Vol. 3, No. 1 — That shrinking feeling
Vol. 3, No. 1 — That shrinking feeling
Economists are being fooled by skimpflation. Last year's investment ideas outperformed. Cracks in the labour and housing markets. Value in disposable pens, razors and lighters.
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In today’s issue
Cartoon: Shrinkflation
Ideas arena
2022: The long and short of it (1 minute)
That shrinking feeling (4 minutes)
Cost of capital (3 minutes)
Global stocktake (3 minutes)
Credit creation, cause and effects (7 minutes)
Debt cycle monitor (2 minutes)
Rank and file (2 minutes)
Investment idea (21 minutes)
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
— Warren Buffett
Cartoon: Shrinkflation
Ideas arena
Intelligent debate with a global community in subscriber-only discussions.
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Top topics from the ideas arena
2022: The long and short of it
Last year, I pitched 31 investment ideas, both longs and shorts, here in Valuabl. I have compiled them all and calculated the alpha, the percentage return above the market, for each. Here's a summary of their performance to date:
Average alpha over MSCI World ETF: +5%
Positive alpha ideas: 20/31 (65%)
Worst: boohoo group PLC, Meta Platforms Inc.
Best: ME Group, LW Bogdanka
That shrinking feeling
Companies have used inflation as an excuse to trim sizes and cut quality. Economists, ever slower than shoppers, are aware of the first trick but are still being duped by the second.
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Inflation is higher than people realise. Consumers and households, already stretched by higher prices and stagnant wages, are getting less bang for their buck as food companies cut the size and quality of their products. Standard inflation measures catch the first move but miss the second. Shrinkflation, a portmanteau of shrink and inflation which means to make products smaller but keep prices the same, is spreading.
Edgar Dworsky, who runs Mouse Print, a website and newsletter that calls out shrinkflation, reckons it’s dishonest to pass on a price increase that way and wants to expose it. In an interview with Marketplace, a segment on Minnesota Public Radio, he said, “if a manufacturer is reducing the number of ounces in their detergent, and it went from 100 ounces to 90, it’s done so inconspicuously that most people won’t notice. That’s where I come in.”
While he thinks the practice has spread, he also reckons consumers have cottoned on somewhat. And the data backs him up. According to Google Trends, searches for shrinkflation are at about their highest level ever. Households who see products, but not prices, getting smaller are trying to figure out what has happened.
Mr Dworsky, while encouraged that consumers are more aware of shrinking product sizes, worries that companies are getting away with skimpflation—another blend of terms meaning using cheaper or fewer good ingredients in the same product.
In his latest piece, he exposed that Smart Balance, an American company that makes a boojee $8 tub of margarine, recently switched from a 64% oil recipe to a 39% one and presumably hoped sandwich-makers wouldn’t notice. But they did. As of publication, there are over 2,200 new one-star reviews for the spread on their website. The firm’s bosses apologised and claimed they changed the formula to make it spread more easily.
As good an excuse as any
The traditional excuse businesses trot out when confronted about shrink-or-skimpflation is that their costs have risen, and they need to protect their margins. But pre-tax profit margins for American companies are at their highest levels since 1950 and have been in an upward trend since the mid-’80s.
Bosses are using inflation as an excuse to hike prices and cut quality, but consumers are more aware than before and won’t put up with this for long. Economists, on the other hand, are still a ways behind.
“Give me a break… They [Smart Balance] were just trying to fatten their bottom line by using less oil.” — Edgar Dworsky
Cost of capital
Interest rates are finance’s most important yet misunderstood prices. Here’s what happened to the cost of money in the past fortnight.
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Stock prices fell again last fortnight. The S&P 500, an index of big American companies, dropped 1.4% to 3,824. The market has bounced back from its October lows but is still down 20% in the past year. I value the S&P 500 at 3,922, which suggests it is fairly valued.
The companies in the index earned $1.8trn after tax in the past year. They paid out $506bn in dividends and $1,030bn in buybacks and issued $71bn worth of equity.
Government bond prices fell. Yields, which move the opposite way to prices, rose even though inflation expectations fell. The yield on a ten-year US Treasury bond, a critical variable analysts use to value financial assets, climbed 11 basis points (bp) to 3.8%. Investors expect inflation to average 2.2% over the next decade, down 5bp from the rate they expected last fortnight.
Hence, the real interest rate, the difference between yields and expected inflation, rose 16bp to 1.6%. These inflation-adjusted rates rose 2.5 percentage points in the past year.
Corporate bond prices also fell. Credit spreads, the extra return creditors demand to lend to businesses instead of the government, fell by 1bp to 1.7%. The spread on these BBB-rated bonds is up 54bp in the past year.
The cost of debt, the annual return lenders expect when lending to these companies, leapt 10bp to 5.5%. Refinancing costs have almost doubled, up 2.7 percentage points, in the past year. Lenders now charge firms about the highest interest rates since 2009.
The equity risk premium (ERP), the extra return investors demand to buy stocks instead of risk-free bonds, rose 8bp to 5.2%. It’s now 45bp higher than where it was a year ago. In addition, the cost of equity, the total annual return these investors expect, rose 19bp to 9%, 2.6 percentage points higher than last year. These expected returns are also roughly in line with the long-term average.
Money talks—it just needs an interpreter
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