restaurant, but many large companies are also struggling to obtain the talent they need.

How Should We View Inflation Right Now?

So, how do we look at inflation currently? Over the next few months, the PPI and CPI may decline, though they will likely remain uncomfortably high. Earlier in 2022, companies were able to pass most of their cost increases through higher prices. That pricing trend with companies in 2021 and early 2022 has a solid potential to end abruptly in the second half of 2022. That should get reflected in management guidance during the second quarter earnings season in July and August.

Change is the only constant we can count on, and we’ll continue to update you and provide our perspective on the issues impacting your life and financial goals. You can contact the team here at Arbor at any time to speak with your advisor and ensure your investments are still aligned with your financial plan.

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