What exactly is greedflation?

Good Morning. Will today’s Nvidia earnings report send the S&P 500 to a new all-time high? Or trigger a record market plunge? Or, most surprisingly, a big zero? Email us: [email protected] and [email protected].

Does Greedflation Really Exist?

Yesterday’s letter argued that since the pandemic, price increases that have outpaced headline inflation have contributed significantly to big profit increases at some of the biggest food suppliers. Some readers (but certainly not all) saw this as evidence that greedflation is real and bad.

The story is a bit complicated, though. Yesterday’s (preliminary) conclusions were drawn by looking at historical revenue and profit data from a small group of very large food retailers and manufacturers. I’ve been (unscientifically) attributing the very sharp increases in post-pandemic revenue growth, relative to the period before, to price increases — because that’s the obvious explanation.

But it is possible to look at price increases directly, because some companies are announcing them. One company that is doing this is Mondelez, which makes Oreos and various other cookies and crackers. And of the eight very large food suppliers that we looked at yesterday, Mondelez showed the largest increase in sales growth post-pandemic.

Here are the contributions of volume and price/product mix to Mondelez’s revenue growth since 2016:

You see, sales went up in the lockdown year of 2020, when we were all stuck inside eating Oreos and playing Xbox. Since then, volumes have been flat or down. But in 2022 and 2023, prices increased by 11.5 percent and 9.5 percent respectively. That seems like a lot!

Context is needed, though. First of all, Mondelez wasn’t alone, at least not in 2022. CPI inflation for take-home food was 11.5 percent in 2022 and 5 percent in 2023.

And those price increases need to be viewed alongside Mondelez’s expenses. Here’s a chart of revenues and total expenses (cost of goods sold plus selling, general and administrative). These are global results, not just U.S. results, but the pattern of high prices and low volumes is broadly consistent across Mondelez’s other regions:

Costs rose as quickly as (price-driven) revenues. While Mondelez’s operating margins did rise, they didn’t do so much or very consistently. They were 15.8 percent in 2019, peaked at 17.4 percent in 2021, and were 16.6 percent last year. The main driver of the high profits — at Mondelez and most other food companies — wasn’t higher profit margins, but higher revenues with similar margins. In that sense, it’s true that Mondelez and other food companies were merely “passing on” increases in input costs.

But perhaps food companies do have a duty to keep prices low, compress their profit margins, in times of inflation? Is failing to do so predatory pricing? That seems wrong. At the same time, however, Mondelez’s profits have been growing faster — and faster than inflation — since the pandemic, and it’s clear that the main driver of that is higher prices. Is the difference between normal business behavior and predatory pricing a certain amount of profit growth?

Here’s where the questions get philosophical rather than financial. Rather than delve into those debates today, I’ll just note that the market hasn’t concluded that Mondelez and other branded food companies have become permanently more profitable as a result of post-pandemic inflation. If they had, their performance over the past five years would have been better:

War and markets

Unhedged believes that geopolitics is almost always less important 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 difficult to predict. There is little to no geopolitical alpha to be had.

One way to test this proposition is to look at a stock market that is almost always in the midst of intense geopolitical crosscurrents.

Enter Israel. Its stock market is larger, in terms of market capitalization, than the larger Turkish economy and the comparable economy of the United Arab Emirates. The Tel Aviv 125 index is concentrated in infotech (22 percent), banking (21 percent), energy (14 percent) and real estate (14 percent).

The stocks are largely held by domestic institutions such as pension funds and banks. Foreign investors such as Vanguard and Fidelity hold Israeli stocks in their broad developed market funds and portfolios, but the universe of outside investors is otherwise small. Private investors are not big players, as Israelis tend to be 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 that is automatically deducted from every Israeli’s salary, and that goes to institutional investors. The institutional investors get a very large flow of money every month that they have to invest, and they buy almost every available fixed income (product) on the market.

If we look at the performance of the TA-125 in previous wars, we see a trend. There is often a dip at the beginning of a war, as the market prepares 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 declines during the last major conflict between Israel and Hamas in 2014, one right when it started, and a longer one as the conflict continued. In both cases, there was a recovery (although the index fell again in the months after the war):

These cases confirm Unhedged’s bias quite well: markets are once again proving quite resilient in the face of political conflict. And the pattern repeated itself after the October 7 attacks and the start of the current war between Israel and Hamas:

This market rout was deeper and its recovery slower than previous conflicts. This could be due to the severity of the initial attacks, or to investors predicting a prolonged war would follow — a prediction that would have been correct. The long-term outlook for the conflict is completely opaque. Yet the market has held up surprisingly well so far.

But this resilience is likely due to wartime economic shifts and stock market structure, not the war outlook itself. The largest companies in the TA-125, including Teva Pharmaceuticals and tech company Nice Ltd, get 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 booming — ideal for the banks that make up a fifth of the index.

The bond market has had more impact. The rising military spending has not been sufficiently offset in the domestic budget, leading several rating agencies to downgrade Israel’s debt. Yields and credit default swap prices have risen.

War is brutal and unpredictable. The ground war is being fought in Gaza, where the economic and social consequences are orders of magnitude worse than those we are experiencing in Israel. If the war were to spread to Israel, it could crush the Israeli economy and close the stock market. Even if the war continues in anything like its current form, Israeli consumers could cut back on spending. The increasingly contentious political and fiscal situation could trigger a real crisis in the Israeli government bond market. The divestment movement, currently confined to college campuses, could spread. But for now, the Unhedged vision holds.

(Reiter and Armstrong)

A good reading

Where crypto goes to die

FT Unhedged Podcast

Can’t get enough of Unhedged? Tune in to our new podcast twice a week for a 15-minute dive into the latest market news and financial headlines. Read previous editions of the newsletter here.