Why Inflation Worries Are Overblown

Besides the price action in products available for hedging/investment/speculation purposes (for example: oil has oil futures), there are very few signs that inflation should be our main concern. Why bother with the CPI, GDP Deflator or PPI? The daily life of an average American could not be a better indicator. Every few weeks Wal-Mart (WMT) has more “Rollbacks”. If I don’t get to my local Rite Aid (RAD) a few days after the weekly circular, the core staple items on sale are usually sold out.

Deflation is alive and well. Given the significant loss of wealth for most households, this makes sense. Some examples experienced/observed over the last several months are listed below. Feel free to add your own in the comments section.

Consumer Discretionary/Staples

• Wal-Mart’s aggressive expansion into private label with a newly designed “Great Value” logo and many more products. Private label market share has increased over the last year, and the U.S.’s largest retailer is doing its best to further that trend. For example: “Great Value Crunch Honey Oats” is ~30 percent less than Post’s. “Great Value Lactose Free Milk” is ~20 percent less than Lactaid.

• McDonald’s (MCD) official rollout of the McCafe undercutting Starbucks (SBUX). We have all been asking for awhile, “Can the consumer really afford a Starbucks’ coffee?” Ring the bell, Starbucks has finally lowered some of its prices by as much as 20 percent in some markets for less complex coffees. Also, the most basic Starbucks coffee can be had for less than $1.

• Discount retailers such as Wal-Mart, TJX Corp (TJX) and Dollar Tree (DLTR) taking share. When I bought 16 hot wings for less than $6, I heard a guy next to me say “I love Wal-Mart” as he bought 2 rotisserie chickens for $4 each.

• Better inventory control in the high end retailers like Coach (COH), Nordstrom (JWN) and Saks Fifth Avenue (SKS). Translation, we now carry more, lower priced inventory, or goods priced appropriately for today’s consumers. Rock & Republic, which typically sold its jeans for $180-$320, now tops out at $280, and has introduced its limited edition “Recession Jeans” for $128-$132. The Recession line is offered at Bloomingdale’s, Neiman Marcus, Nordstrom and Saks.

• Las Vegas. For most leading casinos day rates are 40% lower for player card members (for non-members the discounts are not as good, but many can get close by using discount travel websites) versus last fall, and a small amount of free play and discounted show tickets are usually included. Wynn (WYNN) and Palazzo/Venetian rates can be had for almost $100 lower than last year from Sunday through Thursday. Food is also cheaper as represented by $25-$30 all day buffets at places like Excalibur and MGM Grand. That’s right, all you can eat all day - breakfast, lunch AND dinner for one price! By the way, MGM Mirage (MGM) still wants to go through with building City Center. Hmm, Las Vegas needs more capacity.

• Housing prices still falling. Some say the housing price indexes may actually rise if high end homes start selling. The true measure is to compare the high market value /most recent purchase price (if relevant) of these high end homes to their future selling price. California knows best about this and the data is not pretty. Also ask Tim Geithner if he’s willing to take price concessions, or anyone trying to sell their apartment/condo in New York City. Homebuilders also continue to report new order and backlog ASPs 10-15 percent below last year.

• Can the auto industry get any worse? Will the American consumer prefer Honda’s (HMC) and Toyota’s (TM) small cars versus GM’s? My local used car dealer said that cars $5,000 or less with 100,000 miles are his best sellers. His sweet spot used to be closer to $10,000. The Manheim index could be distorted by newer inventory. Financing rates are also higher for used cars than new cars because there are no special promotions.

• Commercial real estate prices in early stages of falling as cap rates are rising and rental revenue is falling.

• Vacancies trending higher in commercial real estate are leading to lower rent. Also, according to Reis, Inc., in 2Q09 apartment vacancies reached the highest in 22 years.

• Priceline (PCLN) has been crushing the competition, and most of the competitors have now removed booking fees for airline tickets.

• Receive up to $500 in rebates when buying select GE or Maytag appliances at Home Depot (HD), and they throw in free delivery and haul away.

• Hotel RevPAR still down 15-20 percent y/y.

Energy/Commodities/Utilities

• Sequential gains in commodity prices are a small win, but absolute levels should not be ignored. Just ask anyone who bought the NASDAQ from 3000 to 5000. It has been almost 9 years and the NASDAQ has yet to surpass 3000. Currently around 1780. Long story short, most commodity prices are still significantly lower than last year’s levels, and capacity constraints are no longer a problem as there are plenty of factories shutdown that can be easily started.

• Very depressed coal and natural gas prices should lead to much lower utility bills. The world has plenty of coal, and natural gas shut-ins are underestimating inventory. Last week Exxon (XOM) was mentioned to have natural gas wells in the Horn River Basin in Canada capable of producing 5x the average wells in Texas's Barnett shale, and comparable to the big wells in the Haynesville shale.

• Many rigs, especially mid/deepwater rigs, were signed at much higher energy prices. Those contract rates are less economical even at $60-$70 oil, and much lower natural gas prices. Last year deepwater rigs were contracted close to $640,000. Recent signings have moved closer to $560,000-$585,000. Great shale plays may also further hurt rig rates as less rigs are needed in order to generate significant natural gas production.

Healthcare

• Obama. Actually this will probably affect the HMOs, drug and medical device companies the most. The less specialized doctors have already been hurt on a per patient basis by the HMOs over last decade.

• Trend towards higher generic utilization continues to increase. How many more prescriptions are we going to get for $5 or less?

• Biogenerics?

Technology

It’s actually unfair to pick on technology. A core understated theme in technology has always been to get better functionality and performance at the same price or better over time. Nevertheless there have been significant deflationary events.

• Apple (AAPL) lowering price of iPhone to $99 and offering rebates on computers. When the premium-priced hardware company that has gained share without lowering prices starts cutting prices, you have to take notice.

• Low end laptops (for example: ACER, Toshiba (TOSBF.PK), Dell (DELL)) break below $400 before the holidays. For $50-100 more or even the same price for some models, why buy a netbook when you can get much more punch? Are we really going back to the small screen laptops of the ‘90s?

• For $20 more get 3 licenses instead of 1 for most PC antivirus and spyware software.

• Good GPS systems are easily less than $200. For example: Garmin (GRMN) nüvi 255W GPS - features include turn-by-turn voice prompts, 4.3” color touch-screen display and media card slot, to name a few.

• Sony (SNE) Cyber-shot 12 Megapixel Digital Camera for $200. 4 years ago I paid $400 for a 7.2 Megapixel.

• Blackberry specials at wireless carriers over the last several months have included buy 1 Blackberry get 1 or 3 free. Verizon has now ended the buy 1 get up to 3 free offer.

Disclosure: No positions in companies mentioned above.

Comments

[Cyber2u:]

History does not support your case aginst inflation.

Inflation is caused by excessive monatary growth. ie the great society spending, bank bailouts, finincial bailouts, goverment spending bills and the list goes on.

A very informative read on the subject is en.wikipedia.org/wiki/....

The hedge aginst inflation "hard assets".

Mike

Jul 14 09:36 AM

[Commercial ...:]

I agree that inflation ought not be our main concern…"right now". We, indeed, have bigger fish to fry. But we should not be naïve enough to think that our current polices will not eventually lead to inflation. They sure could and it’s a decent bet that they will.

It’s like bringing a wolf pup into your family to play with your kids and saying wolfs are not our main concern…right now…The problem is wolf pups always, always grow into wolfs and will eat your children if you don't watch out.

Jul 14 10:13 AM

[Jimbo:]

As a retiree on a fixed income, Your data does not seem to fit my experience. I have no mortgage, but electricity has gone up 25% in our region. Almost all processed foods have markedly increased, e.g. a house brand package of ten quart envelopes of powdered skim milk has gone from $5.99 to $7.99. It is now cheaper to buy fresh milk but I am reading that dairy farmers are culling their herds because they cannot make a profit in this market. Auto and home insurance have announced marked increases. My state has dramatically increased "fees" to register and license cars. Other "fees" have emerged from local governments. I conclude many ordinary citizens are being squeezed by the economic anaconda. The anaconda's name is STAGFLATION.

Jul 14 11:56 AM

[bindlepete:]

This is a baloney dance Mr. Chung . Check food , medical, education, fuel and do a rewrite. Forget band aids and the promoted deals on minor elements of our lives. HJave auto prices collapsed on the models that make sense or only the Hummers and four wheel drive baby's. Tried to buy an airline ticket lately? How about a newspaper?

Inflation is alive and well and you are OTL or on some fraud's payroll.

Jul 14 01:14 PM

[satyr:]

In the short run, there is no doubt that businesses that sell directly to the consumer are going to lure customers with discounts and deals. Provided that they are not operating on negative margins on the entire transaction, this keeps their businesses afloat. However, using the presence of special or sale items as a proxy for deflationary trends gives a distorted picture of the whole.

In the long run, I don't see how inflation can be avoided. It is driven by monetary policy, and I don't think the printing presses have ever run faster in this country. You can't flood an economy with money supply and expect to sidestep the laws of supply and demand. Each dollar that is inserted into circulation decreases the relative value of those that were already in circulation, particularly in a sluggish economic environment. I would guess that the first clear signs will appear in about a year from now, just as the recession appears to be safely past. The irony here is that real estate may prove to be the greatest hedge, thus driving investors to purchase the very thing that has been that has was eschewed (and often blamed) at the onset of this economic downturn.

As an aside, when comparing granolas, chickens, or whatever else you are putting into your body, I would be careful to check the ingredients. In many cases, you will find you are not comparing apples to apples.

Jul 14 01:43 PM

[White Shield:]

Mr Chung, you are not of the belief that "deflation" preceeds "inflation"? But rather "deflation is here now, why worry"?

Isn't this sorta like going for a drive and using the first few lights as "green", coupled with light traffic as indicators the trip will be quick and painless?

How many "long trips" have you taken?

Jul 14 02:09 PM

[john s. gordon:]

in regard to inflation,
'don't fix the roof today, it's not raining'
> jack

Jul 15 10:01 AM

[Boxed Merlot:]

…You can't flood an economy with money supply… Each dollar that is inserted into circulation decreases the relative value of those that were already in circulation…


Unless the Production of the goods and services these new instruments represent is greater than the value in existence before they were printed. If this were the case, then your anecdotal evidence might have a structural foundation on which to stand. Unfortunately, that evidence is transparent, i.e. it is not visible.

What is visible however is that these new credits, notes, debt, mammon, have been made available to court favor with anyone that will pledge allegiance to disregarding previous commitments to the rule of law, including personal property rights, and dedicated to this “change.” I suppose that newly purchased loyalty could be seen as the product or service these new instruments represent. A magic stone, so to speak.

Jul 15 02:50 PM

[Raymond Chung:]

My only question to you is when do, supposedly special sale items that occur for 6-9 months become long-term. Many of the examples I have mentioned have persisted. Also, WMT and MCD, have made long-term strategic decisions, surely these are not transient.


On Jul 14 01:43 PM satyr wrote:

> In the short run, there is no doubt that businesses that sell directly
> to the consumer are going to lure customers with discounts and deals.
> Provided that they are not operating on negative margins on the entire
> transaction, this keeps their businesses afloat. However, using the
> presence of special or sale items as a proxy for deflationary trends
> gives a distorted picture of the whole.

Jul 15 08:40 PM