Ignoring Inflation Doesn't Mean It Doesn't Exist

The great debate of Inflation vs. Deflation rages on in the U.S. while almost everywhere else inflation has forced policy makers to take stance.  In the UK, the annual CPI came in at 3.7% YoY for December; much higher than the Bank of England's target 2%¹.  ECB President Trichet signaled the ECB would move to raise rates despite the debt crisis in order to defend price stability if further signs of inflation grew.  China and other Asian countries have already raised rates numerous times over the past months to stem their inflation problems. 

How is it that the U.S. CPI is only 1.5%?  Well, according to John Williams from Shadow Government Statistics, the way the government calculates the CPI changed numerous times within the past couple of decades.  In the WSJ article, "Don't Trust the Inflation Numbers," Williams is quoted saying, "if we counted inflation under the old system the official rate wouldn't be 1.5%.  It would be closer to 10%."  

The media likes to report core CPI which takes out food and energy because those components are volatile.  That doesn't make sense to me. Food and energy are vital to our survival.  Regardless of whether or not they are volatile, they still are real costs either to consumers or companies. 

The CRB Index, since the market began pricing in QE2, is up over 25%. Depending on the elasticity of supply and demand, as the price of raw materials increase, companies will have to either eat the increased cost or pass it onto consumers.  Regardless, inflation is around the corner for both manufacturers and consumers.

If corporations decide to absorb increased cost, their cost of goods sold will increase.  Their squeezed margins will lead to lower net income and lower stock prices.  If companies pass increased costs onto already strapped consumers, they will be faced with higher prices at the register and be forced to cut back consumption.  In turn, corporations will have lower earnings and stock prices.

Evidence of inflation has already popped up in the market.  Look at the producer price index rose, the prices paid component keeps rising.

ConAgra and Kraft, two of the largest food producers, forecasted lower profit margins due to rising commodity prices.  As a record number of Americans use food stamps to feed their families and the rest sticking to discounted items, any rise in food prices will spoil already diminished appetites.

On Dec. 21, Nike decided they will pass higher cotton and shipping prices onto consumers.  Nike CEO Mark Parker warned, “while the impact of these cost pressures has been delayed for us, these factors have not diminished. We expect to see these external forces play out for the remainder of the fiscal year,” he added in a conference call.

As the market anticipates increased inflation and a weaker USD, commodities will go up.  Further, demand from emerging nations will continue to keep pressure on commodities.  Particularly, as Chinese consumers continue to trade up their living standards and demand more goods.