OT: Inflation

I know that inflation is the obvious thing that everyone is talking about, but boy, it does keep surprising to the upside.
The latest figures show no slowing at all, in fact the trend in the data to date is still consistent with a continuing acceleration at all time scales.
Sometimes the thing that the talking heads are nattering about really is something worth pondering.
(even if what they’re saying is useless)

For example, Berkshire’s price is down -1.40% in the one year period Bastille Day 2021 to Bastille Day 2022. (July 14, for those not aware!)
Adjusted for inflation, it’s a drop of -9.59%

The interesting question for me is how to adjust for this when assessing the progress of the observable value of a share.
Real value, not nominal value.

To a first approximation, it’s not a worry.
The average company in the average year makes as much money after inflation with inflation high or low.
(except when inflation is so high the economy breaks, probably well into the teens, but that is not the situation now).
In effect, the earnings across an economy’s companies are on average inflation adjusted.
If all costs and all prices go up 30%, then all profits go up 30% and it’s a wash.
On average it’s a non issue.

The tricky part comes when you realize that it hits different businesses to differing degrees, and also with different time delays.
Plus, of course, price pressure is never perfectly evenly distributed across all cost inputs.
For example Berkshire’s carpet division is probably about to have a bad time because carpet is in effect congealed oil.
Their key input price has soared, but they don’t sell an energy product, so their prices are probably not rising more than the general amount.
Maybe less if there is cyclical economic weakness.

Companies with a ton of debt can do well, as the real burden of that debt falls. Particularly those with a whole lot of long term fixed rate debt.
Those with net cash get the reverse effect. Not great for our team.

It’s important to watch out for the money illusion in interest rates, too.
For example, rising interest rates aren’t necessarily bad for borrowers–it’s the real rate that matters.
If a typical company’s ongoing borrowing costs are 5%/year more but general monetary inflation is 7%/year, their costs have dropped, not risen.
Assuming they are typical, meaning their costs for materials, labour, rent, and their selling prices
are all rising by somewhat comparable amounts tracking general inflation.

Businesses with great pricing power should be fine.
Coke will probably report terrible results because of the rising dollar and the way they report
their results but the underlying business should be fine if you look past that.

Then there are things with do fine, but don’t look like they do fine.
For example, consider some asset sitting on the books at Berkshire.
Its booked value won’t be any higher after a year of 9% inflation than it was at the start, even though its true value might wall be 9% higher measured with smaller dollars (after depreciation of course).
So, price-to-book might be an understatement of value more than it would otherwise have been.
One effect of that is the ROE, for Berkshire and many firms, will appear to rise.
That’s because it will be the ratio of earnings in current small dollars divided by equity mostly measured in older bigger dollars.

International businesses will be interesting. Shifting cost and revenue profiles are not just hard to track, but hard to understand.
Though US inflation measured in US dollars has been high, the US dollar has soared in the last year.
The US dollar index has gone from around 92 to around 109.
So, though purchasing power of a greenback for a person in the US is down a lot, the purchasing power of that same greenback for someone elsewhere is actually up quite a bit.
(this dichotomy tends not to last…local monetary inflation will eventually lead to a lower currency, but it can take years for that weighing machine to wake up)
I have an expense profile very much concentrated in Euros, with CAD and GBP getting a look in.
So the purchasing power for me, of my portfolio, is higher now than it was a year ago.
Plus, there is the denomination illusion: for example, the price of oil has gone up a whole lot more than it seems.
That’s because it’s commonly quoted in US dollars which are themselves changing value.
A barrel of oil quoted at (US)$100 would buy a lot more stuff in most countries than a barrel of oil quoted at (US)$100 would have a year a go.
But would buy a lot less stuff in the US.
Generally speaking, on a global scale, one US dollar will buy more, not less, stuff than it did a year ago. So far.

What a dang nuisance.

Jim

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Only peripherally related:

Your comment about carpet being congealed oil reminded me of my realization a few years ago about ice, i.e. the bags you buy at the store for the ice chest.

I started idly wondering at checkout why the ice companies hadn’t consolidated - why there weren’t the same logo or three nationwide, but instead a CoolMax vendor at store X and a CrystalCold vendor (not Kirkland) at the local Costco a couple of miles away. It is a commodity product, after all. To paraphrase your carpet quote: all ice is is a mixture of water and electricity.

So I guess what’s going on here is that ice is necessarily local. About the two heaviest common items to transport in bulk are water and crushed rock, so at a certain distance from the source the transport becomes prohibitive - especially if it needs to stay frozen en route.

But, aggregate has a moat inasmuch there are only so many aggregate pits around as sources. Ice, on the other hand, only needs water, electricity, and a little bit of infrastructure (ice machines, freezers, frozen transport)

So it’s a niche local market. I would think that if I were an enterprising youngster in a semi-rural setting I might consider a lot of sweat equity for a few years, acquiring a machine, a truck and doing a lot of hustle at the smaller stores and gas stations - until I had two trucks, and then five, and I could slow down and watch my twelve employees do the sweaty stuff while I expanded into the car wash business.

It wouldn’t be a billion-dollar business – it’s not franchisable – but if there aren’t a thousand places in the US where a youngster with hustle and say $20K available couldn’t make a go of it I’d be surprised. People get complacent.

Anyhow, it was a more productive use of waiting in a checkout line that looking at National Enquirer headlines

–sutton
whose Dad told him that in the 1920s there were two items that could be legally discharged from a moving vehicle onto a public highway. One was melting water from the ice truck, going around with the weekly icebox deliveries. The other was…

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there were two items that could be legally discharged from a moving vehicle onto a public highway. One was melting water from the ice truck, going around with the weekly icebox deliveries.

In the early 1940s in Buffalo, NY, my parents had a used wooden icebox because they could not afford an electric refrigerator. We were not unique because there was an ice man who delivered a huge block of ice to put in the top of the icebox, and a tub underneath to catch the water (melted ice). There were enough people in town that there was an ice man. I do not know how many. In those days, they harvested ice from Lake Erie in the winter and stored in an insulated warehouse from which they made deliveries all year around. IIRC, they came every other day in winter and every day in summer.

I guess you would not want to put any of that ice in a drink: I have no idea how pure it would be.

When gasoline was hard to get during the war, the bakery truck was pulled by a horse, and the milk truck was electrically battery powered. I forget how the ice truck operated.

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my parents had a used wooden icebox

Parents? Pshaw.
Our milkman had a horse drawn wagon. In the middle of the city. Well into the 1960’s.
The local dairy had such a high market share that it seemed to pay: the horse could head to the next house while the milkman was in the back making up the next order.
Take that, FSD.

Jim

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For example, Berkshire’s price is down -1.40% in the one year period Bastille Day 2021 to Bastille Day 2022. (July 14, for those not aware!)
Adjusted for inflation, it’s a drop of -9.59%

It might not be that bad (yet). The price index is calculated monthly, and expressed as an annual rate. Currently, prices are rising at a monthly rate which would exceed 9% if maintained for a year. In August of 2021 the monthly rate was only 5.25%. By October it was 6.22% and it did not exceed 8% until February of 2022. Correct me if I’m wrong (not uncommon!) but the actual drop in value of cash over the last year is less than the current inflation rate.

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my parents had a used wooden icebox . . . Our milkman had a horse drawn wagon.

I too was there! The good old days weren’t as luxurious as some like to think.

We were slightly better off; when dad returned from the war we got a new metal lined wooden ice box. Our ice man had a mule instead of a horse. He knew exactly what size of ice block that fit each house. The mule automatically walked to the next house on his route. Same for the milk man. It wasn’t for several years that we had an actual refrigerator. We had the first 12” TV on the block in ’49 when the first station started transmitting, (a neighbor had just gotten a 3” console TV). Came home from the grocery store and found a crowd of at least 25 people most of whom we didn’t know in our house watching the world series.

RAM

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What I’m getting from this thread is that the Berk board leans quite heavily toward the octogenarian end of the age scale, and at 60 I’m feeling quite young. Thanks :blush:!

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Another meandering observation on the inflation front.

There’s an old saying that inflation is always and everywhere a monetary phenomenon.
Whether that’s completely true or not is (ahem) not universally agreed, but it’s certainly mostly true most of the time.
A deserted island with nothing but a few trade-addicted residents, 10 coconuts and $100 in cash is likely to see an average price of $10 per coconut.
Double the money supply? Expect an average of $20 for a coconut.

The US money supply (broad Divisia M4) exploded starting around April 2020, when year-on-year CPI inflation was still 1.5%.
The year on year money supply growth was then over 20% for a year, peaking at over 30%.
Then, with a somewhat predictable lag, headline inflation started accelerating.

The interesting observation is this: the money supply growth spike is long gone.
The six month rate of change, annualized, is -0.3%.
The one year rate of change is +2.3%.
The two year rate of change is +3.4%/year.
The year-on-year rate of growth has been under 4% for over two years.

It remains faintly possible that the currently discredited notion that the inflation spike was/is transitory remains a possibility.
Who knows?
Barring any additional evidence to the contrary, I expect the year-on-year rate to settle back to a much more modest level soon, maybe within the next 18 months.
Not as low as it was, but much lower than the recent figures would suggest.
As a wild guess, I’m thinking maybe 4% or 4.5% will seem normal in a couple of years, give or take.
I’ll be wrong, but I try to pick the number that makes it a 50/50 chance of being wrong one way versus the other.

This number matters to me primarily when I am estimating the implied real interest rate built into a call option.
Conservatism means picking the lowest plausible assumption for the rate of inflation.

Jim

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