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Jubak's Journal
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• Jubak: 5 stocks ready to bounce back, 7/14/2004
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3 ways we already feel inflation's sting
The Fed thinks it has time for a measured response to inflation, but its already affecting my spending habits -- and probably yours, too.
By Jim Jubak
With underlying inflation still expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.-- The Federal Reserves Open Market Committee report, June 30, 2004 Thats the Feds opinion on inflation, and theyre entitled to it, I guess.
But let me suggest another, more personal gauge: In my world, inflation has just passed that important psychological point where it starts to change behavior. Because of inflation, Ive recently found myself buying less of some things, substituting to find lower prices and even rushing purchases to avoid future price increases. If enough consumers stop shrugging off price increases and instead start to change their behavior, then the U.S. economy has got an inflation problem.
Before you protest that one persons experience in a trillion-dollar economy is inconsequential, let me say that normally I would agree with you. But inflation is as much about consumer psychology as it is monetary policy, and in my world, and the world of those closest to me, inflation is changing our economic behavior.
Classic inflation effects
Let me start with a couple of very straightforward examples of a classic inflation effect, the way that inflation lowers the demand for goods and services.
Example No. 1 of falling demand due to inflation: Living in the typical New York apartment with too many kids and not enough closets, we rent a storage room for seasonal stuff (and a distressing amount of junk) that we dont use very often. Last year, the cost of that storage room went up 3%. I paid it. Last month, the storage company put through a 14% increase. Im cleaning out my room and giving it up this month. Ill either throw out the stuff in the room, sell it at my block associations yard sale (trying at the same time not to buy anything new from my neighbors) or just cram my closets a little fuller. In any case, Im one less customer for the storage industry.
Example No. 2 of falling demand due to inflation: Just this morning I finished writing out the school tuition checks for my two young children. Ouch and double ouch. The bill is almost 11% higher than it was last year. Now Ive known, intellectually, for years, that inflation for private schools and colleges was running way, way ahead of the rate of inflation. But I hadnt felt how much ahead until this year. The pain still isnt sufficient to lead me to uproot my kids from the schools they love to find cheaper alternatives, but it has set me thinking about the future.
If future education inflation is anything like this, then Im quite possibly not putting enough aside for college. So, next month, Im upping my regular contribution to my kids college funds. And that will have to come out of current spending. I think youll find the same process at work for individuals who pay all or part of their own medical bills, perhaps through a medical savings account, or who are saving for retirement. Once you start to apply a psychology of inflation to future financial goals, you quickly find yourself thinking about the need to save more and to cut current spending. Again, this damping of current consumption is a classic effect of inflation.
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Finding cheaper alternatives
But doing without or cutting back isnt the only response to inflation. Another effect is the substitution of one good or service for another. Here are my two real-life examples of that.
Example No. 1 of substitution due to inflation: I dont own a car. To get to work I either walk or take the New York City subway. When I need to drive to a friends in the country or run an errand in the suburbs I rent a car. Up until recently that rental was routinely from one of the mainline rental car companies. Id plan my errands, when I could, to take advantage of the off-peak rates the car companies offered. But this year, Ive noticed that the off-peak rates have gone up, the off-peak windows have narrowed and peak-hour prices have soared. And so Im using a new rental company, called Zipcar, that lets me rent by the hour, so I save money on all my less-than-full-day errands. And thanks to the companys use of the Internet to eliminate rental offices and to minimize staffing, even the day rates are often cheaper than those I used to pay. In this case, inflation hasnt reduced my demand for rental cars, but it has shifted the demand from Avis, Hertz and the like to a new company.
Example No. 2 of substitution due to inflation: Im about to change my phone service. Again. But this time, Im likely to do business with a new company that sends voice calls over the Internet (Voice Over Internet Protocol or VOIP). Over the last few years, like many telephone customers, Ive shopped around and shopped around until Ive driven the cost of my phone service to new lows. But I now think I can do better: A VOIP company, Vonage, sent me a postcard offering unlimited local and regional calls plus 500 minutes of long-distance for less than I pay now for my local service alone. And it comes with free voicemail, call waiting, call forwarding and caller ID that Id have to pay extra for, but dont, with my current local service provider.
Beating the inflation clock
Finally, theres the way that inflation actually speeds up current consumption. Consumers who are convinced that prices are about to climb and keep climbing accelerate some purchases to get todays cheaper prices.
Example No. 1 of purchase acceleration due to inflation: My utility bill, which combines the charges for gas and electricity, is up sharply this year, even though were using about the same amount of energy in our house as we were a year ago. Without getting into the complexities of the modern utility bill, for simplicitys sake let me just say the price per kilowatt hour of my first 250 kilowatt hours a month is up 7% since February 2004, and up 16% since June 2002. So the next time air conditioners go on sale, Ill be replacing my two oldest and biggest energy-guzzling units with more energy-efficient models. We were going to make that buy someday because the new machines are so much quieter than the old ones and weve been looking forward to the day when we can be cool and hear our TV. But the rising cost of electricity has pushed that buy to now from someday.
Example No. 2 of purchase acceleration due to inflation: Ive always pretty much ignored the Subscribe for two years instead of one offers from the newspapers and magazines that I read. The money was better in my pocket than theirs, despite the discount, thank you very much. But inflation psychology has pushed me over the edge, and Ive started to lock in multiple-year deals at current prices. That, of course, does add extra dollars to the publishing companies cash flow for investment, by smart companies, in new business opportunities.
Who wins and loses?
So inflation subtracts demand, substitutes demand and accelerates demand. For the economy as a whole, its tough to figure out how that all nets out if you dont know what the actual inflation rate will be or how fast it will climb (or decline) over the next year or two.
But the effects are easier to net out for individual companies. High-cost producers who cant cut costs to keep prices to the customer the same or lower will lose. High-cost companies that can offer products with more perceived value at the same price will survive. Low-cost or new companies that can offer better products and services at lower prices will thrive. And companies that get a big boost in revenue now thanks to customers accelerating their purchases to escape future price increases will have to be very smart about how they invest that seeming windfall that is actually an advance on future sales.
Inflation, even rising inflation, isnt the end of the world for every company. Some companies will actually do unexpectedly well because of inflation. And from your own inflation experience, you can even begin to figure out which companies those might be.
Send me your nominees for those inflation winners and Ill pass on the best suggestions, and add five inflation stock picks of my own, in a future column.
Changes to Jubaks Picks
Buy Micron Technology
I may be early on this one, of course, but somewhere in here theres a bottom for chip stocks. Micron Technology (MU, news, msgs), which may currently be the low-cost producer of memory chips, has the leverage to make the risk worth taking. According to the Semiconductor Industry Association, the DRAM memory market grew by 30% in the first two months of the second quarter, versus 17% for flash memory, the second-fastest growing sector, and 11% for the chip market as a whole. I expect that June saw a slowdown, but the chip sector is moving from its weakest quarter, the second, to the stronger second half. Chip-company CEOs are being very cautious on guidance for the third quarter, setting up the possibility of upside surprises, and in my opinion, Micron Technology is one of the companies most likely to surprise when it next reports on Sept. 22: The stock beat Wall Street estimates by 62% when it reported its May quarter earnings on June 23. Im adding the shares to Jubaks Picks with a target price of $17.50 a share by October 2004.
New developments on past columns
The next wave of airline bankruptcies
The news that a full-scale fare war has broken out between the low-cost carriers and the high-cost incumbents certainly isnt good news for companies such as Delta Air Lines (DAL, news, msgs) and US Airways Group (UAIR, news, msgs) that are trying to fend off bankruptcy. AirTran Holdings (AAI, news, msgs) fired the first shot with a 30% across-the-board cut that has been followed not only by the other low-cost carriers, but by the high-cost majors on more than 48,000 fares. But that actually isnt the worst news. That distinction goes to the big expansion plans at the low-cost carriers. These companies are adding new planes even as they batter high-cost competitors with fare cuts. JetBlue Airways (JBLU, news, msgs), for example, which already increased capacity by 43% in the first half of 2004, announced that it would add up to 17 planes a year through 2012. AirTran will increase its fleet to 87 planes this year from 73 in 2003. With all that extra capacity still to be added to the market, this round of fare cuts will be followed by another, and another and . . .
3 big threats to Chinas economic miracle
The growth rate for Chinas industrial output slowed in June for the fifth consecutive month as evidence continues to mount that government efforts to cool but not crash the economy are working. But the June numbers were cool only by standards of Chinas overheated economy. Industrial output rose 16% in June 2004 from the June 2003 level. That was slower than the 17.5% growth rate in May and the 19.1% rate in April.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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