Readers: If you are new, welcome! You can read about who I am and what I am up to here.
Three announcements.
In ten days, I leave for a trip to, among other places, Bosnia and Serbia. I’ll be posting when I can, not necessarily on the regular schedule until 26 August. If you know thoughtful people to talk to in those locations, please send them my way.
If you are curious to see how I translate these essays into a portfolio, subscribe. These posts are more than musings, they are the way I wrestle with the uncertainty we all live with and translate that into specific investment decisions. In my case, money management helps pay for the writing. We all want to pay for something. I am not trying to sell you any investment and this isn’t investment advice. You do, however, get to see what I am up to for you to take or leave. If having that view makes you $1000 a year better investor, the subscription pays for itself pretty fast. The more subscribers I get, the more I will invest in data and staff.
I’ve got polls in today’s post…I am very curious in your answers!
Today’s post covers a) a summary of recent posts b) a case study on Carvana c) an anecdotal Russia update and d) investment implications.
Summary
Based on speaking with a few subscribers, I think it will be helpful if I summarize what I am seeing, with links to past posts if you want to dig in further. We are at a very delicate time, both economically and politically. Below are some of the moving parts.
You may like or dislike thinking about money, but money is a part of our life from birth to death. There is no escape. Your choice is either try to understand money or be constrained by it.
Over time, economies grow and assets that help facilitate that growth rise in value, but the process is messy and money is highly unstable.
The “system” works by savers handing their money to entrepreneurs, who borrow that in the form of debt or equity and use it to build companies for the future that boost productivity. If these companies succeed, investors get a return on their capital.
At moments in time, however, the economy shrinks. Assets can lose value. That’s what happened in the last six months. The typical portfolio has lost about 20%.
What matters is your after-inflation return. US inflation (where I live) is up almost, gasp, 9%, meaning the typical savers portfolio has lost, one-quarter of its value (20% + 4.5%).
Assets are losing value because of two interrelated forces—inflation and central bank tightening. The tricky question is what happens from here and in this my views are evolving. I think we are close to a turn, whereby the economy starts to slow and inflation starts to fall, though it is tough to say precisely. When/if this happens markets will begin to shift (and I’ve begun to shift my investments as you will see later on).
Inflation is the average prices of a pile of stuff…everything you buy. If you look at the guts of the inflation report, it’s clear that Covid and war are having a significant impact on the cost of the things we buy. For instance, the cost of buying a ticket on a cruise ship has fallen 7.8% because who in their right mind wants to be stuck on a cruise ship with a Covid? Recall my posts earlier this year from Cyprus, now a cruise ship graveyard. The cost of using natural gas in your home is up 38% because Putin invaded Ukraine and the West is trying to get off Russian energy exports, constricting supply.
The cost of any good is a function of how many goods there are and how much money there is to buy them.
The central bank can’t control how any goods there are, they can only control how much money there is to buy them.
Given how high inflation is, the central bank is reducing the amount of money, which will then touch all the assets you can buy, like stocks, bonds, houses or anything else.
The tricky thing is that markets are forward looking. Hold your breath, this is one of the most odd ideas for non-specialists to grasp. The central bank is already expected (priced) to increases interest rates to 3.5% by next year, or almost 2% higher from where interest rates are today. Said differently, the bond market is pricing in economic strength, when the most likely shift in the economy is (probably) toward weakness. This is important. Sometimes, this is the beginning of a good time to buy assets (guarantees, as the Russians say, are given in the morgue).
I’ve shared the Rose Chart below before. Note the blue line…when EXPECTATIONS of Fed policy start to shift, the market bottoms.
No one, including the Fed, knows the rate at which inflation will come down, but when it does, the money will flow back into assets. There was a hint of that this week, as a survey of inflation expectations declined just a bit even as inflation remains way too high.
Moreover, oil prices, which touch everything you buy, have declined about 10% in the last month. President Biden’s trip to Saudi Arabia this week echoes similar efforts by Reagan to get the Saudis to pump and weaken Gorbachev’s hand by lowering the cost of oil. As one mentor of mine once told me, “everyone is idealistic until they get scared, at which point they become very practical,” which is why Biden is meeting with a guy who carves up his enemies. Foreign policy is not pretty.
In China, Xi is focussed on getting a third term, which would be unprecedented since Mao and violates the post-Deng agreement that each President would get two terms. China has inferior vaccines and zero tolerance for Covid. In the US and Europe, now most of the populations have been infected by Covid. In China, rolling locks downs around Covid crushed growth in in the second quarter and I suspect this will continue.
On net, we’ve had three big shocks (Covid, Ukraine and China’s growth slowdown) which are all hard to make sense of and don’t have neat historical parallels in the last 50 years. It’s like combination of 1918 (pandemic), 1939 (Hitler invades Poland) and the Great Leap Forward (1958), except that we watch it on TikTok. My hunch is that the economy will begin to slow down in the next few months and when it does inflation fears and measures will start to ebb.
Case Study: Carvana
If the above sounds abstract, let me make it concrete. When I write about a “tech/information” revolution, this includes a host of companies that are trying to transform business. In the last twenty years, there was a template to these businesses: find an industry with a lot of small, inefficient players, use an App or web page to consolidate consumer demand and outsource the small players, give consumers lower prices and a better product, make software engineers rich and the middle-man poor. So far this has happened to book and grocery stories (Amazon), taxi drivers (Uber), card catalogues (Google), movie rentals (Netflix), etc.
There is a reason, however, Amazon started with books. Books are easy to ship and don’t kill you if they malfunction. Carvana, down a cool 90% this year, tried to do what Amazon did, but with cars. I am not a stock analyst and generally don’t trade individual stocks so this is not an argument to buy or sell the stock. Individual companies are however the building blocks for the economy overall, so you can see how the economy works via the companies.
Carvana interested me both because their advertisements are clever and because my experiences with car dealerships is universally bad. Caravana’s materials claim 81% of customers dislike the experience of buying a car, which sounds right to me. They also note car dealerships are fragmented and “ripe for disruption,” which also sounds right.
The car business is complicated, however. First, car prices are highly dependent on global supply chains, thus vulnerable to Covid disruptions. Second, for many people, a car is the second most expensive thing they buy (after a house), difficult to ship and stock and exposed to myriad state regulations. Carvana has sold about $25 billion of cars in its less than 10 year existence and its profits are … zero. They spent all the money trying to build the App. Investors wrote them huge checks. Carvana issued about $1.8 billion of stock and borrowed $5.7 billion, which was fine when money was free, which it was particularly during Covid. Now money is getting tight.
Like Amazon, Carvana ran as hard as they could with negative cash flow. Amazon also had a near death experience after the last technology bubble in 2001. So the question is, do venture and private equity investors bail out Carvana or not? As Carvana themselves note in their 10K “in the absence of such cash flows or resources, we could face substantial liquidity problems.” There is more to this story but I won’t dig into it for the sake of space. Suffice to say, Caravan’s CEO, Ernest Garcia, is the son of a billionaire financier convicted in the 1990 Lincoln Savings and Loan collapse who has complicated interests in the company and himself is a used car salesman.
The key point: low inflation and easy money allowed the Caravas to exist, will they live on? Perhaps if tight money doesn’t last for a long time or get too tight, yes, but it is also possible they die.
Russia/Ukraine Anecdote
As many of you recall, my mother-in-law lives in Moscow and her older sister in Ukraine. I wrote a WSJ op-ed about this. This week, Russia bombed the actual city where the sister in Ukraine lives. At least 20 people died. Despite this fact, my mother-in-law is still resolutely supportive of Putin. I don’t know if the West understands that a negotiated settlement with a regime like this will not lead to good things.
Polls
Substack now offers polls. I’m excited to hear your thoughts.
Investment Implications
Keep reading with a 7-day free trial
Subscribe to Things I Didn't Learn in School to keep reading this post and get 7 days of free access to the full post archives.