Thursday, February 16, 2006

This ‘Low Inflation’ is Starting to Bite!


Inflation pressures increased in 2005….

Nevertheless, the increase in prices for personal consumption expenditures excluding food and energy, at just below 2 percent, remained moderate, and longer-term inflation expectations appear to have been contained.

—2/16/06 Bernanke testimony.


Shortly after the new Federal Reserve Chairman Ben Bernanke presented the above testimony to the Eco-1 dropouts in Congress, a far more relevant sort of testimony was presented to Wall Street’s Finest by a publicly traded company which, unlike the folks at the Fed, consumes food and energy and all kinds of materials that do not seem to appear in the government inflation statistics.

The company was Guitar Center, a large musical instrument retailer whose stores carry pretty much anything a musician could want to play—with high end guitars lining the walls and drums crowding the floors.

The stores are staffed with actual musicians, which is good except that these musical junkies tend to prefer playing their chosen instrument on the sales floor, which they do as much as possible, to actually ringing up a sale. So the stores can be a little intimidating to a novice, what with all the Hendrix-type guitar solos wailing in the background.

Whether the stock itself has merits is a different discussion, but, being a hack drummer myself, I can say that it is almost impossible to leave a Guitar Center without either buying something or craving an expensive new piece of equipment.

In any event, the company’s inflation ‘testimony’ came during yesterday’s fourth-quarter earnings call after the market close, when management discussed the real-world pressures many retailers are now seeing as a result of the higher costs of not only energy but building materials, labor and money itself.

According to Bruce Ross, the CFO:

In terms of the cost of building out the [Guitar Center] stores, we have seen a roughly 20% increase of [building out] a large format store…and roughly a 10 to 12% increase in the costs on the [smaller store] format.

So take Bernanke at his word: that inflation is well-contained. After all, Guitar Center is not raising prices on, say, Gibson Les Paul Classic guitars or Pearl MMX Masters drum kits by 20%.

Still, when costs go up 20%, somebody, somewhere, eats the cost. Somebody like Guitar Center.


Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

19 comments:

credibility said...
This comment has been removed by a blog administrator.
Ryan said...

And somebody, somewhere, pockets the 20% increase.

Hells_Satans said...

I would assume this is simply the price of the land, plus some nominal increase in labor?

Chris Fischer said...

My homeowners insurance (in Philadelphia) is going up 11% percent next year, because of the rising cost of building supplies and construction costs.

BDG123 said...

The cost of the land, labor.......lumber, concrete, copper wiring, gypsum board, steel, block, paint, flooring, insulation.....basically anything that is a commodity is through the roof. Oh, then there is health care for the workers, increased insurance premiums, corporate energy bills, increased rents, higher fuel prices for the contractors, etc, etc, etc.

In a world of dumbed down retail experiences, Guitar Center rocks!

It's bloody expensive out there.

whydibuy said...

Fine. Now go tell the bond market. The 10 yr is very comfortably in its multiyear trend between 4% and 4.8% and trades well behaved. Guitar guys are seeing ghosts according to nostraBONDus. The future is clear sailing.

Ryan said...

It all sort of depends on what time frame you want to use.

I looked at some lumber pricing (Random Lengths Framing Lumber Composite).

In January 2006 this index stood at 382. Data for the previous January's:

2005: 382
2004: 341
2003: 284
2002: 303
2001: 271

So, flat y-o-y but certainly up from earlier this decade.

Continued:

2000: 393
1999: 379
1998: 365
1997: 442
1996: 334
1995: 387

The yearly average price in 2005 was 387. In 1996 it was 407.

Were 2001, 2002, 2003 prices unsustainably low? Are today's prices too high?

I don't know...but, my hunch is we're under more threat from deflation than inflation.

BDG123 said...

Hey Ryan,
I'm sort of curious if you have some other data at your finger tips.

I'm curious what the cost of "manufactured" wood products are looking like. ie, OSB, laminated beams, plywood, etc. I think those tend to comprise alot of the building content these days and they are more prone to follow chemical costs, energy costs, etc.

Just curious

Its_strange said...

Walmart is fighting inflation for us and the Fed...Maybe they should run our gov and health care system and the military and the whole works.. Perhaps we should go with a parliamentary system ..Walmart vs Fed gov in the next election

Ryan said...

BDG,

I don't have much at my fingertips.

This is the site where I took the previous data from:

http://tinyurl.com/arzzm

That's a link to, I hope, Random Lengths, and more specifically to current data on plywood pricing.

Unfortunately I couldn't come up with historical pricing (at least not for sufficient enough timeframe).

Some Googling uncovered this article:

http://tinyurl.com/9sldo

The article is from May 2004 and references plywood pricing (referencing Random Lengths)

Seems plywood prices hit a historical high in April 2004 ($735). Unfortunately it doesn't say what index it's referencing. I'm assuming it's the composite index, since that's the one most widely quoted elsewhere.

In any event, all the current plywood prices are in the ~$300-$350 range, with the composite index at $369.

Note that the article mentions prices at $392 a year before the article (so, May 2003) before 'booming'.

Based on that - though I certainly am open to being corrected - it would seem current plywood prices aren't out-of-whack.

Hope that helps.

dkman said...

Will any of this be reflected in tomorrow's PPI numbers?

I am definitely not a macro-econ guy, but shouldn't there be some relationship between what GTRC is seeing and the overall price/cost trends in the economy?

DaleW said...

Carl Weichart at Wachovia does some good work here.

His index of building materials is up 2.2% compounded since 1984. The index went nowhere from 1996 to mid-2003 and has compounded at about 9% since.

The two biggest components of his index, framing lumber and sheathing, are down 3% and 2.4% YoY, respectively, and down 4.3% and 7% YTD. It's not all wine and roses for the inflation bears. I agree with the guy who believes the bond market, the world's largest, most liquid, most efficient capital market.

Its_strange said...

I'm a burnt out house framer from way back . Did it until the joints gave out ( the manufactured lumber , the laminated stuff is a good product but its "hard" and it IS taking a toll on everyones joints ) ...Well ..the builders have been hosing the public for so long the price of the stuff doen't matter.

bubbles said...

The reason the bond market or more appropriately the 10 year note's yield has not risen dramatically is because China’s been a big buyer of our debt. China’s not particularly concerned about inflation here in the U.S., they just need a place to park all that cash from their exports.

Ryan said...

I'm not convinced that China is behind the low yields.

Looking in today's FT they show 10-year bonds for 20 other counties.

Out of these 20 only two (Australia and New Zealand) have 10-year yields higher than the U.S.

Also, I'm not sure why China would be indifferent to seeing their Treasury portfolio decline in value due to inflation concerns.

Sam S. Park said...

I remember when the Gibson Les Paul Standard was sub-$2000... the funny thing is I'm not that old. That price level occurred only several years ago. Jeff, it's cool to know that you bang on the drums... perhaps we could jam out one day. The question is... can you keep up?

Captain Obvious said...

Industrial commodities of all types have obviously gone up a ton over the past couple of years. Thinking of construction, lumber is just one piece of the puzzle. Think about all of the wiring and plumbing in a commercial building. Copper, plastic resins, steel, etc. have all seen huge increases in price. Even something as seemingly prosaic as cement has seen big price increases. I couldn't find any data series on wholesale bulk cement prices, but look at the stock chart of Cemex. It has had a huge move...some of that has to be because of pricing.

Then there is insurance. Premiums for all types of insurance have gone up a lot.

The fact that energy costs are up a lot is not lost on anybody, but the extent to which higher energy costs have a knock-on effect on the prices of lots of other things is still underestimated, I believe.

I have no doubt that real inflation is substantially higher than the "real" rate of inflation the official, ridiculously massaged, figures show.

Alex Khenkin said...

The funny thing is that, apart from the REALLY high-end stuff, all this music gear has never been so cheap. Looking at the proliferation of home recording studios, it's certainly not musicians who pay up the 20% increases. The drive for lower prices in this industry is unrelenting.
Small Investor Chronicles

Aaron Koral said...

Speaking of higher costs, how about Mel Karmazin at SIRI announcing higher losses due to increases in programming costs? Looks like he's about to over-promise and under-deliver again, just like he did at VIA.b (but then, I could be wrong though...)