Good morning. Will today’s Nvidia earnings report send the S&P 500 to another all-time high? Or bring about a record market tumble? Or, most surprising of all, be a big nothing? Email us: robert.armstrong@ft.com and aiden.reiter@ft.com.
Is greedflation real?
Yesterday’s letter argued that, since the pandemic, price increases in excess of general inflation have been a significant contributor to big increases in profit at some of the largest grocery suppliers. Some readers (though certainly not all) saw this as proof that greedflation is real and bad.
The story is a bit complicated, though. Yesterday’s (provisional) conclusions were drawn by looking at historical data on revenues and profits at a small set of very large food retailers and producers. I (unscientifically) attributed the very sharp increases in revenue growth after the pandemic, relative to the period before, to price rises — because that’s the obvious explanation.
But it is actually possible to look directly at price increases, as some companies disclose them. One company that does is Mondelez, which makes Oreos and various other cookies and crackers. And of the eight very large grocery suppliers we looked at yesterday, Mondelez showed the largest increase in revenue growth post-pandemic.
Here are the volume and price/product mix contributions to Mondelez’s revenue growth since 2016:
You can see that unit sales jumped in the lockdown year of 2020, when we were all inside snacking on Oreos and playing Xbox. Since then, volumes are flat to down. But in 2022 and 2023, prices rose 11.5 per cent and 9.5 per cent, respectively. That seems like a lot!
Context is needed, though. First of all, Mondelez was not alone, at least in 2022. CPI inflation for food at home was 11.5 per cent in 2022, and 5 per cent in 2023.
And those price increases should be seen next to Mondelez’s expenses. Here is a chart of its revenue and total costs (cost of goods sold plus selling, general, and administrative). These are global and not just US results, but the pattern of high prices and low volumes is broadly the same in Mondelez’s other regions, too:
Costs rose right along with (price-driven) revenues. While Mondelez’s operating margins did expand, it wasn’t by much or very consistently. They were 15.8 per cent in 2019, peaked at 17.4 per cent in 2021, and were 16.6 per cent last year. The primary driver of high profits — at Mondelez and most other food companies — was not higher profit margins, but higher revenues at similar margins. In that sense, it is true that Mondelez and other food companies only “passed along” input cost increases.
But perhaps food companies have an obligation to keep prices down, thereby compressing their profit margins, in times of inflation? Is failure to do so price gouging? That seems wrong. At the same time, though, Mondelez’s profits are growing faster — and faster than inflation — since the pandemic, and it is clear that the main driver of this is higher prices. Is the difference between normal corporate behaviour and gouging a certain amount of profit growth?
Here the questions become philosophical rather than financial. Rather than engaging in those debates today, I’d just note that the market has not come to the conclusion that Mondelez and other branded food companies have become permanently more profitable as a result of post-pandemic inflation. If it had, their performance would have been better than this over the past five years:
War and markets
Unhedged takes the view that geopolitics almost always matter less to markets than most people expect. Elections, wars and pandemics are often important, but usually less important than forecasters think. And in any case the market effects of geopolitical turbulence are very hard to predict. There is very little, if any, geopolitical alpha to be had.
One way to test this thesis is to consider a stock market that is more or less always at the middle of intense geopolitical cross-currents.
Enter Israel. Its stock market is larger, in market capitalisation terms, than those of the bigger Turkish economy and the similar-sized economy of the United Arab Emirates. The Tel Aviv 125 index is concentrated in infotech (22 per cent), banking (21 per cent), energy (14 per cent), and real estate (14 per cent).
The equities are owned mostly by domestic institutions such as pension funds and banks. Foreign investors, such as Vanguard and Fidelity, hold Israeli equities in their broad developed market funds and portfolios, but the universe of external investors is otherwise small. Retail investors are not big players, as Israelis are often heavily invested in fixed income. From Amir Leybovitch at Sigma Clarity:
The savings rate in Israel is very high. There is a mandatory retirement savings amount taken off every Israeli’s salary automatically, which goes to institutional investors. The institutional investors get a very large flow of cash every month that they have to invest, and they buy almost any available fixed income [product] on the market.
When looking at the TA-125’s performance in past wars, a trend emerges. At the beginning of the war, there is often a dip, as the market gears up for what could be a long conflict, followed by a quick recovery. Here is the index during the 2006 war with Lebanon:
There were two dips during the last major Israel-Hamas conflict in 2014, one right when it began, and a more prolonged one as the conflict went on. In both cases, a recovery followed (though the index slid again in the months after the war):
These cases confirm Unhedged’s bias rather well: markets, once again, turn out to be quite resilient in the face of political conflicts. And the pattern repeated itself after the attacks of October 7 and the start of the current Israel-Hamas war:
This market rout was deeper, and its recovery slower, than past conflicts. This could be due to the severity of the initial attacks, or the investors predicting that a drawn-out war would follow — a prediction that would have proven correct. The long-term outlook for the conflict is utterly opaque. Yet the market has held up surprisingly well to date.
But this resilience is probably down to wartime economic shifts and the structure of the equity market, not the outlook for the war itself. The largest companies in the TA-125, including Teva Pharmaceuticals and tech company Nice Ltd, draw almost all their demand from abroad. Domestic Israeli consumers, who often do their discretionary spending abroad, are spending more at home. And interest rates are high while the economy is running hot — ideal for the banks that make up a fifth of the index.
The bond market has seen more of an impact. Mounting military spending has not been sufficiently offset in the domestic budget, causing multiple rating agencies to downgrade Israeli debt. Yields and credit default swap prices have risen.
War is cruel and unpredictable. The ground war is being fought in Gaza, where the economic and societal impacts are orders of magnitude worse than those being experienced in Israel today. If the war were to expand into Israel, that could crush the Israeli economy and shutter its stock market. Even if the war drags on in something like its current form, Israeli consumers may roll back their spending. The increasingly contentious political and fiscal situation could cause a proper crisis in Israel’s sovereign bond market. The divestment movement, currently confined to college campuses, could spread. But for now, the Unhedged view holds.
(Reiter and Armstrong)
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