This linked article discusses how the trucking industry is experiencing a huge shortage of drivers. Given the current trends in the economy, this shortage is likely will have a major, cascading effect on the economy and its health.
Inflation is starting to heat up. Inflation has always been a major component of interest rates.
For those not familiar with interest rate composition, an interest rate is composed of two parts - the nominal interest rate and the real interest rate. The nominal interest rate is the combination of the real interest rate plus inflation. Real interest rates are the lender’s “true return” for lending funds. To find the real interest rate, inflation is subtracted from the nominal interest rate. The nominal rate would be the rate a borrower has to pay to borrow funds. This means that inflation can cause interest rates to rise even if the real interest rate remains the same.
Any entity charging an interest rate is interested in getting a return on their “investment”. This return is the real interest rate. Similar to a retailer, their goal is to get a return on their “product”. In this case, their product is lending funds. If an inflation factor is not “baked into” the rate they charge, they will be essentially “spinning their wheels”. For example, if the real interest rate is 2 percent and inflation is 2 percent, the entity will need to charge an interest rate of 4 percent to get a 2 percent real return. If they only charged 2 percent and the inflation rate was 2 percent, net/net they would be getting is a zero percent real return (2-2=0). Therefore, lenders will anticipate future inflation into the interest rate they charge.
With tariffs causing increased costs in key sectors such as wood and steel products, inflation is starting to climb. Both wood and steel are significant input factors in major economic goods such as construction and manufacturing. This is worrisome by itself. With transportation costs increasing as well, the result could be a “one, two punch”. Trucking costs are unavoidable with both brick and mortar, and on-line retailers. Somehow, the product has to get to your home.
Businesses will see increased material and transportation costs early on in their production cycle. The question will be, “can they pass those increased costs on to their customers?” If not, the business will have to absorb the increased costs and it will decrease profitability. If they can pass the increased costs on, customers will have to pay the increased prices.
Businesses who are able to pass on the costs will to have a competitive advantage that enables them to sustain profitability or minimize lost profitability. An extreme example (but unrealistic) would be an industry that has one producer but it is a necessity to consumers. The consumer has almost no choice but to absorb the cost. This is why monopolies are highly regulated. On the extreme is an industry where there are a huge amount of producers, such as farmers, that cannot pass on the increased costs to the consumer. The price the producers get is determined by supply and demand of many suppliers.
This is the clear reason why Buffett always looks for a competitive “moat” around businesses he owns. Berkshire owns a utility. Utilities are regulated because they would be a monopoly, but they are “entitled” by law to a fair rate of return. Berkshire owns a railroad. They are also regulated, but there aren’t many other choices for bulk shippers in most geographic areas. Berkshire owns an insurance company. They are regulated, but they sustain a competitive advantage by being one of the lowest cost producers. You get the idea.
This is a good juncture to consider your investment holdings for their competitive advantages in light of increasing inflation. Do your holdings have a sufficient competitive “moat?
This is something to critically evaluate. Companies who cannot stave off lower profitability will experience lower stock prices. If they can pass those costs on, their customers will feel the effects of higher prices and interest rates.
This discussion only covers a small amount of potential issues involved, but these issues are significant. Are you prepared? Ten Four good buddy.
