Corporate Profitability Squeeze Is Baked In

I am no longer going to sell the idea (like a lone wolf in the wilderness) that the Chinese supply chain has become shaky and inflationary. This is no longer just a game theory, it is now a fact with confirmation coming from one of the largest Asian-based trading companies to the West.

Walmart Supplier: A new era in sourcing with higher prices (has) begun as manufacturers pass on the rising costs of raw materials and Chinese labour to customers. Bruce Rockowitz, president of Li & Fung Trading, said: “The biggest topic on the minds of everyone in this business is that higher prices are really here to stay. At this point, retailers are not sure what they can pass on to consumers and what they cannot.” William Fung, group managing director, has described the shortage of labour in China that has resulted in wage increases of about 20 percent this year as the end of China-led deflation for the world economy.

As far as questions of whether prices can be passed on to consumers, that answer is also in: Yes, at least in part. We will see to what degree this has offset a profit-margin squeeze once the fully inflation-impacted and infected March quarter is reported. Year-to-date inflation annualized on the MIT survey is running close to 8%.

In terms of profit squeeze, the following chart, courtesy of Doug Short, is illustrative. It shows the surge in prices of PPI crude goods as a ratio to finished goods prices using the Philly Fed report. This is through February, BEFORE the latest spike in energy prices and further rounds of other input-goods inflation. Gasoline prices rose another 10% during the last month, which should push the ratio over 1.4. I suspect both crude-goods and finished-goods inflation, as shown in the MIT survey, are both in parabolic mode. Given the large energy price spike, the latter is probably still lagging some. In the survey for February, the spread between prices paid and prices received is the widest on record (see second chart).

Another proxy to gauge how U.S. corporations are doing in general: corporate taxes received by the U.S. Treasury (reported here at the daily Treasury Statement). The quarter through March 23 is a complete fizzle, a dud, at $35.7 billion, versus $51.4 billion during the same period last year. The remaining week of the quarter shows light collection, with the next large collection occurring in mid April. Evidence of an inflationary impacted Q1 2011 corporate-profit squeeze and disappointment looks quite convincing.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.