No. 36: Belt Tightening, Semiconductor Analysts, Portugal
Belt tightening
Based on the anecdotes of a few friends around the globe, interest rates and lending terms have started to get tougher. In Germany, if you had an OK job contract, you could get a 1-2% fixed interest rate on a home for 15 years. Now these rates have more or less doubled in some geographies, with long-term rate fixing becoming less likely.
Even though headline rates haven't gone up that much, tighter term loan policies result in higher overall financing cost and risk for the consumer.
House prices (at least in cities I have looked at) haven't moved - which basically means the cost of home ownership has increased.
I'm curious to see how much this assault on household net worth can hold up before demand simply pulls back. Broader stock market pullbacks create reverse wealth effects, making people feel poorer. My friends who made killer trades during COVID with zero investing experience are no longer high-fiving each other. At the same time, inflation continues its squeeze on blue-collar households, reducing rookie cash coming into markets.
It looks to be getting worse. But in reality nobody knows what will happen. After all, worsening inflation creates business opportunity and human ingenuity that peaceful times can't.
There will be some people who continue to gain advantage during this time though.
Young people in highly skilled jobs are likely to retain earning power, and might even grow it faster than their cost inflation, while being able to buy equities slightly cheaper each month as inflation takes capital out of markets. They don't need to retire any time soon so they can tolerate a brutal stock market for long periods.
Great companies might be able to increase prices on their products above cost, inventory and capex increases - therefore continuing to generate internal capital. This would leave them able to undertake cheap share repurchases, cheap M&A, or cheap investments in mopping up talent that might be abandoned by marginal companies.
Microsoft's strength comes to mind. Instead of increasing Cloud capex in line with usage, their investments in software optimisation will help them wring more value out of their capex. And if there are some capital-starved tech companies looking for a quick exit, Microsoft can turn them into a button on Excel.
At the same time, the tasks that today look impossible - such as supply chain innovation - will be quickly pursued by hungry entrepreneurs who smell opportunity embedded within hard problems. For example, warehouse automation looks more attractive since handling labour costs have skyrocketed. Societal ROI for self-driving trucks has gone up amidst the acute truck driver shortages, which could speed up regulatory approval. And as we speak, companies are shuffling around production and distribution to boost service levels and drop cost.
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Portugal
Travelling through Portugal was interesting. I spent some time in the south, near beautiful beaches on the Atlantic Ocean. A few interesting themes popped up.
In small towns like Albufeira, tourism was, and still is the main driver of the economy. A young ice cream store owner told me about how most of his money is made during the summer. Winters, he said, were "empty and boring" - with no opportunity to work.
"Those digital nomads - they have the best life. They work all year round, but they switch off their laptops after 4pm and head to the beach. Whereas us locals work long hours during the summer, with no time to surf and swim, and are bored and cold during the winter."
He told me that COVID dealt a death blow to the tourism industry in Portugal. Aside from two years of living on meagre government handouts, continued uncertainty makes it even harder to attract workers. The ice cream guy explained further:
"We used to be able to promise that tourism workers would be able to have work 9-10 months of the year. Now we can't do that since there's ongoing COVID disruptions. And even if they (disruptions) completely go away, workers still feel uncertain. Also, tourists buy up all the local property, making it expensive for seasonal workers to rent in the area. This means we have fewer workers, and have to pay them more for them to justify relocating here 9 months per year."
There is a mix of reliance upon and resentment of tourists. Tourists feed the Portugese with precious dollars, and bail out cash-strapped locals by purchasing coastal properties above local prices. The resentment comes from locals who feel the beauty of their seaside towns has been ruined by tourist traps.
Is there a way out, apart from tourism?
The EU's free labour movement has sucked all the mobile talent from Southern Europe into the larger, richer nations like Germany, France and Netherlands. Meanwhile, Portugese industry has become less competitive. Since Portugal uses the Euro they can't simply de-value their own currency like the old days, and stay cost competitive with more expensive EU countries for manufactures.
As this downward spiral continues, tourism becomes increasingly important to keep cash flowing in. Not only do Germans, French and Dutch contribute directly by spending tourist dollars in Portugal, the governments of rich EU countries effectively borrow against their virtue to bail out the weaker parts of Europe.
Barring some sort of Silicon Valley development from the nomad worker boom, Portugal's medium term downward trajectory seems set in stone.
Semiconductor analysts
Semi analysts are a special species. I talked to quite a few of them in Omaha just last week.
The old guard of semi analysts spent years in a suicidal industry. Excess industry inventory would pile up without warning, semi companies would all commission new capacity at the same time, which of course came online all at once, causing massive crashes. Crashes were followed by layoffs, bankruptcies, and the odd acquisition by those who had any cash left after the bloodbath.
It's therefore difficult for the old soldiers to accept that the industry might have improved. One ex-semi analyst I met said "it's an industry where the new kids are probably able to see clearly - and the old guard are permanently traumatised".
I don't think most new kids have seen a full cycle. They (myself included) probably don't fully understand how hard the industry can get dumped in a full downturn - given the massive fixed cost base of semi IDMs and foundries.
The truth, of course, lies somewhere in between. In the short term, semiconductors are cyclical by nature - and things can change in an instant. This is a hard technology business with competitors, customers and even suppliers, trying to disrupt it from every angle.
In the long term, however, massive amounts of processing power, memory and storage are needed to move the world forward. At the same time, the number of players who have the manufacturing and design prowess in semis is dwindling - due to massive capital and skill requirements. In other words, incumbents look stronger than ever.
That doesn't mean every semi company will do well. There might be some consolidation or technological obsolescence yet to come. But my bet is that the industry as a whole will do better in future years - of course with bumps along the road.