‘Greedflation’ – Major companies report record profits
The ability to raise prices above their rising costs has even given rise to the term “greedflation” in markets.
When inflation is high, companies may compensate by raising their prices. From supply and demand to logistics, many factors affect sales and profits. Figuring out whether companies benefit from high inflation is a challenging proposition. If a company raises its prices, it might gain short-term profits but consumers may go elsewhere in the long term.
Some industries with the greatest changes in profit margins include oil and gas. The Russian invasion of Ukraine in February 2022 saw a disruption to the global oil and natural gas supply, pushing both commodities to record highs. Oil companies raked in billions in short-term profits as fuel costs continue to rise.
Fred Razak, CMTrading’s Senior Trading Specialist, answers all your trading questions and more.
Q: Despite the poor economy companies are reporting record profits – why?
Razak said: “Why are some companies still making money in a recessionary environment so? During a recessionary environment who gets hit the worst? It’s certain parts of the market that were growing fastest. That’s generally what happens. So, in 2008 – 2009, the housing credit crunch debacle saw home builders getting hit the worst. Out of all the markets, they were the ones that went the highest from 2006 to 2007. So, it made sense that they got hit the worst.
“Now the rest of the market sold off a little bit but not as extreme as what happened to the home builders and the real estate investments. So currently we’re in an environment where not everything is getting hit in the recessionary environment that we’re in. We’re watching the tech stocks, which were the ones that led us to these massive heights that were at. They’re the ones that are retracing the most, and that’s because they were the ones that carried us here.
“So I guess you could call it the ‘bubble effect’ for that. Many of them are still rebounding and many of them are still correcting themselves. That’s more correct as a reactionary to this.
“So now remember, also in recessionary environments, not all money disappears, it just relocates itself. So for example, somebody is not buying Starbucks coffee but they’re going to Krispy Kreme instead, and guess what, many times they’re spending more money. Instead of going to Starbucks and spending $2-$3 on a coffee, they’re spending $4 – $5 at Krispy Kreme because not only are they getting coffee for $1.00 but they’re getting a doughnut as well. So this is just an example of how money relocates in a recessionary environment. It’s just one of those technical things that affect the markets.
Q: Why would markets be down if companies are making profits?
Razak said: “Companies are very resourceful when it comes to profits. So, if they’re not showing sales growth, they’re showing sales decline but they’re also showing profit increase. If I increase my profit my expenses are less, and my income is more, but I’m compensating for my income by lowering my expenses.
“For example, if you are, you know you’re a household and you have expenditures every month, you’ll still be making the same amount of R15,000 – R20,000 every month. But at the same time, you tighten your expenditures and limit your budget because we’re in a recessionary environment. So instead of spending maybe R15,000, you end up spending $8000 a month. You’re keeping the difference of the $6000 for a rainy day. So, in essence, you haven’t made more money because sales are still declining, but you’ve become more efficient in running your business. This is important because you still want to show that you’re a healthy business and the way you do that is by showing healthy profits. So that’s a technique that companies use during a recessionary environment where they pump up their profits, through increasing prices or curbing expenses but they can’t avoid the fact that their sales are diminishing.
“And that’s really what’s drawing traders to these companies. They showing higher profits and that’s why these companies are being traded yet they’re at a lesser value than they were six months ago.
Q: Are there any companies you have your eye on?
Razak said: “Yeah, some companies had my eye on it. Specifically, I’m looking at the FAANG stocks – Facebook, Amazon, Apple, Netflix, Google, and Microsoft. They’re all coming up with huge earnings this quarter. It’s not the most important quarter as it’s the Northern Hemisphere summer. The next quarter will be the most important. The next quarter is really in October, where historically speaking, it’s a sell-off month from any crashes that already happened during that period.
“So this is an important quarter but the one leading to the next quarter is much more important.”
Q: Are oil companies raking in profits?
Razak said: “There’s a double-edged sword if you’re an oil company – yes you’ll make more profits in the short-term but long-term you could suffer. When we’re in an inflationary state, the price of oil has gone up from, let’s say, $70 to $100. The short-term effects of that are that, yes, the oil companies will benefit by bringing in more profits because of an increased price of oil, but that’s not necessarily so, because ultimately an inflationary environment, they’re also getting affected.
“The oil companies are also affected by it. Whatever it costs them to run their facilities is also increased it’s like a trailing expense to their income. So if their income goes up because of the price of oil, so too are their operating expenses because inflationary prices are going up in tandem.
“So whether they’re drilling it might not be cost-effective in terms of production of oil. So in essence, they’re still making the same profits. They’re still making profits. They’re not losing money.
“Nonetheless, I wouldn’t say that they’re raking in profits. It’s really, they are subject to supply and demand. There are three uses of oil – petrol for vehicles, home heating and commercial products. The coronavirus is behind us now and there is much more transportation via planes.
“Airlines are now almost at 80% capacity in pre corona state, so there is an increase in demand. However, with that said, that has increased the price of oil and that’s a knee-jerk reaction. I do expect it to correct itself and to level off somewhere in the $80 to $90 range at some point.”