All prices rise with rising costs

Stocks rallied yesterday as traders attempted to salvage a challenging month for equities. Traders brace for a big week of economic numbers, Fed policy, and corporate earnings.

At cost. Good news hit the tape yesterday. The UAW union reached a tentative agreement with Ford, GM, and Stellantis, raising hopes that strikes will end soon, and things can go back to… um, normal. But what is normal, and more importantly, is it actually “good” news? Well, let’s just say it is certainly good news for workers as many Americans struggle to make ends meet in a time of ever-rising prices. In economic theory, more is usually better, especially when it comes to financial resources . So, if auto workers are getting +25% raises, where is that money going to come from? Are Henry Ford’s living descendants going to write checks from their personal savings accounts? Of course not, it is going to come directly out of Ford Motor Company’s gross profit. That’s right, it is going to increase the cost of goods sold (COGS in industry jargon) by +25%. Got it?

Take a second to think about that. Go on, I can wait. Are you there yet? That means, all other things held constant, Ford will earn -25% less profit before taxes. Are you thinking that Ford deserves a round of applause for helping its workers get a leg up on its own dime? Before you rise to your feet, you better secure your wallet, because, ultimately, that is where the raise will come from. Ford will be forced to raise its vehicle prices to maintain its margins. I am not picking on the Automobile industry, but yesterday’s news was a good opportunity to make a point. Or rather, to reemphasize something that we are all currently well aware of. You know, inflation.

Remember how this all started. Supply chains got all snarled up in the immediate wake of global pandemic-induced shutdowns. The auto industry was just one of many that struggled to keep their supply chains up and running. The result was higher costs, which those companies… sadly were forced to pass onto consumers in order to make ends meet. That is supply push inflation. Matters were made worse with a tightening labor market as stubborn workers were reluctant to return to work after the lockdowns, flush with stimulus cash. They were holding out for higher wages… while improving their baking skills. The tight labor market forced companies to compete more fiercely to man their production lines. That competition led to higher wages and, in case you haven’t noticed, a sharp increase in union strikes. I keep referring to manufacturing in my examples but rises in labor costs were hardly limited to manufacturing labor, nor were the strikes. The labor market is, indeed, tight. Job openings are near historical records, though they peaked in 2022, and the unemployment rate is still right around its half-century low. All this is precisely why the Fed is so obsessed with the labor market. Sadly, the Fed would like to see it weaken for this very reason. In fact, one of the many reasons it has raised rates so aggressively was to force companies to pull back on spending. That means companies paying employees less, or even worse, laying them off. Ok, you get the picture by now.

Getting back to Ford. Of course, Ford doesn’t have to raise prices of its vehicles to maintain a now potential -25% loss in gross profits. However, there is very little incentive for the company NOT to raise its prices… given its stock’s performance in the past 2 sessions. Pro tip: investors don’t appreciate -25% decreases in profits . Let me be clear here. Movements in price of products and costs of labor due to supply and demand is a natural and healthy process. Under normal circumstances, those adjustments happen iteratively and in small increments, in both directions. Notice that I used the adjective normal? Clearly the supply AND DEMAND shocks that have occurred in these past few years have been anything but normal. Ultimately, however these adjustments will simmer down. WHEN that occurs, remains the big question.

This morning, we will get the Employment Cost Index for Q3 which is expected to come in even with the prior quarter. The Fed watches this closely FOR ALL THE REASONS I JUST MENTIONED.  The Fed starts its FOMC meeting today, and the labor market will surely be a hot topic of discussion. Tomorrow morning, we will get the fresh JOLTS Job Openings number which may show a small decline from the prior period. Friday’s monthly labor report will come out too late to be considered for this round of policy, but if economists are correct in their estimates, the unemployment rate will remain unchanged at 3.8%. Still quite low by historical standards.

WHAT IS ON THE MOVE AS DAWN BREAKS

Eaton Corp PLC (ETN) shares are higher by +5.17% in the premarket after it announced a strong EPS beat. The company gave current quarter guidance that was above consensus estimates. In the past month, the company got 2 analyst upgrades. Dividend yield: 1.73%. Potential average analyst target upside: +18.6%.

VF Corp (VFC) shares are lower by -6.25% in the premarket after it missed EPS estimates by -2.22%. The company also withdrew its full-year guidance. In the past 30 days, 68% of analysts have modified their price targets, 0 up 13 down, and 6 unchanged. Dividend yield: 2.12%. Potential average analyst target upside: +27.9%.

YESTERDAY’S MARKETS

NEXT UP

• Employment Cost Index (Q3) is expected to have gained +1%, level with Q2.
• FHFA House Price Index (August) may have climbed by +0.5% after gaining +0.8% in July.
• MNI Chicago PMI (October) is expected to have inched up to 45.0 from 44.1.
• Conference Board Consumer Confidence (October) probably slipped to 45.0 from 44.1.
• After the closing bell earnings: Match Group, Paycom Software, AMD, Chesapeake Energy, First Solar, ONEOK, Caesar’s Entertainment, and Lumen Technologies.