Post 228

A snapshot of what’s going on in the world’s economy.  Financial Ructions and book reviews can be a bit more technical so feel free to skip them.  See disclaimer at the end of this note.

Summary

  • It looks like there may be consequences for Boeing with their latest 737 Max mishap.
    • The issues could come down to poor corporate culture.
  • Proctor and Gamble is still increasing prices but they’re slowing.
    • Prices up 4% in the last quarter vs. 10% at the beginning of the year.
  • Netflix’s crackdown on password sharing is paying dividends.
    • A small investment in its stock when it was listed on the stock market in 2002 would have made you very wealthy.
  • China’s residential property market is in trouble.
    • But is a result of bad policy rather than free market forces.
  • Some large financial companies are trying to force workers back into the office.
    • But flexible work from home has increased since the beginning of last year.
  • Business is shrinking in Europe.
    • Both manufacturing and services.
  • As electric vehicle growth stalls, the price of lithium, used to make the batteries, has plummeted.
  • More countries are recognising the benefits of nuclear power.
  • In Financial Ructions
    • Two former Federal Reserve members were cleared of insider trading despite the fact that they were trading for their personal account at the same time that they were printing trillions of dollars to drive asset prices higher.
      • I include a rant from my 2021 Ivy Quarterly.

News

Down To Earth

In an interview on CNBC, United Airlines CEO said that the company is reconsidering buying Boeing 737 Max 10 aircraft.

  • This is a result of a number of issues but he said that the recent incident of a door plug blowing out on an Alaska Airlines 737 was “the straw that broke the camel’s back.”
  • A number of experts have said that it’s extremely fortunate that the plane was only at an altitude of 16,000 feet when the incident happened.
    • If the plane was flying at 35,000 the quick decompression could have been catastrophic.  See USA Today article ‘here.’

PM: Boeing seems to be suffering from years of poor corporate culture where it appears that a focus on the share price has resulted in possibly cutting corners when it comes to aircraft development.

  • There is a book on the subject called Flying Blind: The 737 MAX Tragedy and the Fall of Boeing.
  • See Globe and Mail article ‘here’ by Brian Barsky who teaches a course at UC Berkeley called “Boeing 737 MAZ: Money, Machines, and Morals in Conflict.”

PM: The following is from my post in September of 2022

  • As you probably know the MAX suffered two crashes killing 346 people.
    • I remember looking into it when I was analyzing a company called Southwest Airlines which exclusively uses 737s.
  • The problems with the aircraft started over twenty years ago when Boeing bought McDonnell Douglas and the financial engineering culture of the latter infected the former.
    • Boeing was always run by engineers rather than financial types and was headquartered in Seattle close to where the planes were being designed and built.  However, they became not to be run by engineers and moved their headquarters to Chicago (one rumour was because the CEO liked opera).
  • Anyway, when they needed to design a more fuel-efficient plane to compete with the Airbus A320 they simply added more fuel-efficient engines to the existing fuselage of the 737.
  • The only problem was that the new engines were larger and wouldn’t fit in the usual spot under the wing and doing so would have required designing a new fuselage taking years and costing billions of dollars.
    • The reason they wouldn’t fit is that the 737 is the oldest design still in commercial use in the US and the fuselage was deliberately built closer to the ground so baggage handlers could have easier access to the freight doors and many airports back then didn’t have gates and instead used portable stairs.
  • The solution for Boeing was to put the engines further forward on the wing to create enough clearance with the ground.
    • But this changed the centre of gravity of the plane and to compensate for this they installed a flight control software called MCAS.
      • Crash investigators determined that issues with sensors and inadequate pilot training with this software contributed to the accidents.

Price Over Volume: Just.

Procter & Gamble was founded in Cincinnati in 1837 and owns brands including the following:

  • Pampers
  • Bounce
  • Downy
  • Gain
  • Ivory Snow
  • Ivory Soap: introduced in 1879
  • Tide
  • Bounty
  • Charmin
  • Always
  • Gillette
  • Braun
  • Head & Shoulders
  • Cascade
  • Mr. Clean
  • Swiffer
  • Crest
  • Scope
  • Vicks
  • And more

Announced their latest three-month results:

  • Adjusted sales: +4%.
    • Price: +4%
    • Volume: -1%

Adjusted sales by quarter:

  • 1Q/23: 7%
  • 2Q/23: 8%
  • 3Q/23: 6%
  • 4Q/23: 4%

Price increases by quarter:

  • 1Q/23: 10%
  • 2Q/23: 7%
  • 3Q/23: 7%
  • 4Q/23: 4%

Netflix Sales Growing.

Netflix announced their latest results.

Sales growth over the last four quarters:

  • 1Q/23: 3.7%
  • 2Q/23: 2.7%
  • 3Q/23: 7.8%
  • 4Q/23: 12.5%

Global streaming paid memberships: 260 million.

  • Up 12.8% from last year.

Sales accelerated in part (mainly?) due to Netflix cracking down on password sharing and instead launching paid sharing.

  • For paid sharing, you can add people outside of your household to your account, but you have to pay for it.
    • In Canada it’s an extra $7.99 per extra member added.
  • It looks like revenue growth will continue to accelerate, but to the extent the growth is  due to the implementation of paid sharing, sales growth should start to slow.
    • That is until they:
      • Boost revenue through making you watch more ads.
        • “Our aim is to make ads a more substantial revenue stream”
      • And as they say “As we invest in and improve Netflix, we’ll occasionally ask our members to pay a little extra to reflect those improvements.”

Share of viewing in the US for streaming companies:

  • YouTube: 9%
  • Netflix: 8%
  • Disney/Hulu: 5%
  • Prime Video: 3%

Since Netflix was publicly listed in 2002 its share price has increased at a rate of 33% per annum.

  • A $10,000 investment would now be worth $5.3 million.

Bad Policy Coming Home To Roost

The WSJ reports that housing prices in China’s four largest cities for December were down anywhere from 11-14% vs. the prior year.

  • The property sector is struggling with sales of newly built homes falling 6% in 2023.
    • Of course, this has brought forth calls for the government to offer support to the sector.
    • However, according to an article by Reuters, there are still around 7.2 million unsold homes in China.
    • And there are millions of previously sold homes that are sitting vacant.
      • One former government official estimated that China’s current population of 1.4 billion people still wouldn’t fill the currently available vacant homes.
  • PM: This is what happens when you encourage speculation and unproductive investment.
    • In the short-term, building millions of homes that people won’t live in provided employment and boosted the GDP number (final spending).
    • But if those homes are sitting vacant, they are not contributing to society in any way and in fact it was capital that was wasted, and which could have been put to more productive use.

Work From Home

For companies with hybrid working models 87% of them require staff in the office 2-3 days per week.

The FT reports that Bank of America has sent letters to employees warning them of disciplinary actions if they don’t return to the office.

According to the Flex Index (Scoop), officer requirements breakdown is as follows:

  • Full time in the office: 38%
    • This number was 49% at the beginning of 2023.
    • Employees choice: 26%
    • Minimum days per week: 18%
    • Fully remote: 7%
    • Specific days per week: 5%
    • Minimum and specific days: 3%
    • Minimum % of time: 2%
    • PM: I never knew there were so many categories.
  • For those in the “minimum days per week” category the number of days required:
    • 3 days: 49%
    • 2 days: 38%
    • 1 day: 7%
    • 4 days: 6%
  • In terms of the percentage of companies within an industry:
    • The most flexible:
      • Technology: 97%
      • Media & Entertainment: 92%
    • The least flexible:
      • Manufacturing & Logistics: 48%
      • Retail & Apparel: 49%
        • Their report says that even excluding the Technology sector, companies with fully flexible working models outperformed by 13% on a revenue basis from 2020-2022.
        • PM: I wonder if this had anything to do with certain industries suffering more during this time i.e. was it more about the industry rather than work flexibility.
        • PM: Would be good to see a comparison of different levels of flexibility within industries.

PM: As I have said before, it’s hard not to be suspicious that banks are trying to start a trend of getting workers back into the office as they’re worried about loans they’ve made to property owners.

  • According to S&P Global, Wells Fargo had the largest exposure to office properties with over $36 billion of loans at the end of 2022.
  • But maybe it’s nothing.

European Business Falling

Business activity in the Eurozone according to S&P Global as per the HCOB Purchasing Managers’ Index: A number below 50 means contraction:

  • Composite Index:
    • Dec/23: 47.6
    • Jan/24: 47.9
    • The composite index has been in contraction territory for 8 consecutive months.
  • Manufacturing:
    • Dec/23: 44.4
    • Jan/24: 46.6
  • Services:
    • Dec/23: 48.8
    • Jan/24: 48.4

Order backlogs have fallen in 18 of the last 19 months.

  • They said that Manufacturing backlogs “continued to fall especially sharply.”

The overall cost growth has accelerated to “the fastest recorded since May:”

  • Falling for Manufacturing:  Have now fallen for 11 consecutive months.
  • Rising for Services: Have risen to the highest level in 8 months.

Lithium: Needing a Recharge

Lithium is used in the production of batteries for Electric Vehicles.

I’ve noted in earlier posts how the growth of EVs has been slowing.

  • According to the FT, growth of EVs in China:
    • 2022: 84%
    • 2023: 25%

Combined with increasing supply of lithium this has resulted in a significant fall in the price of the metal:

  • Peak: Around $80,000 per ton.
  • Today: $13,200 per ton.
    • Down over 80%.

The Nuclear Option

The International Energy Agency forecasts that global nuclear power generation will grow at 3% per annum through 2026.

  • New reactors:
    • China
    • India
    • Korea
    • Europe
  • Restarting reactors:
    • France
    • Japan

More than 20 countries intend to triple nuclear power capacity by 2050.

Financial Ructions

Good News

The FT reports that two former Federal Reserve officials have been cleared of “any unlawful activity” related to trading their personal stock accounts.

  • PM: They were buying stocks at the same time that the Federal Reserve was printing trillions of dollars which they hoped would “ease financial conditions” i.e. drive stock markets higher.
  • Both subsequently resigned when news of this broke out in the fall of 2021.

Here is a rant from my Ivy Quarterly Report of September 2021.

  • Sounds like I was in a bad mood that decade day.

Ivy Quarterly Report

September 30, 2021

Bad policy, bad outcomes

As anyone who has been reading our Ivy Quarterly Reports over the last 12 years or so will know, we’re not big fans of central banks and the Federal Reserve (Fed) in particular. The reasons are many, but the main ones are:

  • The Fed’s grotesque distortion of price discovery which erodes the productive capacity of the economy
  • Its practical institutionalization of moral hazard leading to reckless speculation, which ultimately comes at the expense of the taxpayer
  • Its failed attempts to “fix” the economy by creating a wealth effect by driving asset prices higher, which only created a wealth effect for the top 1%
  • Its encouragement of debt-fueled consumption because it believed it would enable the economy to achieve “escape velocity,” but instead created a country of debt serfdom and two separate groups of citizens: the haves and the have-nots.

However, even we were shocked by recent news surrounding various officials of the Federal Reserve investing their personal assets in securities that the Fed itself was buying with printed money.

Fed officials, including Fed chairman Jerome Powell, hold securities like municipal bonds and corporate bonds, which the Fed decided to start buying during the early days of the COVID crisis.

Others held mortgage-backed securities (MBS), which the Fed has been purchasing at a rate of $40 billion per month. Still others had been trading stocks on a regular basis and as of writing, two Federal Reserve Bank presidents have tendered their resignations.

Powell said he was unaware of the stock trading activity of various Fed members and suggested their personal investments should be restricted to index funds. This strikes us as someone who is completely unaware of the issue at hand. The Fed has been attempting to create a wealth effect by driving asset prices, particularly stocks, ever higher: they call this an improvement in financial conditions. If policymakers at the Fed are all invested in equity index funds, then any time they decide to print money they drive the value of their personal portfolios higher. And any time the markets fall, and they rush out to print yet more money to save the stock market, they’re effectively bailing themselves out of holding onto overpriced stocks in an index fund.

Astonishingly, it seems that none of them have broken any rules with respect to the Fed’s ethics policies, which tells you a lot about its views on ethics. We would have thought there was a huge conflict of interest in allowing members to invest in assets that directly and indirectly benefit from their decisions on how loose monetary policy should be.

We’re sure that they will respond that their personal investments in mortgage-backed securities or index funds do not come into play when deciding on appropriate monetary policy. However, when maintaining ultra-loose monetary policy drives your personal assets higher and tightening could cut your multi-million-dollar investment portfolio significantly, it’s ludicrous to claim that you are not influenced by that. Perhaps they believe themselves to be part Vulcan with a Spock-like ability to suppress their emotions. But then they would be lacking the extreme logic trait of the Vulcan race as they would know that even if they “were” able to convince themselves that their personal investments did not influence their leanings on monetary policy, there would be no chance in hell they could convince anyone else (except perhaps some financial media outlets).

The power of the Fed is enormous and should come with great responsibility. While in office, no personal investments should be allowed that would potentially benefit from Fed policy. Of course, house prices also benefit from Fed policy, however we wouldn’t deny them the right to own a home, even though they stand to benefit financially from doing so. We believe that when it comes to personal finances, members of the Federal Reserve should only be allowed to keep their money in a savings account at a bank (perhaps they could receive an interest rate premium based on improvements in the productive capacity of the economy). This would ensure that the financial repression that they are imposing on savers is also imposed upon themselves. There would be at least some sense that we’re all in this together. Not, of course, that financial repression is an ethical policy that’s going to fix the economy. It’s unethical and has made the economy worse, but at least Federal Reserve Board members could point to the fact that they too are suffering from their own policies and are willing to do so because ultimately, they believe we’ll all be better off. But they don’t lead by example and we’re not going to be better off. Better off is now the exclusive domain of the top 1%.

Disclaimer: Note that Paulitical Economy™ should not be considered as investment advice, and I have not verified all of the sources of information.  It is meant for general interest purposes only.  Please consult an advisor if you plan on putting any of your hard-earned capital to work during these turbulent times.

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