By Kate Gibson
With businesses and consumers paying less for goods than a year
ago, Corporate America is getting a bigger break than the average
shopper, a disparity that historically represents a good omen for
U.S. stocks' performance in the third quarter.
In theory, the margin between prices paid at the producer and
consumer levels offers insight into a company's ability to pass on,
or benefit from, price adjustments to the consumer, said Dan
Greenhaus, an analyst at Miller Tabak & Co.
"When PPI comes down and CPI outperforms it, that's a favorable
environment for retail, since in theory, costs are going down and
prices are holding firm. So I would say that's true especially for
firms that sell real basic goods to consumers, like a Home Depot
(HD), that sell lumber, fertilizer and all that stuff," said Jack
Ablin, chief investment officer, Harris Private Bank.
There tends to be a lag between price declines in producer
products and those purchased by consumers, given corporations tend
to sign long-term contracts and hedge their purchases of oil and
other commodities on the spot market, said Owen Fitzpatrick, head
of U.S. equity group at Deutsche Bank.
"It's rare for Procter & Gamble (PG) to say, 'we're going to
buy resin on the spot market,' when maybe they bought 50% of it
when prices were higher," said Fitzpatrick.
Oil companies, like XTO Energy Inc., (XTO) have hedged out a lot
of their contracts, unlike the average consumer, who isn't going
'go ask the A&P to give me a forward contract on their basket
of goods,'" adds Fitzpatrick.
On Monday, the financial and energy sectors fronted the gains as
stocks extended their longest winning streak of the year. The Dow
Jones Industrial Average (DJI) added 104.21 points, or 1.2%, to
8,848.15. The S&P 500 Index (SPX) rose 10.75 points, or 1.1%,
to 951.13, while the Nasdaq Composite (RIXF) climbed 22.68 points,
or 1.2%, to 1,909.29, with the technology-laden index tallying
gains for a ninth consecutive session.
In the latest government readings, producer prices were down
4.6%, year-over-year, while consumer prices were down just 1.4%,
"suggesting that while businesses are paying 4.6% less for goods
than one year ago, consumers are paying only 1.4%," said
Greenhaus.
Going back to 1950, the S&P 500 has increased 1.39% in the
three months following quarters in which the PPI has increased at a
greater year-over-year rate than the CPI, the analyst said. "For
instance, the CPI increased 4.9% at the end of the Q3 2008 while
the PPI increased 8.8%," said Greenhaus.
However, following times in which consumer prices increased at a
greater year-over-year rate than producer prices, the S&P has
increased 2.32% over the following three months. "For instance, the
CPI increased 1.5% in the third quarter of 1998 while the PPI fell
0.9%. The S&P rose 21% in the fourth quarter of that year," he
said.
And, while declines in year-over-year CPI figures are few and
far between, if history is any guide, "a widening spread between
the prices paid by businesses and the price paid by consumers could
bode well for equity performance in the third quarter," said
Greenhaus.
The equities market enjoyed strong earnings growth coming out of
the 2003 recession, and investors could well see a replay in 2010,
said Fitzpatrick.
"The real story from earnings has more to do with leverage. It's
not going to take a lot of revenue growth, based on cost structure
coming down. With unemployment close to 10%, companies have done
quite a bit of cutting, and the business models are very
leverage-able," said Fitzpatrick.