Friday, May 23, 2008

CPI , PPI and Profits

Disregarding how government statistics are calculated, producer prices have recently been rising significantly faster than consumer prices. We can observe this in the chart below that tracks the PPI and CPI indices (click to enlarge).

Data: St. Louis Fed

A clearer picture emerges when we plot the ratio of PPI to CPI - see the chart below.

What does this divergence mean - assuming that statistics are honest, or at least equally biased?

In my opinion, the divergence - if it lasts - is a precursor of a structural negative shift in corporate profitability, i.e. lower profit margins for finished goods. Interestingly, retail prices started rising faster than producer costs back in the early 1980's, just as the bull market in stocks got going. The two events are related on a fundamental level, since stock prices are clearly a function of profitability.

The widening process continued unabated until 2003 when it reversed. And in the last 18 months it appears that companies are losing pricing power even faster. All other things equal, this sequence should impact profits and share prices on a fundamental basis.


  1. Hell:

    Another interesting aspect of the CPI-PPI relationship is that right about the time the second wave of cheap Asian manufacturing came online (S. Korea and the Tigers), the PPI started growing less fast than CPI. If manufacturing pricing power in the U.S. waned because of lack of pricing power (competition from abroad), and languished for about 24 makes you wonder who was capturing that unprecedentedly huge profits gap between the PPI and the CPI.

    That 24-year period also, coincidentally, corresponds to the Wal-Mart phenomenal run-up in sales, and the abandonment of their much-touted "Made In America" promotional campaign.

    The recent run-up in the PPI may signal that even without pricing power, U.S. manufacturing has had to pass on fuel prices (or use the excuse to pass on a whole lot of latent expand-the-margin needs). It may also signal a structural change in pricing coming from Asia, as wages there come up, moving the pricing-power equilibrium point toward the U.S., and EU, etc.

    I'm thinking it's more fuel prices, though. Chindia wages have a long, long way to go to catch up.


  2. Dink,
    There's an article in the Charlotte Observer "Duke Shuts Off Power To 500 Each Workday". The USAToday article about Xcel Energy now isn't the only harbinger of Mad Max summer. If people don't have money for utilities, they won't be contributing much to profit margins being squeezed by rising PPI.

  3. It's all about relativity and I concur 100% with your theory regarding your pricing model.

    Equities are extremely over valued, based on extremely over optimistic earnings assumptions. That of course need to take into consideration that earnings and profit margins matter at all.

    Do they....?

    Best regards,


  4. I believe we are into the early stages of a long cycle of corporate profit under-performance, the reverse of the 1982-2002 cycle. We may go back to average p/e's in the single digits or very low double digits (10-12x), based on core operating earnings.

    If everyone thinks it through logically, this is the most likely scenario, assuming pressures on resources and the environment persist.

    Bottom line? Production costs are going up and businesses can't raise consumer prices fast enough - except in isolated cases.

    A perfect example is American airlines being reduced to charging $15 for the first checked bag. They simply CAN'T keep raising fares - they are killing traffic.

  5. Well, manufacturing can always shift to somewhere else.

    It's obvious that Asia will catch up in competition and climb the society ladder with higher earnings and therefore cost.

    China is now moving large manufacturing base to Vietnam for over 2 years already, in case you have not noticed.

    I also think Africa is the next target for manufacturing shift, especially with its vast resources.

    Got Africa ETF?!

  6. "In my opinion, the divergence - if it lasts - is a precursor of a structural negative shift in corporate profitability, i.e. lower profit margins for finished goods."

    Very smart observation. I have similar chart on oil that I watch almost everyday.

    The shift in trend also means that the difference between rich and poor in USA will go down over time now. Also corporate executive pay will come down with respect to average employee pay. Do you see these?

  7. "If everyone thinks it through logically, this is the most likely scenario, assuming pressures on resources and the environment persist."

    I do not think the assumption is necessary. As long as prices of resources do not come down as fast as crashing debt load, the profit margin will erode.

    It is peak debt, stupid.

  8. Shawn-
    "I also think Africa is the next target for manufacturing shift, especially with its vast resources"

    It'll still take oil to ship the products. The cost of oil may mean its going to be cheaper for the US to make our own Hanna Montana beach towels and other assorted trash.

    "Mad Max summer"

    My tin foil hat is sparking. I'm muttering "Entropy..entropy" at everything I see. No doubt I'll soon be wearing a bath rope in public yelling "Don't you know about plastic outgassing? at strangers with water bottles.

    I'm truly a little concerned about my decreasing ability to feel sympathy; I've always been the "nice one" (Time Bandits geek reference). How can I (or the government) be expected to put more energy into keeping individuals alive than they are? People say things like "the gov needs to do something about the obesity epidemic". $%^^!#$R%^@!!! The only way an outside entity (gov, doctor, teacher, me) can alter a person's obesity is by making decisions for them since their own decision making ability is obviously impaired. And making decisions for someone is taking away their freedom. Honestly, even if people offered me power over them, why would I want to spend my finite lifetime hours doing so?

    Anyone know how long gasoline can be stored (in case a certain tinfoil wearing fool wanted to buy a tanker of it for the summer)?

  9. Dink,
    There was an article on AOL 2-4 weeks ago about storing gasoline and the author (supposedly some kind of expert) said that it does go stale after 3-4 months and can leave gunky residue in the engine. Best to leave as little air in the container as possible until you're ready to use it; that rules out one big tank buried in the back yard.

    BTW, what's outgassing?

    The notion that the entire population of the world can move up the industrial ladder is a fallacy. Modern production is simply too productive to employ more than a small fraction of the world's labor and the resources don't exit to supply 6.6B people with a western life style. The big battle will be how to allocate the pools of poverty amongst the world's inhabitants. Will they be concentrated in certain areas of the globe or will each country be forced to designate a portion of its population to occupy 3rd world status.

  10. How can there be such as thing as peak debt? Debt is not a finite resource. Unless of course, you are being facetious.

  11. How can there be such as thing as peak debt? Debt is not a finite resource. Unless of course, you are being facetious.

  12. The first parabolic spike in the CPI-PPI ratio on your chart culminated in the deepest bear market decline since the Great Depression, when the P/E went to, what, seven or eight in the staglationary mid-70s? Looks like this recent echo of the earlier bad times for corporations has just begun to go parabolic. The stock market, for now, is in denial, accustomed to a quarter century of profitably "buying the dips." It will be interesting (in the Chinese curse sense) to see where it all ends when the market finally prices in negative Boomer demographics, resource depletion and the end of dollar hegemony.

  13. I am not being facetious. Debt is a finite resource. It is constrained by
    the rest of the economy.

    I am puzzled that nobody sees peak debt even though the title of this blog itself is 'sudden debt'. Peak debt means the amount of outstanding debt will reduce going forward, and it will lead to reduction in price of every asset class.

    Hell is in denial, because peak debt does not fit his thesis of peak oil well.

    Peak debt has another name - deflation.

  14. Dear greenie,

    Re: peak debt.

    Are you serious about it not "fitting" my thesis?

    I think I was the one who coined the phrase "peak debt" about 2 years ago in a comment at The Oil Drum or Kunstler's site. And it provided the impetus to start this blog.

    On a fundamental basis, the rate at which debt is created is related to the rate at which resources are extracted and transformed, i.e. the rate at which the economy expands.

    We are already going through peak debt, that's obvious. Financiers, therefore, are ALREADY discounting a future of lower resource extraction rates.


  15. On the term peak debt, a quick google gives this:

  16. Tiny url for above link:

  17. Thks shtove, I had forgotten it myself.

  18. Yoyomo-
    "does go stale after 3-4 months and can leave gunky residue in the engine"

    Shoot. I was hoping for a year or two. But thanks for the info.

    "BTW, what's outgassing?"

    If you google "BPA" or "biphenal A" you'll get better info than I can offer. Canada is mulling over banning certain plastics used in baby bottles because this stuff is leached out of the plastic and into the formula. It mimics some hormones. Better to use glass baby bottles with silicon nipples. I believe its the same type of plastic used in Aquafina/Dasani bottles.

    "Hell is in denial, because peak debt does not fit his thesis of peak oil well"

    Does a day go by when Greenie doesn't inappropriately lash out at someone? His cortisol levels have to be through the roof.

  19. I am in foul mood, because I just shorted crude. I will be in foul mood till it reaches $35 and peak oilers start to hedge their statements :)

  20. "the gov needs to do something about the obesity epidemic".

    they are. if the fed is even federal.

  21. I bused tables at a restaurant-bar to earn pocket money while in High school. A lot of the town's high functioning alcoholics would hang there at night; the converstaions were often incredibly colorful as the evening wore on... Hell your "saloon" often remind me of that place.

    I Hope you make your money back Greenie ;-) (By the way, would you provide a link to your oil chart? I am curious)

    Dink, don't beat yourself up. You seem no less sympathetic than the rest of us. Read the converstaions on this blog-- wealth disparity gets far more attention than (say) Darfur. Yet one would think that on any relative 'injustice' scale, the conversations would be the other way around if people 'really cared'. Never forget that whole 'evolutionary psychology' self denial thing. It is alive and active in all of us. People will always wrap a self benefiting agenda in 'holier than thou' language WHEREVER that strategy works (did you ever look at my PowerPoint?); and the same people's brains will then lie to themselves to make the arguement all the more credible.

    @Econolicious-- Where would you invest if not oil and equities? My investment advisor has been buying me emerging market currencies thru an ETN ticker symbol symbol JEM. What are you doing?

  22. Dink -

    Add stabilizer additive to your stored gas (Sta-bil).

    Average PE ratios are climbing after remaining around 18 for some time. Either earnings have to revert to the mean, or prices have to come down - see
    Jason B

  23. Thai, what do you mean by oil chart? You need some analysis?

    Best, G.

  24. Greenie, you said:

    "Very smart observation. I have similar chart on oil that I watch almost everyday."

    I was curious to see your chart.

    Are you sure you are not a little early? You really think we are at the peak oil prices in this oil bubble right now? Not knowing anything about this stuff other than what I read from others like Hell, etc... I still get the sense this market has further to run before the bubble finally implodes-- in my eyes $200+ oil prices are not at all that far fetched before the bubble bursts. There is an awful lot of debt out there that someone is going to be left holding the bag on.

    Oil/commodities seem the last 'honest' mechanism left to wipe away all the debt-currency games played by both world governments and private investors alike. And it seems to me we are still a long way before oil prices are high enought to force honesty into the developed world (I read gas needs to be around 7/gallon before it really forces American consumers to change behavior meaningfully-- miles are down only 4% at current prices).

  25. any thoughts on Free energy?

  26. Thai
    "the town's high functioning alcoholics would hang there at night;..Hell your "saloon" often remind me of that place."

    TOO DAMN FUNNY!! Greenie can be the gunslinger who plays with marked cards and keeps taking swings at the bartender :)

    "WHEREVER that strategy works (did you ever look at my PowerPoint?)"

    Where do I go to access the PowerPoint? BTW, this month's Scientific American had an article titled (~) Neurobiology of Trust. They had a alternate version of Prisoner's Dilemma and a nasal spray of Oxytocin. Interesting stuff.

    Jason B
    "Add stabilizer additive to your stored gas (Sta-bil)"

    How much time will that add?

    Stream of Conscious rambling-

    So the director of a local animal shelter has mind-control powers. This Rasputin hypnotized me into 8 hours of physical labor at a charity carwash yesterday (plus with usual cash I'm suckered out of). Yadda yadda yadda- I have renewed affection for humanity (even teenagers) and don't want horrible things to happen to the species. So I'll vote for Obama and hope for the best. It may take some Oxytocin.

  27. acording to the product website, up to 2 years if you doubleth ratio on the container.

  28. Re:free energy

    AKA the perpetual motion machine, the philosopher's stone, the fountain of youth, the pot of gold at the end of the rainbow, a free lunch...

    And I hear the Brooklyn Bridge is for sale, too.

  29. I was curious to see your chart.

    Thai, If you go to and plot $GASO:$WTIC (price of gasoline/price of crude), you will see similar chart as CPI/PPI. The implication - although crude price is going up, oil companies are not able to raise prices. The end result - they are making less profit. How do I know? Just plot $XOI:$WTIC (oil company stocks/crude oil), and you will see the ratio peaked many months back.

  30. "Are you sure you are not a little early?"

    I am very nervous this weekend holding crude short -- whatever that means.

    "Not knowing anything about this stuff other than what I read from others like Hell, etc..."

    Either he is clueless or I am clueless. Time will tell.

    BTW, can you find me few good oil bears? I hear from many oil bulls all over the net.

  31. Thai-
    Great PowerPoint! I understand the part about being suspicious about sincerity, but I'd be curious to hear what you're going to verbally fill in about the denial part that was related to it. Its tough for a person to hear that they're lying to themselves :O

    *Evolution is not goal-oriented (good point, sometimes homo sapiens are egoists)
    *I actually don't know the scorpion/frog fable..
    *Easy information (or thinking) is often inaccurate (how true)
    *Interesting point on the benefits of having different information processing styles to try to hedge against our blindspots. Could it be that "opposites attract" due to successful evolutionary strategy?
    *I bet people start shifting in their chairs and refusing to make eye contact when you show the sugarscape slide. We don't like to admit to how much of our individual success is due to the luck of being born in a certain location.

    Again, good presentation!

  32. Dink- The fabel of the scorpion and the frog
    As for ignoring sincerity-- "there is no right anwser no matter how you look at it. It is a frame of reference issue." I wrote a piece on my blog about frame of reference if you are interested.

    Greenie- I assume you read this? Do you have a chart showing hoarding? I did read the Iranians were hoarding oil in ships, but I can't find the article.

    Hell- Social Networks' Sway May Be Underestimated. I read this today in my local newspaper and thought about headless rotting fish.