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Analysis: Inflation Or Lack Of Profits



February 14, 2011 – Comments (0)

While the markets have soared almost every day on the back of QE-2, a smart investor must start taking note of one major issue. This issue is beginning to pop up in quarterly earnings announcements but has not caught the attention of the markets just yet. Inflation in commodities and growing input costs into goods sold to consumers has rocketed higher. Commodities have soared of late but inflation has remained in just food and energy. It has not yet spread to other consumer goods.

There are two paths this can take. As companies produce goods like TV's, plastics and such, their costs are skyrocketing as oil and other energies are used to produce these goods. Right now, these companies have not passed it onto the consumer because they fear the consumer is too weak to handle it. Thus, core CPI (Consumer Price Index) has remained low. This is starting to take a bite out of margins and thus profits. As commodities continue to rise, profits will start to drop more and more. The only way companies can combat this is by raising prices.

Just last Friday, PepsiCo, Inc. (NYSE:PEP) said this very thing in their earnings announcement. Costs are rising! Almost every company is at risk because producing anything, will intimately involve some sort of energy use. Plastics for instance are made with oil. Companies from Caterpillar Inc. (NYSE:CAT) to Apple Inc. (NASDAQ:AAPL) will be facing these head winds.

So that brings out the main point. Which one happens? Will inflation start to rocket higher as companies raise their prices to offset their rising costs? Will profits begin to diminish as they must eat the cost increases in the production of their goods? Most likely, the answer is a mixture of both. Companies will start passing on costs to the consumer. This will send the CPI higher. In addition, profits will start to stagnate as costs continue to rise.  There is no great outcome here. A smart trader or investor must monitor this situation closely.

Gareth Soloway

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