The Wednesday Letter 187 – 27 September 2023

Editors

THIS WEEK: Labor Unions Return; Market Correction; Immigration Chaos; 2024 Presidential Race; China After the Dividend; S&P Sectors Update; GeoReads #006; Tweets and Charts.

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LABOR UNIONS RETURN

Are unions having a moment? It is quite possible, after decades in the wilderness. President Reagan famously fired 11,345 air traffic controllers when their union (PATCO) called an illegal strike. This marked the beginning of a long decline for labor unions in America. Decades of disinflation and prosperity, and the twin rise of a service economy and a digital economy, eroded the appeal and effectiveness of unions. In addition, a steady supply of new young workers and of more women joining the workforce impaired the negotiating power of workers. But today, several of these factors are reversing, and we may see as a result a revival of unions. Inflation has come down from last year but prices have outpaced wages. House affordability is low and is keeping young people in rentals where they have less opportunity to build wealth. Borrowing rates are higher than they have been in over a decade.

Most important, the supply of new workers is less strong than it was in the 1980s and 1990s. There are fewer women joining the workforce. And there will be fewer new adults per year in the next 20 years than in the last 40 years. This can be see in the population pyramid below from the US Census. The narrowing of the pyramid at its very bottom means that there will be fewer 20 year olds this year and every year for the next twenty years than there were in decades past. Immigration can fill some of this gap but not enough. A large share of immigrants are low-skilled workers who do not speak English and who require some training.

Unlike in Reagan’s time, unions now have a friend in the White House. President Biden joined the UAW picket line yesterday and endorsed their demand for a 40% wage increase over three years. This is unprecedented support, even among Democrat presidents. There have been three Democrat presidents since Reagan. Clinton was more interested in Wall Street. Obama was helpful to unions in the GM rescue of 2009 but kept himself aloof. But Biden assumes the role of the working man’s friend more comfortably. It is possible therefore that the current period will be seen as the closing bookend of a period that started with the PATCO firings.

Yet demographics and politics are not everything and are often upstaged by technology. Increased adoption of robotics, now AI-assisted, will work against labor unions’ attempt to increase their power. How effective unions are in the next five years will depend greatly on how fast Artificial Intelligence applications spread into all corporations. In our view, there is now a window of time for unions to make some gains, but perhaps not a very long one.

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MARKET CORRECTION

Several indicators point to a stock market correction. Before we get to them, it is worth mentioning that the valuation of the market seems in line or slightly high for this level of interest rates. The large 7 tech companies have very high valuations and skew the valuation of the market upward because of their important weighting in the S&P 500. It follows that the weighted valuation of the remaining 493 in the index is on the low side of its historic average. This should bring some reassurance about the probability of a broad and severe correction.

If there are any value investors left out there in the world, an obvious hedged trade for them would be to go short the seven tech names and go long the other 493 names (or representative subset thereof). This can be dangerous if the tech mania somehow reignites in the last few weeks of 2023. Then the last value hedge funds will limp to the end of the year before they die out, a month or two before a reversal of fortune.

Outside of the scenario of a grand finale rally by the big techs, there are many reasons to be cautious about the market: oil prices are rising and with them the possibility of inflation reaccelerating; unions are getting more active and pressuring wages upward; unemployment is ticking up from a low base; the ten-year Treasury yield continues to climb; earnings of Apple, Tesla and other large techs may disappoint when released in October; questions are being raised about the quality and longevity of NVIDIA’s earnings boom; student loan repayments have resumed; tensions are rising in the Taiwan Strait; the federal budget deficit is out of control etc.

Peter Lynch reminds us frequently that there is always something to worry about, and that those who worry too much miss out on the market’s gains. This is undoubtedly true. Market-indexed optimists have fared very well this year and on a multi-year basis (except for the occasional year like 2022). The S&P 500 is having a bad month and is down 7.2% since its July 27 high. The mid and long term look promising if the US can clean up its fiscal mess, but the near term will be driven by the 10-year Treasury yield.

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IMMIGRATION CHAOS

Illegal (or undocumented) immigration is certain to be one of the hot topics in the upcoming presidential campaign. Under President Trump, the number of new immigrants declined but that was mainly due to Covid. The Cato Institute found that Trump had no impact on illegal immigration but that he reduced legal immigration. That may be a generous appraisal. Once Trump was out of office, the number of illegal immigrants surged to unprecedented heights. And now that Title 42 has been lifted and that Trump is leading the GOP field, the number is surging again (see chart). So is it possible that Trump in fact caused a net increase in illegal arrivals during periods when he was not president, with immigrants deciding to take a chance while they still can? Trump supporters will scoff at this notion that a president may be held responsible for events that take place when he is out of office. But decisions by any executive have long-lasting consequences.

Whether one feels permissive or restrictive about illegal immigration, nearly all will agree that the present situation is chaotic and unsustainable. The huge influx is impacting communities and cities near and far from the border. Most places are under severe budget constraints and do not have the resources to house, feed and otherwise integrate large numbers of migrants. The number apprehended at the border this month will reach a new record of about 210,000, a run rate of 2.5 million per year. When Title 42 was still in force (until May 2023), as many as 30% of migrants were deported after being apprehended. This percentage is likely lower today and of the order of 10 to 15%. If we add the approximate one million legal immigrants, the total net inflow comes to more than 3 million annually, or approximately 0.9% of the US population. This is an elevated but not unprecedented percentage by historic standards. The biggest question is how effective is the economy at integrating those who end up staying here.

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2024 PRESIDENTIAL RACE

This evening, the second debate among GOP presidential hopefuls (minus the clear frontrunner Donald Trump) will take place. The lineup will be the same as last time, except for former Arkansas Governor Asa Hutchinson who did not qualify. The remaining seven participants are former Vice President Mike Pence, Florida Governor Ron DeSantis, former U.S. Ambassador to the UN and South Carolina Governor Nikki Haley, South Carolina Senator Tim Scott, former New Jersey Governor Chris Christie, businessman Vivek Ramaswamy and North Dakota Governor Doug Burgum.

One dividing line among the candidates is where they stand relative to Trump. The “I am not at all like Trump” contingent includes Christie, DeSantis, Scott and Burgum. The “I worked with Trump but I am over it” are Pence and Haley. And finally, the “I can be like Trump, more or less” is Vivek Ramaswamy. Because Trump remains very popular with the base and is leading the polls by a wide margin, the first group faces a daunting challenge. The eminently reasonable (based on his first debate performance) Burgum would normally get more traction, but we don’t live in normal times. Ramaswamy’s rise seems to have deflated and there are questions of how exactly did he get so rich, and whether his trading acumen surpasses even Nancy Pelosi’s.

That leaves Pence and Haley. Pence seems cast from a different period and would gain from an image reboot. Although he stood up to Trump on January 6th 2021, he is straddling an impossible line of trying to distance himself from Trump without completely alienating the base. Haley has no such qualms and has wagered on the risk of criticizing Trump openly. She has shrewdly invoked the name of Margaret Thatcher and promoted her own experience and foreign policy credentials. Her performance tonight may confirm her as the leading alternative to Trump.

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CHINA AFTER THE DIVIDEND

We published a second article with Exante Data on China’s economy and its ability to overcome its demographic decline. Read it here >>> China After the Dividend.

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S&P SECTORS UPDATE

The major indices sold off hard in the past week. The S&P 500 was up 19.5% for 2023 as of the end of July, and it is now up 11.3%. The Nasdaq 100 was up 44% and is now up 33%. All sectors were down in the week. Health Care XLV and Energy XLE were the best performers but they were down 1.4% and 1.5%. See the bottom table for more detail.

The table below shows September and year-to-date performances as of yesterday’s close. The major indices are down 5% or more in the month. The Russell 2000 has given back all of the year’s gains. Real Estate XLRE, Technology XLK, Consumer Discretionary XLY and Industrials XLI were down the most in September, while only Energy XLE was positive. Among the large tech names, NVIDIA gave back 15.1% in September but is still up 187% in 2023. Apple and Amazon are down over 8% in September. The next few weeks will hinge on the price of oil and on the 10-year Treasury yield. The market will struggle if they keep rising.

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GEOREADS #006

We published the editors’ sixth weekly selection of the best articles on geopolitics and world events. Click the image to access the list.

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TWEETS AND CHARTS

The economy is doing well on the surface, with low unemployment and moderating inflation, but some negative indicators are churning below. In this case, it is worth keeping an eye on BANKRUPTCY FILINGS as they have now reached levels of 2008 and 2020. (via @WhaleWire)

Is ACADEMIA TOO LIBERAL? Boards of Regents may resist this idea but more academics self-described as liberal in 2018 than in 1970. In fairness, it is possible that the meaning of the word “liberal” has evolved since then, which would make the comparison invalid and the chart moot. (via @cremieuxrecueil)

Here is an update as of Friday of an issue that we discussed at length. This year’s stock market performance is nearly all from the SEVEN LARGEST TECH NAMES. They are up 50% in 2023 while the remaining 493 in the S&P 500 are flat. (via @KobeissiLetter)

Holger Zschaepitz expects US TREASURY YIELDS to rise further, if this chart reverts to the mean. (via @Schuldensuehner)

As does Michael Howell of CrossBorder Capital. The BUDGET DEFICIT will push Treasury rates higher. (via @crossbordercap)

The US OIL RIG COUNT has been trending down, confirming that incremental US production will be limited. For fund manager Eric Nuttall, this means that oil prices will continue to rise. (via @ericnuttall)

Jurrien Timmer of Fidelity Investments sees 2024 earnings expectations as ambitious and does not see upside in the stock market unless the equity risk premium (ERP) falls below 4%, which is the average ERP for the past sixty years. (via @TimmerFidelity)

MILLIONAIRES MOVE to other countries for reasons of lifestyle, taxation and political repression. China is losing more millionaires than any other country (via @ianbremmer). Their favorite destinations are the United Arab Emirates, Australia, Singapore, the European Union and Northern America.

SANCTIONS DON’T WORK is an often heard argument. They only raise the costs of transactions and push those transactions onto a black market. (via @igorsushko)

GOLD is not far form its all-time high but investors are unenthusiastic. Most of the buying is from central banks etc. (via @VogtAlexander)

As noted previously, the vast majority of HOMEOWNERS are unaffected by RISING MORTGAGE RATES because they locked in lower rates years ago. This chart shows that the aggregate mortgage to income ratio is still near all time lows. (via @SteveHarney)

When it comes to HOUSE AFFORDABILITY, one reason the average house is less affordable than in the past is that it it much larger. (via @donnelly_brent)

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China After the Dividend

SAMI J. KARAM

This article was first published at Exante Data’s Money Inside and Out.

Will it overcome its demographic decline?

In a recent post, we described China’s unprecedented success at realizing a demographic dividend starting in the 1990s until around 2010. We discussed the confluence of factors that made this dividend possible. In this post, we look at present conditions and try to discern what is in store for the future. We use our usual approach and look at the three main pillars of wealth creation: Demographics & Health, Innovation & Productivity, Society & Governance.

Demographics & Health

The first thing that is evident is that demographics is no longer a positive vector of economic growth. 

The tailwinds created by a falling dependency ratio have died down and are now expected to turn into headwinds (see chart in our first post). The dependency ratio fell between 1970 and 2010 and was a key driver in the country’s GDP acceleration in that it opened a window of opportunity to realize a demographic dividend. China was able to realize that dividend because 1) it had liberalized its economy and opened up to trading with the world, and 2) it had improved its levels of education and infrastructure. As things stand today, the dividend has been fully realized and is behind us. There is instead a risk of a reverse demographic dividend, in which deteriorating demographics create a drag on growth, if China is unable to implement counteracting measures.

This risk is illustrated in the first chart below which shows the Chinese population by age groups. The population aged 15 to 64, aka the working-age population, soared between 1965 and 2015 and is now set to decline, slowly for the next decade but more rapidly thereafter. Meanwhile the population aged 65 and over will more than double between now and 2055. Finally, the youngest group aged 0-14 will taper off for decades to come.

Using the same data, the next chart shows the difference between the number of workers (those aged 15 to 64) and the number of dependents (those aged less than 15 and more than 64). The coming decline is as dramatic as the rise was in past decades. In 2015, there were 636 million more workers than dependents. But by 2055, this figure will fall to 189 million, or about the same as in 1980. Yet during this period, 1980-2055, the total Chinese population will have grown from 1 billion to 1.37 billion. (See in this article how the working-age population of other countries will have evolved between 1960 and 2050).

In addition to the longer term rise in the dependency ratio, China is seeing more recently a decline in its birth rate. China’s total fertility rate (TFR) fell to 1.09 children per woman in 2022, a new low in a recent downtrend that started after 2017. The next chart shows the evolution of the TFR since 1950. Note that it had fallen from over 6.0 to 2.75 before China enacted its one-child policy in 1980. Between 1991 and 2019, the TFR hovered between 1.5 and 2.0 but it fell below 1.5 in 2020 and fell again in 2021 and 2022.

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How China Realized a Demographic Dividend

SAMI J. KARAM

This article was first published at Exante Data’s Money Inside and Out.

China was ready for its historic opportunity.

Although a widely used aphorism, “demographics is destiny” is not strictly true in the modern era. Long gone are the days when troop size could on its own determine the outcome of a war, or when deploying manpower on a massive scale could result in a decisive economic advantage. Brute force just isn’t what it used to be. Today, thanks to advanced technology, small groups can inflict enormous damage in war, and a handful of software programmers can create billions in new wealth.

That said, demographics remains an important part of destiny in combination with other non-demographic factors.

Some of these factors can mitigate, or even completely counteract, a deteriorating demographic picture. Others can multiply the positive effects of demographics. This distinction—between demographics as a leading determinant of national stature vs. demographics as merely one of several components —can be illustrated by the following two opinions.

The first is a view promoted among others by Fareed Zakaria in his book The Post-American World (2008). Here is Zakaria in a 2008 Newsweek column The Rise of the Restrepeating the theme of his book:

It is an accident of history that for the last several centuries, the richest countries in the world have all been very small in terms of population. Denmark has 5.5 million people, the Netherlands has 16.6 million. The United States is the biggest of the bunch and has dominated the advanced industrial world. But the real giants—China, India, Brazil—have been sleeping, unable or unwilling to join the world of functioning economies. Now they are on the move and naturally, given their size, they will have a large footprint on the map of the future.

The second is from Winston Churchill’s speech Fifty Years Hence. It is from 1931 but remains as pertinent as ever:

When we look back beyond a hundred years over the long trails of history, we see immediately why the age we live in differs from all other ages in human annals. Mankind has sometimes traveled forwards and sometimes backwards, or has stood still even for hundreds of years. It remained stationary in India and in China for thousands of years. What is it that has produced this new prodigious speed of man? Science is the cause. Her once feeble vanguards, often trampled down, often perishing in isolation, have now become a vast organized united class-conscious army marching forward upon all the fronts towards objectives none may measure or define. It is a proud, ambitious army which cares nothing for all the laws that men have made; nothing for their most time-honoured customs, or most dearly cherished beliefs, or deepest instincts. It is this power called Science which has laid hold of us, conscripted us into its regiments and batteries, set us to work upon its highways and in its arsenals; rewarded us for our services, healed us when we were wounded, trained us when we were young, pensioned us when we were worn out. None of the generations of men before the last two or three were ever gripped for good or ill and handled like this.

Zakaria was not wrong about the growth of China, India, Brazil and others (he was after all writing in 2008 when that growth was already evident) but he gave demographics more weight than it deserves. Zakaria saw the overwhelming success of the less populous West as an “accident of history” while “the real giants – China, India, Brazil – have been sleeping, unable or unwilling to join the world of functioning economies.”

By contrast, Churchill saw the West’s advance as no accident and as the logical result of scientific progress. Note in the excerpt Churchill’s mention of India and China, to emphasize that demographics had been overtaken by science.

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Demographic Dividend: Which Countries Are Next?

SAMI J. KARAM

Sub-Saharan Africa is nearing a historic opportunity, but most of its nations are not ready.

Published on Africa Day 2023.

The population of India will have surpassed that of China by the end of this year, with each country counting 1.43 to 1.45 billion people. This milestone has led several observers to wonder whether the Indian economy can achieve a demographic dividend in the same way that China did after 1990. There is however widespread misunderstanding around the question of what constitutes a demographic dividend. This recent statement from a leading Indian daily is typical but inaccurate:

“A high population, especially in a younger age cohort, is generally seen as an asset rather than a liability for the economic fortunes of a country. The simple reason for this is that more people also means more working hands.”

The Financial Times similarly published “Can India Unlock the Potential of its Youth?” in which it discussed India’s prospects of deriving a demographic dividend from its youth bulge.

“More people” or a “youth bulge” could in theory mean “more working hands” but only if there is a sufficient number of jobs being created. The fact that tens of millions of new young cohorts will come of age every year and will need to take jobs to make a living does not automatically mean that those jobs will be there for the taking. A benign economic outcome cannot be taken for granted merely because of a shift in demographics. If for example investment is weak or if literacy is low, having more people may result instead in greater poverty and other deteriorating conditions. In addition if there is a too-large “younger age cohort”, there may be new headwinds slowing the economy in cases where the number of dependents (the young and elderly) overwhelms the number of workers. All of this is to say that while the sheer total number of citizens is important, it is less important than the age distribution of the population and other non-demographic factors.

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On Oil and Energy into 2023

SAMI J. KARAM

This post, the second in a series on the energy sector, was first published at Exante Data’s Money: Inside and Out.

In an earlier post we recalled the recovery of the energy sector in 2022. Here we look ahead to prospects for the oil market in 2023. In particular: 

  • Will we see more of the same, upside for energy stocks? 
  • Or will the energy sector subside again? Or mostly flatline? 

In previous times, we could offer some answers to these questions by focusing on market supply and demand for oil and gas products. Today, these market forces are made more complicated by factors that are not solely economic, but also political and geopolitical. 

Let us consider the key variables and some scenarios.

Key Factors to Watch in 2023

  1. Inventories

Inventories of crude oil and of some oil products now stand near historic lows in the US. This decline was exacerbated by the Biden administration’s sale of oil from the Strategic Petroleum Reserve (SPR) at a rate of about one million barrels per day. These sales have depleted the SPR from a total of over 600 million barrels in March to less than 400 million today, the lowest level since the early 1980s when the SPR was being filled. 

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The Great Energy Recovery of 2022

SAMI J. KARAM

This post, the first in a series on the energy sector, was first published at Exante Data’s Money: Inside and Out.

The energy sector outperformed in the past year, and not only because of Russia-Ukraine.

“By the fall of __, it was clear that a nation’s prosperity, even its very survival, depended on securing a safe, abundant supply of cheap oil.” 

When Albert Marrin penned this sentence in his book Black Gold: The Story of Oil in Our Lives, he was looking back nearly a century and referring to the fall of 1918. But we can agree now, looking at the wreckage suffered by the European economy and at severe disruptions elsewhere, that it applies just as well to the fall of 2022. The six months since the start of the Ukraine war have shown like no other recent period that the global economy in the 21st Century is still very much predicated, as it was in the 20th Century, on the story of oil (and natural gas), of nations searching for it, competing for it, trading it or withholding it.

This realization is not quite what we expected. 

On the contrary, rich economies had been for over a decade moving slowly but methodically to reduce their dependence on fossil fuels. As a result of climate change concerns, investors were pouring money into renewables and curtailing fresh outlays to oil, gas and coal projects. Natural gas was previously seen as the cleaner source of energy but it was now deemed as only marginally better than oil. There was a spreading consensus in some quarters that fossil fuels were on their way out, sooner or later but preferably sooner.

University endowments and other large institutions were scrubbing their portfolios free of fossil fuel holdings and were doing so with fanfare and as proof (in their view) of good responsible citizenship and of adherence to ESG standards. Their timing was good because, starting in late 2014, a surge in shale oil production in the United States depressed the price of oil and with it the price of energy stocks. From late 2014 to early 2020, the mere avoidance or diminution of fossil fuel holdings allowed many endowments and funds to deliver significant outperformance vs. the major equity indices. Their returns were further boosted by their generous allocations to the technology sector where stocks rose smartly year after year.

Consider that from its peak in June 2014 to the end of 2019, the XLE energy ETF declined by 40% while, during the same period, the XLK technology ETF rose by 142% and the S&P 500 by 92%. It is easy to see how many “clean” or “green” funds outperformed the S&P 500 in 2014-19, in particular if they overweighted the technology sector.

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The Wednesday Briefs – Evaluation Update 1

Editors

In our August 2021 evaluation of The Wednesday Briefs under the headline Are The Wednesday Briefs Worth Reading?, we concluded that The Wednesday Briefs made a large number of accurate predictions. Separating the survey by topic, we included excerpts from previous issues that had proved prescient. We encourage you to read or re-read the first evaluation. We include those excerpts below again.

We also accepted that not everything had been perfect. For example, we were too optimistic about the pandemic. We thought and hoped that the numbers of cases and deaths would be far lower than they turned out to be, and that the pandemic would fade faster than it did. We had little precedent to go on and hoped for the best.

The other place where we stumbled or thought that we had stumbled, in the issues preceding that August 2021 evaluation, was on the question of inflation. Here we quote from our post back then: “We called it right but overworried a bit about inflation”. As we all know now, we had not in fact overworried about inflation, but were unfortunately correct to worry. It just took longer for inflation to show up in the official numbers.

Net net therefore, our main miss before August 2021 was about the pandemic. Not a negligible miss, but again one with little precedent in our collective experience.

Let us now examine the record since August 2021, using the same template of topics (POLITICS, MARKETS, ECONOMY) that we used in the first post and substituting “GEOPOLITICS” for “PANDEMIC”. The first is heating up while the second is subsiding.

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2022 French Elections with Axel Gyldén, 16 April 2022

Editors

Between the two rounds of the French Presidential election (last Sunday and next Sunday), Sami J. Karam speaks to Axel Gyldén, veteran reporter at France’s leading weekly L’Express. Topics include analysis of the first round results, President Emmanuel Macron’s popularity, Marine Le Pen’s probability of winning and what such a victory would mean for France and for Europe.

TO HEAR THE PODCAST, CLICK HERE OR ON THE TIMELINE BELOW:

Twitter Punished

Editors

The following opinion first appeared in The Wednesday Briefs 110 – 6 April 2022. Access to The Wednesday Briefs is free but requires a password. Subscribe to populyst for access.

Tesla does not advertise in the media. That is true if you ignore the free advertising that Elon Musk gets by tweeting daily on Twitter. Musk in addition to everything else is a cult leader not only of the Tesla cult but also of the cult of Musk. In fact, the cult of Musk is the primary reason why Tesla is valued more highly than all other automakers combined. Musk sells electric vehicles and space rockets, but he sells first and foremost the public persona of Elon Musk. His purchase of 9.2% of Twitter therefore can be seen as an integral extension of his efforts.

Twitter has become vital to Musk, as vital as it had become to President Trump. Both Musk and Trump have (or had, in Trump’s case) tens of millions of followers and were able to reach them every day at a cost of exactly zero. We noted in the past the absurdity of this “free lunch” anomaly and have long argued that Twitter should invoice certain categories of users, not only in order to generate revenues but also in order to enforce a code of conduct.

We included this graph in The Wednesday Briefs 073 and 046. The x-axis refers to a user’s frequency of tweeting. And the-y axis to whether Twitter is indispensable to him. In our view, Twitter should charge users who fall in the green box, as well as some of the more prominent bloggers (the chart is from 2017 when there were few prominent bloggers; that bubble should extend to the right).

However, Twitter has remained free to all users, bypassing normal market forces and their necessary disciplining effects. Now as tends to occur with all free services, it has been ambushed by reality on two fronts: rogue users and low revenues.

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With Eduardo Mufarej, Founder of Renova, 17 March 2022

Editors

What makes an effective politician? Politicians come from all walks of life but the vast majority of them do not have any formal training in political science or in government or in the tasks and tools of being a politician. Renova, an innovative non-partisan non-profit organization in Brazil, seeks to change that and to also improve governance, by training aspiring political candidates. In this podcast, Sami J. Karam speaks to founder and chairman Eduardo Mufarej about Renova’s mission, its training curriculum and its prospects.

TO HEAR THE PODCAST, CLICK HERE OR ON THE TIMELINE BELOW: