FEBRUARY 14, 2011
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.
"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:
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.