The Week That Matters (11-15 March, 2024)
"I have a lot of money because I pay good wages." Robert Bosch, German industrialist
Statistical blips: Ignore the noise
This newsletter pointed out a few weeks ago that inflation prints tend to be seasonally strong in January and February in the US. The author argued therefore that we would see an uptick in inflation expectations and that would worry the market. That seems to be happening.
The move higher in some commodity prices this week also gave pundits a reason to call for a second wave of inflation. Ignore them. The technical bounce we are seeing in the likes of nickel means very little for broader prices. The pundits who urge you to worry about them are the same people who called for a 1987-style crash in September, when the equity market bottomed.
CPI might have come in slightly higher than expected but the headline number was a tad misleading. Inflation actually did not rise. Energy just didn’t deflate as much, thus creating a net effect on the CPI.
Powell will be remembered in history books by what he does next. He must understand that monetary policy will have no impact on two areas that are stubbornly high, namely rents and auto insurance, unless he wants a full blown recession. It’s now his job to manage the business cycle and that means he must cut rates!
Earnings: Oracle and Adobe
Two sets of numbers stood out this week. First, Oracle confirmed that the cloud recession is now firmly in the past. For the author, that means SaaS multiples will increase in aggregate. Venture capital firms, who have missed many bargains over the last 24 months, will now start paying up for investments, as a result.
Interestingly, Oracle also said: “Gen 2 AI infrastructure demand exceeds supply.” This would suggest it might be a bit premature to call the top on names like AMD and SMCI, especially when Jensen Huang, the CEO of Nvidia, is supposed to talk on the 18th. A man with that many leather jackets is unlikely to be moderate in his bullishness.
The other set of earnings that were noteworthy belonged to Adobe. As the author has pointed out in the past, there are two sins you can commit when investing in quality growth names. First, you can over-pay. With enough time, you will be forgiven for that one. Second, you can invest in a business with a wide moat that’s becoming a business with a moderate moat. For that sin, you will not be forgiven.
Adobe, for a long time, was feared to be in the second category. Adobe’s primary differentiator was its suite of products. No single app was a category killer, but the total package was. It was all going fine until competitors Canva, Figma and now Sora showed up. The sell-side argued many people didn’t want a photo, video and illustrator suite. They just wanted to make content for social media. It was a punchy argument but like most snippets from the sell-side, it was only partially true.
Adobe reported a slight miss on Friday with its quarterly sales forecasts and all those fears seemed to come back with a vengeance. But it seems like an over-reaction. There will always be new entrants to any industry but Adobe’s sheer market share in the graphic software market should be considered. Adobe Photoshop has 41.74% of the market, followed by Adobe InDesign with 26.13% and Adobe Illustrator with 12.24%. Is there really that much to worry about? The creator economy isn’t going to slow down. And Adobe is still a growth name. Remember the allocators are OVERWEIGHT private credit, UNDERWEIGHT tech. Nibble below $500?
Why Japan represents a blueprint for the world
Anyone runs the risk of being “cancelled” these days but one of the first “cancel” victims in modern times was arguably the economist, John Maynard Keynes. People forget how despised the quirky but brilliant Englishman was in the 1930s. Keynes was a confidant of Franklin D Roosevelt and influenced Roosevelt’s economic policies in the 1930s. Those policies in turn hurt many wealthy and powerful families like the Bushes and the Bloomingdales, who had enjoyed the laissez-faire US economy up until that time.
Keynesian policy remained dominant in the years immediately after the 2nd World War much to the chagrin of someone like Prescott Bush. Truman, Hoover and Eisenhower all committed to the Keynesian program of stimulating industry through fiscal manipulation, especially by government expenditures. There would be no GI Joe Act without Keynes. More significant, perhaps, there would also be no Federal-Aid Highway Act of 1956, which undoubtedly set off one of the great economic growth periods (1958-1966) that the USA has seen.
The Keynesian legacy started falling apart in the mid 1960s, when the general level of prices started going up. We often assume the Fed is all-knowing but they have been making it up as they have gone along since 1913. In the 1990s, Alan Greenspan admitted the Fed had no idea why prices started falling. The Fed then had data on everything but were clueless. It was the opposite problem in the 1960s. Prices edged higher every year from 1966 but the Fed had no idea and they had a lot less data to lean on.
The powerful families behind the scenes knew it was their chance to undermine Keynes’ reputation. He had died in 1946 and so couldn’t defend himself. His disciples were no match to Keynes and made plenty of errors, to be fair. And the families had plenty of money to fund the Chicago School and other positions in the US university system. They also had the charismatic Ronald Reagan and the showman that was Milton Friedman in their pocket.
Friedman Indoctrination
We have become indoctrinated to believe since the mid 1970s that government policy tends to always be wrong and that monetary policy is the only thing that is needed. Margaret Thatcher even used to tell us that public finances should be balanced like the finances of a housewife. The narrative is appealing in its simplicity but completely wrong. Public finances are nothing like the finances of a household.
Government debt can make the private sector rich. Boeing, which was in the news this week, is a good example. Boeing gets about 40% of its revenue from government contracts and much of the rest from plane orders that US officials regularly peddle abroad. This is noteworthy as it illustrates how government deficits can fund private surpluses. They do not crowd out private investments. And Boeing has used much of those revenues to buyback over $40Bn dollars for shareholders.
Don’t cry for me Argentina
The simplistic negative thinking regarding government debt persists unfortunately. And it might explain why Javier Milei, the Argentinian President, is being lauded the way he is in certain circles (some of the author’s friends LOVE him). There is no doubt the Argentinian government is probably inefficient but Milei has simply overdosed on Friedrich Hayek. That’s it. The trouble with Hayek’s theories on balanced budgets is they tend to have side effects on the broader economy, especially one as fraught with problems as the Argentinian economy.
In Argentina, the poor will no doubt disproportionately suffer, leading to potential social unrest. Throughout the country’s history, civil strife and social protest has been a huge part of life. Remember Evita? The trigger might come if all those government officials that are being sacked are replaced by offshore management consultancy firms, on expensive contracts. That would be a disaster and be quite insidious.
We all know what consultants can do to government. White Hall in the UK, for example, was once the Rolls Royce of civil services. Today, it’s a shambles, “infantilized,” to use a line from Professor Mariana Mazzucato, by the likes of McKinsey and Boston Consulting Group.
The Example of Japan
This brief summary of the author’s view on history has a point. It is supposed to set a scene to understand why what has been achieved in Japan over the last 10-12 years is truly remarkable. It is the best example in the world currently of what good government with a good civil service can do. Japan was the first developed nation to fall into a deflationary slump. It is likely to be the first to break out of a deflationary hole thanks to inspired, top down policy. (Onshoring in the US, to be fair, is a close second. Was that Trump or Yellen or both?).
Some inflation can be a source of good, no matter what the monetarists say. A general increase in prices serve the young, the risk taker and the indebted (isn’t it all debt nominal?). Deflation corrodes the soul of a nation. It only serves the old and the rich. And the old and the rich do not drive economies.
Former Prime Minister, Shinzo Abe, and Haruhiko Kuroda, the former head of the Bank of Japan, intrinsically understood something needed to be done to make Japan great again. It is the author’s opinion that what they set in motion is on the way to making that happen.
This week Japanese firms agreed to wage increases averaging 5.28 percent for this year's negotiations with labor unions, in a preliminary survey. This marked the sharpest rise in more than 30 years. That is huge! It is the result of government led top down policy in coordination with a civil service, that has not been hollowed out, and an effective association of private interests in the form of the Japan Business Federation (the Keidanren).
Wages matter
As a very experienced financial professional told me in Japan this week, wages were probably too high in the late 1980s in Japan, when the Bubble burst. They are now too low. The author spends a lot of time working with tech start ups. The average programmer in Japan is cheap, even compared with Vietnam at times, and many seem as good, if not better, than their counterparts in the US, Australia or Europe. It’s not just technology, however. It’s across the whole economy.
Higher wages make people feel good. They become optimistic and spend more. This is why the former Treasury Secretary, Steve Mnuchin, as discussed last week, was so smart to move quickly during COVID. He sat on a deflationary cliff in March 2020. It was vital for people to feel like they had a surplus to spend. And this is why the former Bank of Japan governor, Haruhiko Kuroda, said Japan’s interest rate policy would not normalize until wage growth was above 3%. People need to feel they have some dough in their pocket during times of change or they go into their shell. It’s only natural.
It is bizarre how such thinking can be controversial at social gatherings these days. People, often those who are salaried workers and who have never taken a risk in their lives and never will, call you a socialist. Yet the theory does have a place in US history. In 1914, Henry Ford doubled the basic pay for his workers, did he not? He explained:
“the owner, the employees, and the buying public are all one and the same. Unless an industry can so manage itself to keep wages high and prices low, it destroys itself. For otherwise, it limits the number of its customers. One’s own employees ought to be one’s best customers.”
A contemporary of Henry Ford, the German, Robert Bosch, was vocal about wages in the same way. And Robert Bosch hated left wing thinking and despised the Marxists. The author feels a change in perspective is needed on wages today. Otherwise, we will be seeing deflation raise its ugly head again in the West soon enough.
Returning to Japan, it is now potentially ready for the normalization of interest rates this month or next. And that is a truly remarkable achievement, no matter what Kyle Bass says. It shows what can be achieved by good top down, nation building policy. The private sector just could not have done it by themselves.
As always, thanks for reading. I came back from Japan more bullish than ever. I am very focused on the small end of town right now but believe there might be plenty of upside in some of the larger financial names if the BOJ moves forward with normalization. Looking forward to chatting soon. Wishing you the best with family, business and trading.
Best regards
Mateen
I think you are mired in the details and missing the big picture which is so much more important (and interesting) than neoliberal talking points. I read a lot of praise for the do-gooders, lever pullers, social engineers, experts and smartest men in the room for their top down meddling, manipulations, interference and interventions. But you only need to read what Keynes actually wrote to realize he isn’t so well intentioned: “For a little reflection will show what enormous social changes would result from a gradual disappearance of a rate of return on accumulated wealth.” What gradual disappearance of a rate of return? This means pushing interest rates to zero — he understood the inverse relation between rate of return and asset prices. The enrichment of the few and consequent wealth disparities. He goes on to explain how this would rock the bedrock of a free capitalist society: “In short, the aggregate return from durable goods in the course of their life would, as in the case of short-lived goods, just cover their labour-costs of production plus an allowance for risk and the costs of skill and supervision. Now, though this state of affairs would be quite compatible with some measure of individualism, yet it would mean the euthanasia of the rentier, and, consequently, the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity value of capital.” And, “all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.” And, “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth.”… he mapped out a plan to destroy capitalism. He gave us the recipe for “overturning the existing basis of society.” All you have to do is “a continuing process of inflation,” which will “confiscate, secretly and unobserved, an important part of the wealth of their citizens.” This “brings windfalls, beyond their deserts and even beyond their expectations or desires” to the “profiteers, who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat.” And indeed this is exactly what has happened over the decades.