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
!