No. 37: Kicking the Can Down The Road, Contra-indicators
I’ve published a lot less this year. It’s not because I’ve written less. It’s because 95% of the time I write, I realise I have nothing to say. It’s actually hard to add any value. However, it is cool to look back and have a sort of investment diary.
It’s a bit like most of what we read. Hardly any of it has any economic value. Though that doesn’t mean it’s pointless. It might be a fun way to pass the time. And, as we know, having fun ways in which to spend idle time is a meaningful part of modern life.
Kicking the Can Down the Road
It was interesting to read through GM annual reports through the 1940's and 1950's. The company was giant. They had around half of US market share. They were expanding overseas. Their growth was seemingly unstoppable.
All they had to do was keep the machine running.
This meant fending off anti-trust concerns by keeping market share down, along with keeping their employees happy - and therefore the factories running. The United Auto Workers Union (UAW) was established in the 1930's and expanded rapidly as the overall auto industry grew. The conditions of auto workers advanced rapidly. They were even provided with housing and other various perks at some point, to encourage long-term retention. This was probably true of the other US auto manufacturers of the day.
All GM had to do was keep the machine running.
At some point, when the industry matured, growth rates stalled. Most households already had a car. And those who could afford a second car had already bought one. Additional industry growth came from replacement of old automobiles - which were getting increasingly sturdy, surviving longer.
However, the generous promises made in GM's hey-day to UAW were still in force. UAW workers would strike whenever GM didn't meet various onerous demands - and shut the entire factory - costing GM huge amounts of money. This threat became worse through the 70's and 80's when foreign car manufacturers entered the US auto market, shrinking margins and growth of GM. Whenever GM achieved additional profit or growth, the UAW demanded their pound of flesh. As you could imagine, this was not sustainable. The UAW had shifted to what Sergio Marchionne (late head of Fiat Chrysler Automobiles) a "culture of entitlement".
In the early 2000's, the US car industry was on its knees. Foreign competition destroyed profit margins on most US models (apart from the heavily-tariffed utility vehicle market) while labour costs were more like fixed costs due to generous conditions extracted by the UAW over decades. This and many other managerial missteps led to the eventual bankruptcy in 2009.
I tell this story because I see headlines reminding me of the very early concessions that GM gave employees when it was dominant and growing. Apple retail stores attempt to unionise, while Apple raises wages in efforts to placate workers. Starbucks management engages actively with unions and employees directly, and probably will end up passing larger portions of its growth back to the workforce.
It's of course not that clear whether Apple or Starbucks will be the next GM. However, the story of GM reminds me that every great empire has its judgement day. There will be a time where Apple no longer is an economic colossus. And there will be a time where Starbucks is a distant memory. And most likely anything they promise to employees today will be hard to reverse - while the growth prospects of both Apple and Starbucks will certainly look worse in decades to come, as they mature.
These outcomes don't happen because management are "stupid". It's more because managements are always trying to balance between the short-term and the long-term. And very often, the short-term wins out. And by the way it needs to - because without a short-term profit, you can't have a long-term.
Contra-Indicators
Inflation continues to destroy margins, household wealth, and reduce returns on capital. In addition, economies like Europe face a likely gas pinch over the winter - a fact that most have put aside due to the hot summer currently underway.
People are enjoying a post-covid spending boom. Many of my friends in travel and hospitality businesses are setting profit records vs. pre-COVID levels. So it gets even more implausible to believe that worse times could be around the corner.
Some would argue that inflation doesn't destroy an economy - "I mean look at Latin America or India, right?"
I had this exact conversation with a good friend. And he might be right about that. But my argument was that it's easy for developing countries to grow with inflation, while the responsible countries don't have problems or inflation. But what happens when the responsible countries also have high inflation? Does that make developing economy inflation worse than normal? So far the answer has been an emphatic "YES". You can look at food shortages in Africa, for example, driven by the shortage of Ukraine exports. And the chances are, if the UK government is making dumb promises which involve printing money, or taxing productive capacity of oil companies, then economies with even less sophistication or oversight are probably doing the same thing at a greater scale.
Still, I get stock pitches every day. Comparatively, prices look better each day. Somehow this makes me skeptical... Either I should be buying, or I should be waiting. Of course, knowing myself, I'll do some combination of both.
I think the trajectory of the interest rate environment is going to get worse - at least before it gets better again. Which means for me that the option value of cash is increasing.
And I know we're all meant to think long-term... But has anyone who isn't retired actually invested through an inflationary bear market in the developed world? Are our current financial institutions set up to understand or even acknowledge that risk?
Will equity analysis even be a job, at a time where interest rates are 10% and stocks have been falling for the last 10 years?
Of course, there will be businesses and investors who do well regardless of macro conditions. But accurately calibrating the environment you operate in is still a very important exercise.
It's a bit like planting seeds in land that's prone to desertification in the next 3 years. It's not relevant if the crop you plant bears fruit within a year. But if your crop only bears fruit after 5 years, then you need to have a view on whether the land is going to be fertile in 5 years.