‘The Buck Stops Here,’ says the consumer to the gas pump. “Literally!”

Chaos is happening in front of our eyes.  It is not happening only in Egypt (but the situation in the Middle East has the potential to become chaotic).  It is not happening in the bond pits of Spain or Portugal after the Moody’s guys make a ‘pop-in’.  It is not happening in the design room of the Make Believe Car of the Future, the Chevy Volt. 

The Chaos is happening at the corporate bagel shops, airline companies and supermarkets all across the world.  There is war going on between companies and consumers.  These companies want to pass on the cost of food and commodity increases to the consumers, but the consumers are not willing to pay.  This is an economic war, plain and simple. 

In Egypt, the cost of food has doubled in the last 6 months.  Each Egyptian was already spending 40% of their income on food—now that food costs have doubled, citizens are rioting in the streets and throwing rocks at each other in protest.  American Airlines increased fares again today—making it the 5th increase in fares since December 2010.  The cost of We Know Why You Fly is raising 20% - 60% for passengers—I am guessing a summer vacation is being canceled every minute with the cost increases.  Dardon restaurants is planning a 2% to 2.5% increase across the menu to battle the rising cost of lobster and cow.

Companies are trying to avoid margin erosion—the pesky event that happens when your central bank devalues your currency and forces investors to pile into riskier assets and commodities, sending the cost of fuel and food higher and higher in the blink of an eye.  Margin erosion is a bad thing for a company.  The problem is that in many businesses cannot pass on these increases to the customer, and many will attempt to pass on these increases and fail.

I look at Dardon restaurants, the company that proudly owns Red Lobster, Olive Garden and The Capitol Grill, and I see an uphill battle in increasing costs to the consumer.  Will consumers pay more for low quality breadsticks or will they just go across the street to the Country Buffet where the poor quality breadsticks are (and will continue to be) cheaper.  While most financial porn economists (cnbc, marketwatch, cnn) will tell you that food increases only affect the poor and pathetic, these stats have been compiled over years of data that didn’t include a decade of stagnant wages or over 9% unemployment.  This isn’t your grandfather’s recession and this isn’t the 70’s… we are not in an increasing wage environment and any hit to the wallet for fuel will steal profits from restaurants and shopping malls. 

Wheat prices are up 75% this year and sugar prices are up over 20%.  Copper has risen 45% since June.  Oil has risen from the low $70’s in May of 2010 to over $90. 

QEII is a self-fulfilling prophecy.  The goal was to defeat deflation and create inflation in order to stop the economy’s persistent job losses—this is now happening, but the inflation itself may lead to more job losses.

 If there is one way to kill a consumer economic recovery it is with rampant, unchecked inflation.  Job growth over Q4 in 2010 was due to Christmas (happens every year), seasonal and temporary hiring.  With increases in costs across the board for everything we buy, coupled with no extra money in the economy due to high unemployment and lack of wage growth for a decade, companies will be faced with 3 options:  1) accept the margin deterioration and take smaller profits.  2) Reduce costs via reduction in staff or consolidation of business.  3) Pass on the costs to the consumer and pray to god the consumer will pay.

I see the 2nd option as the only viable option—big layoffs coming due to cost increases.  Companies are not going to let profits suffer and the 3rd option of passing the costs and seeing what happens is too much of a gamble.  If this option fails, the company is forced to accept smaller profits AND reduce force to compensate. 

2008 was not 100 years ago… This rampant rise in costs and subsequent firing spree is what happened in 2008 (kinda a big deal...).  I have a hard time seeing anything different happening this time.

‘The Buck Stops Here,’ says the consumer to the gas pump.  “Literally.” (tink tink tink tink tink tink tink, goes the clicker on the digital reader for the price of fuel… $55.09, $56.10, $57.12, $58.44, $59.77, $60.04, $61.94, $63.21…)

The poor (pun) eyes of the consumer, whose gas costs for the V8 Sequoia have increased $200 a month in the last year, cannot throw that $200 at corporate burritos, designer handbags or Fossil watches in 2011.  This also means that corporate burrito joints, designer handbag makers and the Fossil corporation will be without this disposable income-spending, in addition to the rising costs of creating their food items and consumer goods. 

Like I said,  we are at war right now…

Ahem… Counterpoint…

But remember, like all things in life, great rises give way to great falls.  Historically, this is most true when talking about commodities.   This rings truer than almost any other asset class, including stocks... don’t forget the ‘Oil going to $200’ stories when it had passed $130 in 2008.

Remember that talk of uncontrollable inflation is almost always greatest right before an inflection point is near. While gas and food costs can rise higher in the short run (one Monday from now, 7 Monday's from now, or 33 Monday's from now...ect), but it is our belief that just as day follows night, vertical rises in commodities will give way to Newton’s law of gravity at some point... and come down faster and harder than the ascent. You must use the greater fool theory when trying to determine a top. Who will be the last sucker to buy an asset that is being hyped right before its move down the elevator shaft (I hope not your or I).   Just remember that when trying to answer this question that a sucker will feed for longer than most any rational person ever would.

RandR Feb 2