Food inflation in China skyrockets; Retailer margin squeeze coming; More thoughts on stock picking

Food inflation in China skyrockets

Chinese inflation numbers are set to be released tomorrow, with the market expecting a sub-5% reading….lower than anticipated earlier in the year.

Despite this, inflation in China is rumored to be running at a double-digit clip over the past year, well above the arguably massaged official numbers which place it at less than half that.  ZeroHedge ran an interesting piece today in which they showed that according to China’s National Bureau of Statistics, food prices have risen 4.6% in just the past 10 days!  This is quite staggering.

Now those numbers are not weighted, meaning that the folks at ZeroHedge simply added the change in all items and then divided it by the total items, when in reality there is likely a lot more flour consumed (+0.3%) than cucumbers (+28.2%).  Nevertheless, the official inflation numbers will be difficult to keep tame in the future with food prices accounting for over 30% of the CPI data.

We know how people tend to respond when they feel the purchasing power of their hard-earned money being eroded away:

No doubt aware of this, but also aware that a rapid rise in interest rates would not only halt inflation but also potentially result in a hard landing to their economy, Chinese officials have taken a much more creative approach.  From Reuters:

“Food currently makes up a third of the CPI basket, and the statistics agency is expected to reduce that weighting. Since rising food prices have led the pick-up in inflation in recent months, such a change would likely lead to a lower inflation reading.”

Sure the reading is now lower, but that makes absolutely no material difference to the average resident.  China is somewhat backed into a corner, and risks are significant to the global economy.  A hard landing in China or civil unrest over rampant inflation remains the greatest risk to the global recovery.  The situation in China bears watching.

Profit margins at risk

Commodities continue their relentless march higher, yet the average North American has yet to feel it.  Interestingly, final producer prices have been relatively flat over the past year indicating a difficulty on the part of companies to pass their higher input costs on to consumers.  As such, they are increasingly seeing their profit margins under stress.

From Barrons:

“Rising commodity prices, which are depressing real living standards and are contributing to the social unrest spreading around the globe, also are beginning to be felt at the top end of the economic pyramid as shrinking profit margins. And as higher costs eat into earnings, will companies to try to compensate by curtailing hiring?”

Investing in this current environment

I maintain that one of the greatest risks to many companies is another credit crunch that will inevitably hit if/when banks are forced to mark their assets to market.  If that happens, lending would become significantly more costly and difficult to obtain for many businesses.  As it stands, current fairy tale accounting practices allow banks to avoid pricing their assets based on what they would fetch in the open market.  It’s a great deal.  An asset that they bought for a dollar but could now only be sold for 50 cents still shows up as a $1 asset.  It makes their balance sheets look spectacularly solid while they are in many cases rotten at the core. 

For a great read on this, check out this post:

Denmark gets it right, forces bondholders to take a haircut

The threat of shrinking profit margins is cause for concern.  From my perspective there has never been a better time to avoid companies with poor balance sheets.  I see massive debt levels at many companies as a major hindrance going forward.

I wrote a bit about this earlier in the year when I did my three-part series on building an investment portfolio, but it’s worth revisiting.

Being debt free allows companies to maintain a profit margin when many of their leveraged peers run out of wiggle room.  Similarly, not having to roll over funding during a credit crunch is fantastic.  Look for companies with low debt/equity ratios, lots of cash relative to their debt, and strong, stable earnings that are at least 1/3 of their total debt, and that trade at low multiples of their earnings (varies by industry, but single digit price/earnings ratios are always nice).  A dividend is also always a nice treat.  So is a company that is trading near its 52 week low.  There are still many companies that meet these criteria, but they do take some work to find.

Yahoo has a good free stock screener.  Globe Investor has one that is so-so.  Most  brokerages have their own screening tools that are usually solid.  TD is a great example.  Though I hate their commissions, I maintain a webroker account just to use their research.

Preferred shares in companies that meet these same criteria are also great buys.  As always, consider your timeline, risk tolerance, and portfolio goals when making any stock purchase.

Cheers,

Ben

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13 Responses to Food inflation in China skyrockets; Retailer margin squeeze coming; More thoughts on stock picking

  1. Mango says:

    i see hair tales is up 4.7%, what is that exactly?

  2. Jordan says:

    Actually, in the Chinese food price tables you’ve provided, the price of meat seems to have gone up 2-4% regardless of its animal origin.

  3. Village Whisperer says:

    The level of inflation in China is staggering?

    Nah… they just have to change the way they calculate inflation like we did in 1999/2000 and… presto-chango… no inflation.

  4. jesse says:

    “If that happens, lending would become significantly more costly and difficult to obtain for many businesses.”

    Not to quibble, but it’s not the marking the assets to myth that’s the problem, it’s the inferred guarantee analysts believe governments are providing on bad loans. If the government stated in law they would absolutely not bail out any more bad loans, I guarantee you risk premiums would spike overnight, regardless of the accounting smoke and mirrors. Bond analysts, for the most part, aren’t riding the short bus.

    • John in Ottawa says:

      I agree. The mark to market issue is political. It is about optics and keeping the masses from rioting in the streets; perhaps not working as well as hoped.

      Professional investors (big hedge funds) keep their own set of books where they have calculated their own discounts. Right now they aren’t investing in balance sheets, they are investing in QE cash flows.

      The problem I have in getting my head around the future of the economy is, I can’t tell with any reasonable degree of certainty what will happen if and when QE ends. Is QE the death rattle of the United States of America? I don’t know and I’m not alone in this.

  5. John in Ottawa says:

    There are some translation errors in the table. Happens all the time and is often humorous.

    I don’t see much inflation here. Things are changing and the Chinese in the cities are beginning to eat a larger proportion of meat, but the bulk of the Chinese diet in the bulk of the country is soy, rice in the south, and wheat in the north. Inflation is these key commodities isn’t too bad.

    Celery, tomatoes, cucumbers, and kidney beans are not a large part of the Chinese diet and aren’t heavily represented in the market stalls. They would be showing up more in the new city super markets.

    Things “western” have always been subject to high price inflation in China. They are considered to be cool and highly desirable. They provide “face.”

    I paid US$7.50 for a can of A&W root beer back in 2003 because my son decided that was what he wanted for his birthday. I could buy a can of local SARS (irony alert!) root beer for about 25 cents.

    • jesse says:

      Good pickup, John. The items with large increases are discretionary and prone to price swings anyways. Without a more advanced commodities clearing house and futures market, there will be large swings in prices, especially for livestock. This was the case in Canada too, about 50 years ago before the advent of trading boards and larger volumes on the comex’s.

      That said, I would be very surprised if China is not experiencing significant inflation. They have a pegged currency and a current account; the third variable that has to give is inflation. I don’t know what wages are doing these days but that’s where I’d look for verification that inflation has taken hold. I don’t think the most recent round of interest rate increases is done based solely on aggie reports.

  6. jesse says:

    Slightly OT but I thought this post over at Piggington’s is a great fundamental analysis of one of America’s marquee bubble cities.

    http://piggington.com/shambling_towards_affordability_yearend_2010_edition

  7. Best Place on Meth says:

    Clothing prices to rise 10% this spring.

    http://www.cnbc.com/id/41575599

  8. Draat says:

    The rising inflation in China in itself is an interesting subject however it becomes more meaningful when considering the impact on us (Canadians/Americans). We have spent the last 10 years importing deflation from China. While our local products and services have increased in price, our overall inflation numbers stayed relatively flat due to the ever decreasing cost of Chinese goods. The cheap goods imported from China will no longer be able to mask our overall inflation rate if Chinese inflation takes off.

  9. jesse says:

    “The cheap goods imported from China will no longer be able to mask our overall inflation rate if Chinese inflation takes off”

    If Chinese inflation takes off (arguably it already has) there are other countries available to outsource manufacturing. I do agree there is less “low hanging fruit” around than there used to be. Probably explains the recent run-up in banana prices 😛

  10. earn money says:

    How to evaluate a networking CompanyEarn Money online in India, Know what what you should look for first.

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