Stocks: Negative Return Due to Inflation

Interesting Bloomberg article this afternoon on corporate profits and raw cost inputs:

"Inflation is eliminating the rewards of owning U.S. stocks.

Surging commodity prices have eroded earnings and spurred the Federal Reserve to consider raising borrowing costs just as equities are trading at their most expensive in four years. Standard & Poor’s 500 Index shares yield 0.22 percentage point more in profits than the interest on 10-year Treasury notes, the smallest advantage since 2004, data compiled by Bloomberg show. The last time corporate earnings returned less versus bonds, the index posted its first quarterly decline in more than a year.

The 44 percent advance in oil, 72 percent jump in corn and 41 percent climb in rice pushed the UBS Bloomberg Constant Maturity Commodity Index to a record this year. That’s squeezing profits as raw-material costs outpace consumer prices by the largest margin since the 1970s. Companies in the S&P 500 will earn 7.7 percent less in the second quarter than a year ago, according to analysts’ estimates compiled by Bloomberg."

We know inflation has been significant — how much is this going to matter in the coming days  months and quarters?

What say ye?


Stocks in U.S. Show Negative Return on Inflation Gain
Michael Tsang and Alexis Xydias
Bloomberg, June 16 2008

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What's been said:

Discussions found on the web:
  1. Paul Griffith commented on Jun 16

    INFLATION is the biggest risk we all face — The Big Picture is right: INFLATION is under stated.

  2. Michael F. Martin commented on Jun 16

    “Inflation is eliminating the rewards of owning U.S. stocks.”

    Lately, I’ve been wondering whether in fact inflation ruined the rewards of U.S. stocks a long time ago, and the Fed hasn’t simply been keeping the industry on life support with interest rates that are unrealistically low compared to the rest of the world:

  3. HCF commented on Jun 16

    As a through and through capitalist, it pains me that one of the best quotes to describe our current situation is from a communist:

    “The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” – Vladimir Lenin

    Unfortunately for us, it seems that both are going up for the forseeable future…

  4. Wilbur commented on Jun 16

    Hey, I thought that the Federal Reserve said that we have no inflation in the US if you strip out food and energy. What are the guys at Bloomberg smoking?

  5. sysin3 commented on Jun 16

    Considering that the dollar has lost about 37% of its value since 2002 .. and the SP-500 is barely above that level …

    hmm, let me do the math on that one, it’s tricky

  6. Jay commented on Jun 16

    Inflation? I’d like to know what APR you’d have to make per year, as a European investor, to break even given inflation and profits measured in a currency that will be losing its value for the foreseeable future. And where, I’d like to know, could you get that APR in a country that doesn’t actually make anything anymore?

  7. m3 commented on Jun 16

    this is a bit disingenuous.

    a bull market in stocks is asset inflation.

    a rise in the general price level is consumer price inflation.

    but inflation is inflation is inflation.

    10 years ago the fed inflated b/c of LTCM, and stock prices went through the roof.

    10 months ago the fed inflated b/c of the credit crisis, and oil prices went through the roof.

    same difference.

    it’s all inflation to me…

  8. wunsacon commented on Jun 16

    >> a bull market in stocks is asset inflation.

    Usually, “yes”, because someone’s always levering up/down and playing games on paper. But, companies that figure out how to offer energy, healthcare, mobility, food, etc. of equal quality but at less cost will (over time) increase in value.

    In other words: Because of innovation, I don’t think the economy is zero-sum. In turn, I don’t think stock price increases are necessarily asset “inflation”.

  9. bluestatedon commented on Jun 16

    The worse inflation is between now and mid- October, the worse John McCain’s prospects are. Whether or not it makes sense I’ll leave for others to debate, but many people seething at the gas pump are going to take their anger out on the party that’s been in control of the White House for the last 8 years. It happened in 1980, and Carter was just a one-termer.

  10. Ken H. commented on Jun 16

    I just love an 8% loss in profit. It doesn’t mention how companies who are paying more to operate due to increased operation costs. all businesses need energy. Margins suck. Can’t spend it if i can’t make it?

  11. Darin commented on Jun 16

    I think that inflation is wildly out of control and that equities are the only play here precisely because of that fact. However, the caveat is that buy and hold just won’t work. The great thing is that we still have wonderful volatility, which produces ‘the conditions of the possibility’ for great profits, albeit in non-traditional vehicles and more risky, more levered positions. Inflation is really just asset turnover in a capital market. The higher it is, the more velocity asset exchange must acquire to hit ‘par’. It is also extremely positive because the ‘boomers’ will get fucked (those bastards deserve it) and will now have to keep their ‘nest eggs’ in the market (at 2 trillion, its a sizable amount) to be able to make it. For a society founded on the notion of ‘social mobility’, inflation is actually very necessary. Without it, there is no incentive to take on risk, which means capital stagnates. So, the only real question would seem to be where the new money is going to be made and in which markets. Its the anomaly that makes you rich, just as the exception makes the rule.

  12. Nick commented on Jun 16

    Inflation will be the biggest post-correction problem in the US economy, and it will be much worse if/when the general US populace figures out how wrong the CPI is, how much the government has been lying to them, and how much it affects every economic statistic and measurement. The first two are likely in the next 5-10 years, the last one is less likely, but more devastating if it occurs.

    What’s personally interesting to me is that now is meaningfully different than previous periods of high inflation, in that it’s much easier now to escape the inflation/taxation devastation by expatriating, and that option is readily available to people with lots of assets. Whereas in the past, all people in a country which ran up a massive debt eventually paid for it with taxation and devaluation of savings, now the wealthy Americans could realistically escape the inflation/taxation devastation by moving their assets (and possibly their persons) outside the country until the correction is over. Given the depth of the problem and the complete political unwillingness to even acknowledge it before total collapse, it doesn’t seem like that bad of an option, and I wouldn’t be surprised to see large asset holders quietly exiting the country like rats fleeing a sinking ship.

    Interesting times…

  13. stuart commented on Jun 16

    Stocks will have more reason to maintain negative returns with shadow in the dark moves such as this latest ploy by GS. Create another SIV to buy assets from a defunct SIV. M-LEC II designed to inject false bid into a market where no bid exists. This has to stop, now! These engineers of yet, another scheme intent on obfuscation and deceit need to be accounted for, NOW! Paragraph 6 is key.

    “Hedge funds
    Goldman deal could point way for SIVs
    By Anousha Sakoui in London

    Published: June 16 2008 23:30 | Last updated: June 16 2008 23:30

    Goldman Sachs is close to finalising a plan to restructure a $7bn investment vehicle formerly run by London-based hedge fund Cheyne Capital, in a move that could potentially usher in a crucial new phase in the credit turmoil.

    The US bank’s proposed reorganisation of the so-called structured investment vehicle is set to be just the first of a number of deals that could see about $18bn worth of SIV assets restructured in the coming months.

    John Authers: Goldman’s intriguing replication idea – Jun-15Goldman’s Connolly shifts to private equity unit – Jun-12CIT secures $3bn financing from Goldman – Jun-09Goldman moves star banker to Asia – May-30Goldman set to sever IIF links – May-23Goldman CEO optimistic on end to crisis – Apr-11The deal, which could be signed as early as Tuesday, is likely to be closely watched by the financial industry, since Cheyne is one of the largest independent SIVs – and the deal marks the first time that any collapsed SIV has been restructured in this way.

    Deloitte & Touche, which was brought in as receiver for the SIV formerly known as Cheyne Finance, was on Monday close to signing off on the plan. The SIV went into receivership last autumn when the value of its credit assets, such as mortgage-linked securities, plunged.

    The Cheyne restructuring, which has been brokered after nearly 10 months of negotiations, will require the receivers to organise an auction of the Cheyne assets in the coming weeks, to establish a transparent price for these instruments. This is important because in recent months it has often proved impossible to value these murky assets.

    Once this price is established, Goldman will then create a new off-balance sheet vehicle to buy the assets, with the transfer of assets being funded by the US bank for just one day before being sold on to the new vehicle. Under the plan senior creditors in the SIV will be given a range of options including reinvesting in this new vehicle.

    In addition to the Cheyne fund, Goldman Sachs has been lined up to restructure two other failed SIVs formerly run by hedge funds, called Golden Key and Mainsail, as well as Whistlejacket and Rhinebridge, which were formally managed respectively by Standard Chartered Bank and IKB bank. The same Cheyne model is expected to be applied in some form to all these.

    Consequently, the move will bolster hopes that banks are starting to create solutions to the long-running woes of SIVs, and the plethora of other, shadowy credit entities that have exploded in size this decade, in the so-called “shadow banking world”.

    The Cheyne deal comes after a protracted debate within the policy making and banking industry about the most effective manner to deal with the problems that have been gripping the shadow banking world. In recent years, institutions such as SIVs have exploded at a dramatic pace, largely unnoticed by regulators or investors. However, when the money market seized up last summer, these entities found their funding sources cut off.

    The US Treasury, together with banks such as Citigroup, attempted to organise an industry-wide bail-out of these funds last autumn, to prevent them embarking on an asset firesale. However, this plan floundered, and the SIV problems have subsequently cast a heavy shadow over the credit markets and the banks in recent months.

    There have been numerous attempts to restructure this portfolio of assets since it was placed under the control of receivers last year, and proposals from other investment banks but constantly falling markets made them too difficult to execute.

    Deloitte & Touche and Goldman Sachs both declined to comment.
    Copyright The Financial Times Limited 2008

  14. m3 commented on Jun 16

    I don’t think stock price increases are necessarily asset “inflation”.

    Posted by: wunsacon | Jun 16, 2008 9:21:43 PM

    i disagree. if you look at stock markets all across the globe & throughout history, what has typically happened is that stock prices tend to trade sideways, or at best keep pace with inflation.

    outside of the 1920’s & the tech boom, that’s what has happened in this country. what happened in the US between 1980-2000 & 1920-1930 was a complete aberration, mainly due to easy money.

    I hear what you are saying about increased productivity, but that allows companies to pay higher dividends, not increase the P/E multiple.

    the only rational reason for stock prices to rise is an increase in book value, or dividends. (both of which can only happen with earnings growth, which occurs on a company by company basis, not the entire market.)

    but an increase in the general price level of stocks, aka a “bull market,” is asset inflation.


  15. Andy Tabbo commented on Jun 17

    The inflation “scare” of the 2008 is going to go down in history as a great economic “head fake.” Everyone’s talking about it…everyone is “concerned” about it. The reality is that energy and food inflation are the result of both seriously BONEHEADED economic policies and a lack of regulatory oversight to enforce speculative limits in futures markets. The biofuel/ethanol polices have caused much more harm than good. The subsidization of energy in some of these “hot” economies is blunting serious demand destruction. The failure to enforce spec limits in the commodities markets have simplify magnified the inanity of it all.

    Trichet has made a huge mistake. Bernanke is making an equally big mistake by following along.

    The bigger problem is the credit and housing bubble deflating. What would affect a consumer more? The prospect of hist 220K (median price) home losing 10-20% of its value (i.e. losing 22-44,000 dollars of percieved wealth) or paying an extra few thousand a year on food and fuel caused by some poor policy decisions?!?

    What’s a worst problem? The entire U.S. banking sector completely imploding due to the credit bubble deflating or more inflation than we would like?

    The reality is we have some tough medicine to take. We need to let some big banks take the long dirt nap. We need to allow the country to go into a a prolonged recession. We need to address some of the aformentioned policy mistakes regarding food and fuel. We need to accept higher inflation rates over the next few years as we break this economic fever.

    I’m afraid that any misstep along the way will be CATASTROPHIC.

    – AT

  16. Jim Hancock commented on Jun 17

    Inflation is the Velociraptor chasing Bernanke right now.

    Recession is the T-Rex chasing the Velociraptor.

    He’s got to dodge the Velociraptor until T-Rex kills it …then he still has to kill T-Rex.

    Side note: It’s ironic that Ben created the inflation that will hurt the market …by trying to save the market.

    Low low rates …and $400 billion in T-Bills swapped for mortgage backed toilet paper (that you know is being leveraged 30:1). Wa la …commodity bubble! Brilliant!

    Well at least we aren’t killing ourselves over here for a bag of rice …yet.

  17. m3 commented on Jun 17

    another thought:

    at what point does inflation transition from being a nuisance, to a legitimate economic threat? (i think one’s answer to that question has more to do with one’s class)

    and is that breaking point the same for labor vs. business, or are they different?

    rising sales prices may be good for earnings, but that assumes wages are keeping pace with price increases.

  18. Mike in NOLA commented on Jun 17

    If you think it’s bad in the US, Shanghai A shares are down another few percent tonight. At present they are 55% off their all time high close.

    And Chinese inflation is much worse than ours. A few days ago, Bloomberg reported that Chinese food inflation was “only” 19.9% y/y this year as opposed to 22.1% last year.

  19. J. Diamond commented on Jun 17

    the government numbers are completely unreliable. inflation, unemployment, etc. are chronically under-reported. companies and consumers are getting squeezed big time. the stock market is a joke. it’s a huge liquidity play without the least understanding of risk. sovereign wealth funds are propping the thing up with their ever-depreciating dollars. we had all better have a back-up plan for when this thing unwinds.

  20. DL commented on Jun 17

    In an inflationary environment, the effective capital gains tax is also higher, regardless of which asset one owns.

  21. VJ commented on Jun 17

    Stocks: Negative Return Due to Inflation

    This is news ? It’s been the case since after 2000.

    In inflation-adjusted dollars, the S&P 500 would have to be over 15,000 just to get back to where it was in 2000.

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