1. Where are inflationary pressures?
We are worried because this time, it is about "cost-push" inflation. It would be too clever to call this "CPI", would it not?
In Business Week of June/July, we read that the National Federation of Independent Business' index of price changes is rising rapidly.
What they do is this:
Number of businesses raising prices
Number of businesses cutting prices
= overall index of price changes
This April, it reached 18%, after its recent low of 8% last Christmas.
Their chief economist reckons that this reflects tighter labor markets feeding through into stronger wages growth.
So there you have one form of cost push inflation.
Other cost-push pressures are that
• the weaker dollar, wanted so desperately by Congress, is pushing up import prices (i.e. you have to pay more dollars per unit of foreign currency)
• the stronger RMB, also a Congressional pet, is driving up the costs US imports from China, and
• stronger commodity prices are making themselves felt.
2. Why we are worried about profits
According to said Business Week article, last year, independent businesses got away with price hikes because of strong growth. So, last year's inflation was definitely of "demand-pull" nature: strong consumer demand meant to companies could increase prices and thus raise margins, without forfeiting turnover.
Now, however, corporates have to increase prices because their costs are rising, as we just discussed, courtesy of tight labour markets, a vote-guzzling Congress and strong commodity prices.
Here is why profits are threatened by cost-push inflation:
• if corporates pass them on, then an increasing excess supply of goods implies that consumers will buy less and less, so down goes the corporates' turnover;
• however, if they do not pass them on, then down goes their margin: the companies now have to absorb higher input costs, and
• if the corporates do pass them on, then the Fed will raise rates again: Bernanke is still creating his own market credibility, just as Greenspan had to. He will want to be more "safe than sorry", meaning that he will want to fight inflation as long and as hard as he can - instead of giving in now and seeing it re-appear next year...
How to Make Money Off This Idea
1. Short the US stock market
2. In particular, short financial stocks
3. Once the current convulsions are over, load back into various Asian markets like China/Hong Kong, Korea and India
4. Always discuss stocks and instruments with your financial advisor