"Get Ready For Margin Collapse" Goes Mainstream

Tyler Durden's picture

First it was "Get Ready For Higher Food Prices" going mainstream... Now, logically following, it is "Get Ready For Margin Collapse." As Zero Hedge has long been warning, the one immediate consequence of surging commodity prices as a result of endless liquidity, is a collapse in corporate margins. Now, about 6 months after we first broached the topic, it has finally hit the mainstream media. The WSJ highlights what is so obvious, it is no wonder no sellside "strategist" is willing to touch the topic with a ten foot pole: "This earnings season has seen a much-welcomed return to revenue growth, giving investors another reason to push stocks to two-year highs. But beneath the surface lurks a fresh worry: For many companies, the cost of raw materials is rising at a faster pace than revenue. Blame it on soaring prices of everything from cotton to copper and corn. That has squeezed profit margins more markedly than many analysts anticipated—and is serving as a worrying sign for future earnings." But yes, aside from the painfully obvious collapse in margins, and thus plunge in net income (sorry, companies can't fire their skeleton crew workers any further) which will mean 2011 S&P 500 EPS will come far, far lower than prevailing consensus, everything is fine.. and don't forget to BTFD.

The WSJ - about half a year behind the curve:

rocter & Gamble, Ford Motor  and Kraft Foods are among dozens of companies that reported lower profit margins for the fourth quarter of 2010 compared with the third quarter. Their stocks were punished by investors, even as the companies' profit and revenue exceeded analyst forecasts. The cool reception stood in contrast to the general optimism among investors that has helped the Dow Jones Industrial Average to gain about 6% this year.

About three-quarters of the companies in the Standard & Poor's 500-stock index have reported their earnings so far. Some 25% of those companies have posted lower margins in the latest quarter, according to Morgan Stanley. S&P says operating margins for S&P 500 companies in the latest quarter have come in at 8.69%, down from margins of 8.95% for the S&P 500 in the third quarter.

Stunningly, the computers doing all the trading are shocked, shocked, to find out there have been unpassable price increases going on in here.

"I think this quarter was a wake-up call. We're seeing these stocks get hit on margins and sell off dramatically," said Erin Browne, director of global macro trading at Citigroup. "It's definitely picking up steam and becoming much more on the tops of investors' minds, and it's only going to continue as we move through 2011."

This is the token chart presented by the WSJ, which anyone who lived through 2008 could have seen coming from a mile away:

Even that permabull among bulls, Morgan Stanley is issuing warnings:

Some worry that many analysts aren't taking the lower margins into account and are overestimating future profit margins. Adam Parker, Morgan Stanley's chief U.S. equity strategist, says consensus earnings estimates for the rest of the year imply that analysts continue to see margins expanding. That leaves plenty of room for disappointment if rising commodity prices bite deeply into companies' margins.

"Some analysts may be guilty of 'over-extrapolating' the recent margin improvements into their forward outlooks," and companies that fail to meet these heightened expectations may find themselves punished by the market, Mr. Parker warned in a recent note to clients.

Just who may Parker be envisioning? Why the pathological liars from Goldman Sachs of course, where displacing the truth by 179 degrees under the stern eye of Goebbels exhumated corpse has become a fetish.

Cue David Kostin:

Inflation is the initial topic raised by investors in every meeting. Discussion subsequently shifts in one of two directions: (a) the impact rising prices will have on profit margins and earnings; or (b) the impact higher inflation will have on bond yields and the implications for equity valuation. Both subjects are worthy topics for analysis and debate.

However, the initial premise that inflation is rising may be an incorrect assumption. Simply put, most indicators suggest inflation is falling, not rising. In 2011, the perceived risk to US equity prices from inflation vastly overestimates the actual risk, in our view. Investors should consider the historical evidence and our forecasts before finalizing portfolio decisions.

Unlike China where home prices continue to surge, most Americans would not use housing and inflation in the same sentence. Housing is critical to the consumer inflation outlook because it accounts for 41% of the basket of goods used to measure headline CPI and 49% of the core CPI. High unemployment means labor inflation pressures are also likely to remain low.

In fact, Goldman Sachs Economics forecasts most measures of inflation will decline in 2011 and 2012. We forecast Producer Price Index (PPI) for finished goods will fall on an annual basis from 4.3% in 2010 to 3.7% in 2011 and 1.3% in 2012. Core Consumer Price Index (CPI) will fall from 1.0% to 0.7% to 0.5% and the Personal Consumption Expenditures (PCE) Index willdecline from 1.7% in 2010 to 1.1% in 2011 to 0.9% in 2012.

It gets much, much worse:

Commodity prices have surged by an average of 40% during the last 12 months led by Agriculture (+60%), precious metals +50%), industrials metals (+24%) and energy (+14%). Cotton has stretched 142%, corn has popped nearly 90%, gold has rallied 23%, and Brent crude has risen 30%.

More importantly, Goldman Sachs Commodities Research forecasts prices for many commodities will fall over the next 3, 6, and 12 months. Cotton, sugar, coffee, cocoa, wheat and corn prices are all forecast to decline over the next 12 months along with aluminum, nickel and silver. However, gold, WTI crude, and soybean prices should rise (see Exhibit 3). Accelerating GDP  growth, low inflation, and low interest rates will likely support a higher S&P 500.

But wait. there's more - the punchline(s):

We acknowledge many investors disagree with our forecast and believe commodities and other raw materials prices will increase in 2011. We analyzed changes in profit margins, P/E multiples, and equity returns during nine periods of rising PPI “crude materials” inflation since the mid-1970s. We focused our historical analysis on the PPI “crude materials” indicator, which is more related to commodities inflation than the PPI “finished goods” or headline or core CPI indicators.

The intuition of many portfolio managers is that inflationary pressures will likely weigh on margins. However, the historical evidence does not support this view. Operating margins actually expanded by an average of 13 bp during episodes of PPI “crude materials” inflation. Technology and Materials registered the greatest margin expansion while Energy margins experienced the sharpest margin contraction.

Hold on to your hats:

We forecast S&P 500 margins in aggregate will rise in 2011 and 2012 by 30 bp and 20 bp, respectively (from 8.5% to 8.8% in 2011 to 9.0% in 2012). Actual margin changes will differ by sector and by company. We expect margins this year will be 109% of the previous high reached in 2008 with Information Technology posting the strongest gains. We expect margins will expand in both 2011 and 2012 for all sectors except Consumer Staples where we forecast a slight 3 bp of compression during each year. We forecast 2011 sector margins will range from 62%-111% of previous highs.

Those who wish to subject themselves to the aneurism inducing masochism of reading David Kostin's complete weekly note, can do so here.

So going back from the never-never world of the Little Goldman Prince, here is what is happening in real life:

Kraft reported a 30% rise in revenue on Thursday. But the company said higher costs for meat, packaging and other raw materials sliced $500 million from net income, which the company reported at $540 million. The shares fell about 2% after the earnings were released. Procter &  Gamble blamed higher commodity prices for crimping margins and said higher costs will lower annual earnings by about $1 billion. Since its earnings on Jan. 27, the shares are down 2.1%, compared with a gain in the S&P 500 of 2.5%. Ford shares are down 13% since Jan. 28, when the auto maker reported that rising costs of commodities such as steel and oil helped drag down its fourth-quarter profit.

Companies that are dependent on raw materials to produce their goods are going to feel the biggest pinch, like Procter & Gamble and Ford, said Charles Blood, market strategist at Brown Brothers Harriman. But energy and materials companies are benefiting.

Luckily, the WSJ, where bonuses are not contingent on the size of the lie, has a slightly different view than Goldman:

During the downturn, U.S. companies aggressively cut costs and improved productivity, allowing many of them to churn out profits even as the weak economy kept sales muted. But investors were worried that the cost-cutting would have its limits, and that longer-term growth could really only be sustained by revenue growth.

Bottom line - margins are collapsing, and whatever companies can pass them off (for now), are desperately trying to do so. Those that can't, see their stock prices plunge by 10-15% the day after earnings (see Cisco). And with the myth of recovery not really doing much for consumer purchasing behavior, contrary to repeated lies otherwise (mostly emanating from the very same Goldman Sachs) soon even Goldman will be forced to acknowledge what is an incontrvertible truth. We expect that Jan Hatzius will do so in April (with the lemming Kostin following suit shortly), just in time for the QE3 chorus to hit the 100+ dB level.

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Rahm's picture


plocequ1's picture

Thanks for watching. Now back to our regularly scheduled POMO

Haywood Jablowme's picture


Slowly it's all comin' together...



hedgeless_horseman's picture

(sorry, companies can't fire their skeleton crew workers any further)

Our margins have indeed thinned, but I could fire more than 50% of our staff, if volume warranted it, and still make a profit.  I have contingency plans for a skeleton crew of 1/5 of what we have now.   

Obama will take care of the unemployed, right? 


Miles Kendig's picture

No.  Actually the states will borrow the money from Obama who will borrow it from Bernanke, just like every other administration for years.  The states still owe all of this EUC back to Bernanke, at interest of course.  If the states declare bankruptcy then the fed will take the nominal loss, until it passes it along to the federal treasury.  One more bailout disguised as a get tough measure.  LOOOOL

Astute Investor's picture

The change in Q4 10 incremental operating margins is probably more telling.

Spaceman Spiff's picture

How many bubbles has it been and our MSM still practices willfully dishonest/ignorant economics in the lead up to the problem?


Just wanted to thank the zerohedge staff/creators/contributors for the umpteenth time.  Between the articles and the comments I actually learn something new most days.

Red Neck Repugnicant's picture

Between the articles and the comments I actually learn something new most days....


Yeah, me too.  

I never knew so many rednecks had internet connection and could work a keyboard.  I also never realized how pronounced the "hoarding" gene was in redneck, hillbilly DNA.  I'm sure Gregor Mendel would be truly fascinated.  Has any geneticist ever found a mullet/hoarding pair?

Mullets/Bullets/Camaros and Libertarians!  2012




No Mas's picture

"sorry, companies can't fire their skeleton crew workers any further"

Wrong.  There are still American workers who are employed with their bloated salaries and benefits.

They will be canned in total and replaced with oversea's workers.  It is a no brainer ZH.

This market and the multi-nationals are going to continue to perform until there is no one left making enough money to buy their crap.

And that day is many, many years away.

Mike2756's picture

With the all of the unrest (and potential unrest) overseas? It wasn't too long ago that workers in India and China were taking out management.

sushi's picture

In support of your position:

1) US MNCs pioneered development in China both to obtain access to the future Chinese market and to use China as a low cost export platform to the US. This "export of jobs" took place over a 10 year period and the effects are now being felt in US employment weakness.

2) Chinese exports include less than 5% Chinese value added. The value add is primarily in final assembly labour. The rest of the embedded labour costs reflect US wages for product design, legal, logistics, accounting, marketing and all the rest. Expect to see chunks of this "upper echelon" work being moved elsewhere. India is already making inroads in legal and accounting outsourcing.

The implications are countinued "hollowing out" of the US workforce while Catastrophe Ben is madly printing off ever larger amounts of Bernanke Bucks. A good analogy is the last frame in Thelma & Louise. If Bernanke was in the car he would have the accelerator through the floor despite the car hovering mid-canyon.

eigenvalue's picture

Go long agricultural products and screw the Chinese! China is suffering from an extremely severe drought. If there is no sufficient rain in Feb and March, China's winter wheat crop will be utterly fucked!

bankrupt JPM buy silver's picture

Wrong.  Just like they are buying the real physical metals, they will buy the real physical potash-no worries anymore about no sun, droughts, floods.  If all else fails they can make plastic rice and rubber pancakes.  And 69 was my entry on the CAPTCHA, whats up.



walcott's picture

rubber pancakes! I bet they already have those.

Then styrofoam donuts.

eigenvalue's picture

Potash is not grains... Last year's winter wheat crop in China was not good. Chicoms released a large chunk of its official reserve to suppress the domestic wheat prices. The result is: less official reserves and less people wiling to grow wheat. Methinks plastic rice and rubber pancakes will only make the Chicoms suffer the same fate of Ben Ali.

PY-129-20's picture

Yes, but they are not allowed to riot. If they do anything, they will be killed or seen as a threat to the great society. Why should it be different than '89? And I wonder what would happen to all of these international companies that hire in China. Although I must admit, it would be good to see them getting a bloody nose.

raya123's picture

As I have said many times, QE2 (and QE3) will go from being the safety net underneath the market to the hammer that drives it much lower.

EscapeKey's picture

In real terms, quite likely, in nominal terms I'm not so sure.

Bendromeda Strain's picture

Dow/Gold 1:1

hello old friend...

Snidley Whipsnae's picture

Yep, like Zimbabwe... stocks soar while currency heads south... adjust for inflation... returns negative... then the bust and currency is trash... gold, the once and future money.

GottaBKiddn's picture

Let's see, that's raw materials, margins, wholesale prices, retail prices, then yippee, taxes. Such typical government.

Mike2756's picture

Good point, i don't see how the pols can resist the pile of cash companies are sitting on. If they won't add to payrolls, are higher taxes on the way?

system failure's picture

looks like we need to cut rates again from 0.25% to .00025%, then maybe credit can be expanded again. However, this would lead to the same outcome as the same periods as 2003 to 2007 and 2009 to 2011. Hmm. Well fuck, do we have another bubble derived from the "I don't see any bubbles" crew again, from our cartel central planning folks. These people (FED) would make Bubble Yum envious.

buzzsaw99's picture

Fear not. The Bernank can fix this in less than 15 minutes.

sushi's picture

Thanks to rampaging inflation he now has 16.3 minutes.

sushi's picture

Correction: It is up to  17.8 minutes

What a difference a failed CAPTCHA makes!!

ElTerco's picture

Heck, he can do it in 10 minutes.  He tacked on five minutes for a margin of error.

It's actually as easy as that old game show, "Name That Tune".  Instead of naming a number of notes, he just has to name a number of notes and bonds.

Caveman93's picture

Who the fuck said I couldn't eat my gold?

GlassHammer's picture

The thing about margin compression is: 

At some point "doing more with less" is just "going out of business".


blunderdog's picture

Creative destruction of capitalism, baybee.  And eventually it's one company providing everything and buying all the political favors by paying for the election of the government and the...

...um.  Waitaminute.

Zero Govt's picture

a small point here you cannot "destroy capitalism" though i understand your point... capitalism are the economic rules of the game, you cannot avoid them you can fuk about with them (aka USSR and Washington-Wall Street) but capitalism eventually destroys the tossers... you can't run or hide from capitalism even behind the Berlin Wall, its laws work everywhere and will catch you up.

Those that do fuk with capitalism always get fuked... as Wall Street and Washington are about to find out  

Snidley Whipsnae's picture

Good points all. I prefer to think of 'capitalism' as Mr Market.

Mr Market applies to everyone, every gov, every soul on this earth, at all times. Mr Market may be twisted and tweaked for a time but Mr Market always comes roaring back with a vengance and runs over the twisters and tweakers.

The Fed and Keynes thought that Mr Market could be contained, controlled, made to follow rules contrived by a few men for a few men. Not!

Zero Govt's picture

in someway the best way to describe capitalism is by looking at socialism and communism.. we see in China, the USSR and North Korea deluded moguls pretending they can magician a strong socialist economy by centrally managing everything... the end result is always the same, debilitating bankruptcy.

You cannot hide from the rules of capitalism. Even behind a totalitarian wall it will not protect you. Piss on efficiency, productivity and deny the free competitive market and all the innovation and progress that provides and capitalism will slowly but surely grind you into the dirt... and that holds true for Western Govts too as they are the exact same basic monopoly power structure and everything they touch (healthcare, transport, mortgages etc) also turns to dust.

Capitalism (the free market) Rules 

mcguire's picture

actually, the hilarious punchline will be when the stock market and commodities fall, the boogie man 'deflation' will be dragged out again, and the following equasion gets into the alpha-wave brainwash machine:

1. margin collapse leads to decreased stock prices.

2. decreasing prices (in any asset class) is "deflation".

3. to avoid deflation, print money.

Fazzie's picture

Yep, they gotta sell QE3 while pretending QE2 worked. The very thing that caused margin compression was QE2, but thats OK!


spekulatn's picture

Stunningly, the computers doing all the trading are shocked, shocked, to find out there have been unpassable price increases going on in here.


Fukn brilliant. Well done ZH.

Threeggg's picture

Hey TD have you ever thought about updating this Debt piece from 2009 to 2011 numbers.


I keep hearing on the MSM that all corporate entities have Gazzillions in cash stashed "just sitting and waiting" to invest and it will put everyone back to work.

I have often wondered what the Debt to Cash ratio is and is the MSM still full of shit as I suspect?



Snidley Whipsnae's picture


Put simply, there is a lot of apparent "cash on the sidelines" because the government and many corporations have issued enormous quantities of new debt, often with short maturities, while other corporations have purchased it. It is an equilibrium. The assets that are held in the right hand represent debt that is owed by the left. You cannot call that pile of short-term marketable securities an asset without calling it a liability. The cash on the sidelines is evidence of debt incurred to fund economic activity that is already in the past. It will remain "on the sidelines" until the debt is retired. The government debt has been issued to finance deficit spending. At the same time, a great deal of corporate debt has been issued over the past year apparently as a pre-emptive measure against the possibility of the capital markets freezing up again."


Oh regional Indian's picture

Still so difficult to understand hwo a market and a system that is based on the presumption of perpetual growth can still be standing.

Till you realize it is not. It's being propped up.

Dead market walking....



sschu's picture

Wow, maybe it is time to pull out the old financial management text books from back in the 80s when we discussed the pervasive effect inflation has on companies balance sheets and financial ratios.  Ugh.

Wait, a quick Google finds the following! 

In terms of accounting policies, firms using the LIFO inventory cost valuation are more closely matching costs and prices in an inflationary environment.  LIFO understates inventory value, overstates the cost of sales, and therefore lowers reported earnings.

Soooo, inflation lowers reported earnings, hmmm.  What else does inflation do that distorts the Quick Ratio and Debt/Equity etal?  Seems this was a problem back then too.

Inflation is the Satan of the financial world and company financial statements.  It is the great deceiver, it's pernicious nature hides the true costs it extracts.  Make no mistake, Bennie has taken us down a path that will take decades to fix, if we can at all.

All to satisfy a few equations he watches and to test his PHD thesis.  We are in for a wild ride for sure.



Mark Noonan's picture

Someone explain to me how they can project falling commodity prices with all this fake, new money still hanging 'round the economy...

Zero Govt's picture

Simple, what goes up also comes down... the funny counterfeit Fed money is not neccessarily hitting the commodity sector, most of it is doing precisely what it's designed to do, bail out the 'Too Big to Fail' frauds of Wall Street, plug holes, stop leaks, repair their rotten hulls, buy new paddles so they can paddle a bit further up Shit Creek gathering executive bonuses from robbed taxpayers in the game of 'Pretend and Extend' that Washington, the Feds, the Regulators and Wall Street are playing at everyone elses expense... the usual criminal activity of Big Govt and Big Corps

dogbreath's picture

"The intuition of many portfolio managers is that inflationary pressures will likely weigh on margins. However, the historical evidence does not support this view. Operating margins actually expanded by an average of 13 bp during episodes of PPI “crude materials” inflation. Technology and Materials registered the greatest margin expansion while Energy margins experienced the sharpest margin contraction.


 Yeah I know,  Its different this time.

pitz's picture

One man's margin collapse...is another man's margin expansion.


Shameful's picture

Hmmm, good so the end product price increase fuse is fully lit and burning. Cannot wait for Zimbabwe Ben to explain how this is not because of QE but of incredible economic strength and recover.

Caviar Emptor's picture

Tyler, Tyler....I was the one who mentioned margin collapse over a year ago as a result of higher input prices but that can't be passed on to constrained US consumers, caught in the vice grip of biflation as their real wages and net worth continue to collapse. Let's spread some of the glow around, don't ya think? ZH is as much about group think and mind meld as it is about ego and snark.