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Price Wars

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There is currently overcapacity in just about everything.

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Prices of goods and services have to go up. Right? At least that is what everyone keeps telling me. After all, on the producer side of the equation, energy prices are soaring, raw materials prices are soaring, wages are rising in China and a new minimum wage in the U.S. will send wages up $0.70 this summer and $2.10 by 2009 to $7.25 an hour.

Try again. Wal-Mart (WMT) is cutting prices on 16,000 items.

From Forbes.com:

Wal-Mart Stores Inc., the world's largest retailer, set the stage for price wars Monday as it announced it's cutting prices on more than 16,000 items starting this week in a bid to turn around sales for the critical back-to-school season...


Pricing Pressure

Pressure on corporate margins is only just beginning. What it costs to produce goods is basically irrelevant if supply is outstripping demand. There is currently overcapacity in just about everything. We do not need more Wal-Marts, more Pizza Huts (YUM), more Applebees (APPB), more Targets (TGT), more auto capacity, more furniture stores, more Home Depots (HD), or more nail salons. All of those and then some were way overbuilt as new housing subdivisions went up at a frantic pace. Commercial real estate followed residential and provided huge numbers of jobs (although at the low end of the scale).

The payback for this reckless expansion is now underway. Housing has blown up and corporate expansion of retail is about ready to follow suit. Consumer discretionary spending will take a big hit as rising energy prices and mortgage rates eat away at paychecks.

Rising Minimum Wages Will Not Save The Day

Unfortunately, don't look for rising wages to save the day. That minimum wage bill is going to do nothing but cause problems. Businesses under pressure already will be reluctant to add workers. Instead, look for increased layoffs from retail, financial, and service sectors.

Except economists seem to be telling everyone that "we can't have a recession with unemployment so low." Well, we can and we will. That is what happens when overcapacity meets changing time preferences on behalf of consumers. Before this mess is over unemployment will be soaring. How much the government admits will be another story, but look for massive revisions with the next administration in 2008.

Corporate Profits Will Sink

Corporate profits are under pressure with financials leading the way. Kevin Depew was talking about this on Minyanville in Point 2 of Five Things: Housing Slump Contained to Only Those Things Affected by Housing Slump.

Countrywide Financial (CFC), the biggest U.S. mortgage lender, reported its third straight decline in quarterly profit due to increases in late loan payments.

  • Countrywide this morning reported that 2Q net income fell 33% and revenue fell 15%

  • The company also reduced its forecast for earnings for this year.

  • Why the grim forecast?

  • The company said profit was hurt by impairment charges on securities backed by prime home-equity loans.

  • Well, of course the company said that. This subprime mess is going to continue to hurt for a while. Even Bernanke said so last week.

  • No, sorry. Read that bullet point again: The company said profit was hurt by impairment charges on securities backed by prime home-equity loans.

  • Countrywide Chairman and Chief Executive Angelo Mozilo said "delinquencies and defaults continued to rise across all mortgage product categories."

  • The company also noted it has set aside $293 mln for loan losses in the quarter, more than triple the level a year earlier, blaming a loan-loss provision of $181 mln on prime home-equity loans, the Wall Street Journal said.


So profits are now being hurt by "Prime Loans". Fancy that. But this contagion is not going to stop with either housing or financials.

Check out this headline: FedEx Freight cuts fuel surcharge. Overcapacity in shipping? You bet. What else can it mean when fuel surcharges are removed smack in the face of crude prices near all-time highs?

A few charts:

(Click each chart to enlarge.)

WMT


CFC


FDX


JBHT


HD


JCP


APPB


Containment


Containment is spreading to retail, consumer discretionary spending and even shipping. The underpinnings that have kept speculation high and the stock market buoyant are being removed one by one, sector by sector. The party is all but over, but no one seems to have recognized it yet.

No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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