Look Below the Placid Surface
The directors of such companies…being the managers rather of other people’s money rather than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which [they would] watch over their own.
Adam Smith, 1776
My latest podcast is with writer and former spy David McCloskey. That is here.
THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISK AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.
To look at the headlines, US growth is strong and inflation is “entrenched.” But these average figures miss the cross-currents passing beneath and it is the cross-currents that indicate where we are headed.
The Cross Currents
Beneath the surface:
The parts of the global economy dependent on private-sector borrowing are doing terribly. This is global. In the US, fired middle-class people struggle to find a new job, buy a house, or lease a car. European credit-related activity is frozen. In Asia, while Japan is doing well, China (the larger economy) is in a self-reinforcing Maoist-style decline.
The parts of the economy dependent on government borrowing are doing well. However, only the US, Japan, and Brazil are running easy fiscal policy and of the three, only Japan has easy fiscal and monetary policy. Some of this is workers benefitting from government infrastructure spending. Some of it is seniors getting a cost of living adjustment on their social security. Some of this, in Japan, is workers getting raises.
The parts of the economy depending on spending from cash-flow-positive tech behemoths are doing OK, though this is mostly a US-only phenomenon.
Reality looks something like the below.
The Causes
What brought us to this point? Again, it is a combination of things, all happening at once.
Tech Creative Destruction. We are living through an era of fast, messy, creative destruction. The wreckage is so vast it is difficult to wrap your head around it. The Magnificent 7 stocks (Google, Apple, Microsoft, Meta, etc) are at the epicenter of this. I listened to Meta’s earnings call this week. On the one hand, they are merely an advertising company, like Ogilvy. Except Meta has 67k people, 3.5 billion customers, and $39 billion in profit. I can’t quite imagine a company with half the world’s population as customers. The stock was crushed on announcing earnings…that showed a 27% acceleration in earnings. The fear is that Zuckerberg will waste money…but if their earnings are going up, the spending is working. On the quarterly call, Zuckerberg talked about their new AI tool, Llama. Just keeping up with what these tools (Chat GPT, Gemini) do is a huge amount of work and the fact that Zuckerberg has successfully navigated the waning impact of Facebook, outwitted Tik Tok, and now AI tells me he is a rare leader. I tried the AI tool on Instagram and was impressed.
This creative destruction is incredibly deflationary when it is allowed to work its magic. The classic example is photographs. We used to fork over money to Kodak for that. Now images are free and Kodak is essentially no more. This week, I replaced a Bloomberg Subscription I have had for years that cost $30,000 a year with Koyfin, which costs about $500 a year. Koyfin doesn’t do everything Bloomberg does, but I suspect with time it will do most of it, and what it does, already it does better. That is deflationary creative destruction in action and the entire tech sector is incentivized to do this trick again and again. The trick is:
Find a profitable sector that has grown fat and lazy.
Try to find some interface that can destroy their cash flow, like Netflix to AMC theaters, Uber to a yellow taxi, Meta to Mad Men-style executives, etc. The interface is usually a web page.
Secure venture funding.
Run cash flow negative for years, underselling the legacy industry until you destroy it.
IPO, repeat.
If Koyfin succeeds, the founder becomes another Bloomberg, a billionaire. There are (so far) a few areas of the economy that are virtually immune from this technologically driven innovation, however, and if there is stubborn inflation, that is what’s causing it. Take medicine. (I could add Ivy League schools, but they are not a business and I don’t want to get distracted). Medical outfits are crushing you on pricing (sorry to those in the field who read this) because you can not get around them! Exhibit #1 is hospital price increases based on this week’s inflation numbers. The price you pay when you set foot in a hospital rose 5.8% in the fourth quarter simply because they have you cornered, plain and simple.
But big tech sees this and is coming for them. Amazon’s experiment with One Medical is, like a lot of new innovations, a mess. I tried using it locally and can’t find a good doctor. But once it takes hold, I suspect that medical inflation will begin to sink a lot. When? I don’t know exactly but the bigger the gap in charged price and potential price (like Bloomberg to Koyfin) the higher the likelihood that hospital pricing models implode. I for one will be cheering when it does. A few years ago I went to the hospital for a migraine gone bad. The total bill for being there for an hour was around $5,000.
Monetary and fiscal policy. This tech disruption is, in turn, leading to big swings in wealth, which is leading to divergent policy choices. A tax on billionaires, like Zuckerberg, is popular among 70% of the US electorate and this is an electorate that agrees on nothing. In the US, Biden is using deficit spending to transfer wealth from the rich to the less rich. Even with the deficit at 6%, he is writing off student debt as fast as he can ahead of the election. I suspect he and his team believe this is the best way of averting Trumpism. That might be right. On the one hand, it is working, as the chart I borrowed from Vanguard shows.
Source: Vanguard
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