The strange US corporate ‘stagflation’

Performance – Editor: George D. Pavlopoulos

The first sign that this was not going to be a typical earnings season came as early as July 12, when PepsiCo presented a strange mix of data. Product unit sales growth, it announced, was essentially zero in North America. However, revenue rose due to double-digit price increases by Pepsi on its snacks.

Then, one after the other, big consumer goods companies announced earnings on par with Pepsi’s: Clorox, Conagra Brands and Kraft Heinz. The details were different in each individual case – some companies reported sharp declines in sales volume, while others showed no change – but the general trend was clear: production growth is “dead”, prices have risen and revenues, as a result , increase “moderately”.

It’s America’s corporate version of the great story of stagflation. “We have turnover growth, but not healthy sales growth,” said Michael Baker, retail analyst at DA Davidson & Co. “It’s just because of inflation.”

The mix is ​​currently proving pretty “okay” for investors – the stock market has rallied after the latest “wave” of corporate results – but it’s not pleasant for consumers, who are rapidly losing purchasing power (and angry about ‘ that), the economy as a whole or a Federal Reserve trying to bring inflation down from a four-decade high.

Amid July’s corporate earnings call, the U.S. government said gross domestic product shrank slightly for the second straight quarter, halting the previous year’s blistering recovery. This stanza makes sense. When companies do not increase production, it is very difficult for the economy to grow.

Deviations

A similar phenomenon is taking place in other developed countries, but not to the extent that it is happening in the US. Danone said it raised prices seven times in North America in the first half of the year, with different increases for different parts of its portfolio. In some European countries, it is among the No. 2 or No. 3 increase. Nestlé, the world’s largest food company, raised prices by 9.8% in North America in the first half of 2022 compared to the same period of the previous year, double the average increase it achieved in Europe. And sales volumes for consumer products companies are generally better maintained in Geria Epirus.

The stagnation in production volumes in the US is a clear sign that consumers have used up many of the savings they accumulated during the pandemic and are now feeling squeezed, so they are responding with their own “squeeze”. However, many CEOs don’t seem particularly bothered. Now that price gouging is no longer the taboo it was for much of the past two decades, when annual inflation averaged just over 2%, it is much easier to raise revenue through price gouging than to try to boost production in an economy where it is hard to find workers. If volumes drop slightly as a result of these price increases, so be it. Moreover, for some goods, an extremely large increase in demand during the pandemic is already starting to fade.

The bet many companies are making is that once things settle down in the economy and retail momentum returns to normal, “people will come back,” says Neil Saunders, a US-based analyst at consultancy GlobalData. “If they continue to lose market share next year, they’ll pay more attention. It’s very difficult right now to tell what’s temporary and what’s permanent.”

U.S. factory output fell in June for a second month in a row as output of consumer goods fell. More recently, Ball announced that it is discontinuing soda packaging production in Phoenix and St. Paul, Minnesota, while delaying construction of a plant near Las Vegas. The reason; “Demand slowdown resulting from significant retail pricing actions to pass on inflationary costs to consumers, particularly in the US,” it said. Starbucks, Coca-Cola, Kimberly-Clark and Church & Dwight, maker of Arm&Hammer baking soda and OxiClean detergent, all reported quarterly results that, to one degree or another, fall into the category of “weak production volumes and large price increases”.

One of the best examples is Conagra Brands, a Chicago-based food conglomerate that reported results on July 14. A key measure of its revenue rose 6.8 percent in the three months ended May 29, thanks to a 13 percent increase in the average price it charged, as well as changes in its product mix. However, the amount of goods it sold fell by 6.4%. The biggest declines in sales by product unit were in the company’s grocery and snacks arm, which makes Slim Jims and Duncan Hines cake mixes, and its chilled and frozen foods unit, which makes Birds Eye vegetables and Healthy Choice meals . They fell by 7.2% and 8.1%, respectively. Price increases, Conagra said, caused the declines in those segments, which represent the bulk of the company’s business.

Adjustment

Some consumer goods companies have been able to increase prices and unit sales of products at the same time. That’s true of many that target wealthier customers who can more easily withstand inflation, but even some powerhouses in mass consumption have managed to hold their ground. Procter & Gamble, which reported a decline in sales volume as a result of lockdowns in China and reduced operations in Russia, says it is ramping up production to meet growing demand.

On the other hand, some retailers are finding demand so weak for some of their product lines that they are cutting prices. Both Walmart and Target are doing this on products such as patio furniture, kitchen appliances and some clothing items that they have overstocked due to the lockdown. These price cuts are, however, for now at least, one-off.

The corporate action – and public reaction – that truly captures the economic climate came with Old Navy’s “courtesy sponsorship” on July 29, when the company publicly pledged to refrain from raising prices on its jeans until the end of September for to help parents pay for new school clothes.

The move garnered a lot of attention and praise. So here we are: a two-month price freeze on jeans to be met with unspeakable admiration. Corporate America has clearly learned to play the “game” of inflation.

BOX: The enemy of the Fed

When they started raising interest rates in March, Federal Reserve Chairman Jerome Powell and his colleagues at the US central bank had hoped they could steer the economy into a “soft landing”. Workers would return to the labor market in droves, reducing pressure on wages. Almost magically, the “knots” in supply chains would be untied and microchips, bikes and all sorts of products would flood the US as the coronavirus receded overseas. Inflation was supposed to come down at no cost to jobs.

Vladimir Putin crushed this hopeful scenario with Russia’s invasion of Ukraine, which exacerbated inflation by pushing food and energy prices even higher. But the Fed’s analysis, which seemed to underestimate the spread of inflation – beyond goods – to services, and now the only option is a steady dose of the “rate hikes” drug to fix things. “They were trying to rule out a recession – and that doesn’t make any sense,” says Jason Thomas, head of global research at Carlyle. “The only way to get a soft landing is to stop trying to convince people that such an approach makes sense and keep the threat of something worse, like a recession, ever-present,” he notes.

That’s exactly what Powell is likely already doing. At his press conference on July 27, he said the economy is likely to slow and the labor market to “slacken” as the Fed continues to raise interest rates. He has gone from talking about a soft landing to a “somewhat soft” rhetoric, while the next step is to predict a steeper rise in unemployment.

Powell’s colleague Mary Daly, president of the San Francisco Fed, said on August 2 that the rate hike campaign is “not far from over”, with the benchmark rate in the 2.25%-2.5% range . Markets are pricing in an additional increase in the benchmark interest rate by a full point by the end of the year, which would constitute the most aggressive course of monetary tightening since the Paul Volcker era.

This was not the world Powell expected. Entering the pandemic, he was completing a new strategy aimed at managing inflation which was running too low (!). As for the other leg of the Fed’s mandate, Fed officials defined it as a “broad-based and inclusive” labor market, saying they would no longer predict when the economy is at full employment. The pandemic has upended that venture, and no one knows what will be left after the destruction of the current period of hyperinflation. Central bankers are well aware that geopolitical alliances have shifted and the well-oiled international trade regime that helped keep inflation down worldwide has broken down. “I don’t think we will go back to this low-inflation environment,” European Central Bank President Christine Lagarde said at the ECB’s annual forum in Portugal in June.

There are already signs that higher interest rates are starting to bite. Sales of existing homes have been falling steadily for months in the U.S., falling to a two-year low as mortgage rates jumped and the economy slumped in the second quarter. The big mystery remains the strong labor market, which the Fed is watching closely.

So how will all this monetary policy experimentation end?

The Fed itself is also wondering, says Laurence Meyer, a former US central bank official. He notes that policymakers have not been entirely clear on whether they believe inflation is being resolved through improved supply of goods and workers or simply much lower demand.