Housing, job markets scarred by inflation

Plus Toshiba’s reckoning, Fed’s stress test, China’s 'red tourism,' Thiel’s IRA

Welcome to a new edition of Contention! This week get ready for seven minutes of dissident business news. We cover:

  1. Housing, job markets scarred by inflation

  2. Shareholders upend Toshiba’s inside game 

  3. Rapid Round: Banks get buyback blessing, China makes red tourism billions, Thiel games Roth

We’ll be off next week to celebrate Bill Withers’ birthday but we’ll have a look back this week at one year of Contention. Like what you see? Share it with others here:


Housing, job markets scarred by inflation

U.S. equity markets changed their minds last week and decided that they really didn’t have to fear a hawkish Fed after all, more than making up the ground lost the week before. The S&P 500 gained 2.7% and closed at a new record high, the Dow had its best week since March at 3.4% and the Nasdaq added 2.4%

Only Wall Street seems optimistic, however, as data keeps indicating a system under serious stress. Working people are already feeling the pinch -- the question is whether investors will too.

Last week saw the latest round of personal consumption expenditure (PCE) numbers, including the PCE inflation measure -- the one the Fed prefers to use for its rate-setting decisions. Like every other recent inflation stat, it came in at a multi-decade record: 3.4% for “core” inflation, the highest since 1992. 

The upshot: real income lost 2.4% on the month and 1.1% on the year. Real spending dropped 0.4% month-over-month. It’s not just individual consumers who are holding back their spending. Economists expected purchases of core capital goods -- the physical assets businesses buy to expand production -- to increase by 0.6% in May. Instead, they dropped 0.1%. 

Rising costs, supply chain disruption, and labor shortages all have businesses dialing back. Mainstream economic theory teaches us that demand is the primary force in the economy, but we’re getting an object lesson in production’s predominant role. 

Nowhere is this phenomenon more pronounced than in the housing market. Last week sales figures for both existing and new homes came out, and both were bad news:

Inflation is the obvious culprit in the turnaround, as buyers are getting squeezed out of the market. The knock-on effect in lumber prices -- now down by half since early May -- demonstrates another important fact: inflation is a lagging indicator. That means that soaring prices reflect “hot” business conditions from months ago, and at present rates they pose a fast-growing threat to a still-fragile economy. 

This is starting to show up in the labor market, as jobless claims stayed above 400,000 for the second week in a row, missing expectations for 380,000 layoffs. The previous jobs recovery has now flattened, eroded by rising labor costs. 

By conventional logic, this slowdown should be the solution to the wage problem: layoffs mean a looser employment market, and less pressure on employers. But new data has upturned conventional wisdom again, as the dozen states which have already ended supplemental unemployment benefits have seen below average job search activity, according to Indeed. 

Continuing claims have in fact dropped in those states, but that’s just another way of saying that states not paying as many benefits have paid fewer benefits. Timeclock company Homebase showed zero increase in job activity in those 12 states -- all of the increase has happened in states still paying the extra benefits. 

This is precisely what you would expect from an allocation shock. Last year, more workers lost their jobs faster than any other moment in history, and businesses shifted operations more dramatically than ever before. The aftermath is an economy where available jobs do not match the available workers in either skills or locations. 

This keeps unemployment high, but it also means an excess demand for labor that bids up wages. Workers seeing rising offers have an incentive to wait and see how high they get, further constraining supply and starting a feedback loop. 

Add on top of this, the CDC’s announcement last week that its latest 30-day extension of a nation-wide eviction moratorium will be its last punt. As of July 31, as many as six million American families will face homelessness. The period between now and then isn’t long enough for them to make up the back rent, and if they don’t know where they are going to live, how can they commit to a new job? 

But Joe Biden agrees with Republicans that cutting off benefits “makes sense.” Expect more austerity, more struggle, and more bad policy to keep the suffering going. 

Shareholders upend Toshiba’s inside game 

Activist shareholders at Japanese industrial conglomerate Toshiba ousted 74-year-old chairman Nagayama Osamu at the company’s annual shareholders meeting on Friday. The dismissal is a win for foreign investors who rebelled against what they described as a “dark arts” campaign between Toshiba and the Japanese government to “beat up” the investors and keep management decisions out of their hands.

Toshiba is one of Japan’s most important companies. It invented flash-memory data storage. It’s involved in the defense industry, constructs nuclear power plants, and is heavily invested in quantum computing research. The Japanese government views practically everything Toshiba does as having national security sensitivity. 

The company’s survival is important to maintain a conservative notion of social harmony with lifetime employment for workers, with autocratic -- and patriarchal -- CEOs standing in the way of shareholder meddling and hostile foreign takeovers.

The problem: Japan has also tried to bring in foreign investment to revive decades of low- and slow growth. Former Prime Minister Shinzo Abe pushed “Abenomics,” a package of shareholder-friendly economic reforms and a new governance code to attract investment.

At the same time, Toshiba was running into trouble. A 2015 accounting scandal badly damaged the firm’s reputation, wiped out billions from the company’s market value, and brought down a CEO. The giant also made a disastrous deal with U.S. nuclear power company Westinghouse, which filed for bankruptcy in 2017, bringing Toshiba to the brink of failure. Toshiba then sold off its prized memory chip business and issued $5.4 billion in equity, which foreign investors bought up. They now comprise around half of Toshiba’s shareholders.

One of the largest: Effissimo Capital Management, a secretive fund based in Singapore. Other major institutional investors include the Florida State Board of Administration responsible for the state’s pension fund. Norges Bank -- Norway’s central bank -- and Harvard University’s endowment fund are also big players.

A collision between the foreign shareholders and the Toshiba old guard was inevitable. The shareholders discovered that Toshiba’s executive board collaborated with Japan’s powerful trade ministry and the prime minister’s office to use high-pressure tactics on the investors -- playing the bad cop -- while the company would offer a deal to ensure their preferred directors retained control. 

“If we are aggressive, we can get them with the FEA,” Prime Minister Yoshihide Suga said last year while acting as the government’s top cabinet secretary. The FEA, or Foreign Exchange and Foreign Trade Act, places restrictions on foreign investors before votes at companies deemed important to national security.

This collusion burst into the open in the past few weeks, culminating in an independent report detailing the pressure campaign. The shareholders revolted, bringing down several board members until the coup de grace against Nagayama on Friday.

Their victory has important long-term implications, likely emboldening activist investors in other economic sectors, while eroding the Japanese government’s ability to intervene in strategically important businesses. In the short term, the affair has damaged investors’ perceptions of “old-fashioned” Japanese companies suspected of doing business via backroom cabals.

But in reverse, imagine if Japanese investors were banging on the doors of Lockheed Martin or BAE Systems -- major industries with critical national security importance to the United States and the United Kingdom. Or during the 1980s, when Americans feared that increased Japanese direct investment and ownership of U.S. companies would threaten the national economy -- and then made moves to selectively put a halt to it.

At that time business was curiously comfortable with setting aside liberal norms for corporate governance in order to protect dominant military and political power. Now that the shoe is on the other foot, hypocrisy on all sides is clear for all to see. 

Rapid Round

Fed stress test greenlights buybacks

The Federal Reserve announced on Friday that all 23 major banks subjected to its “stress test” for financial stability passed, clearing the way for unlimited dividend payments and stock buybacks. The central bank had restricted capital returns to bank shareholders following the coronavirus crisis, but the stress test indicated that the institutions could suffer $474 billion in losses and still retain more than double the capital required. 

Barclays estimates that the banks will send more than 100% of their earnings this year back to shareholders, with the first buyback announcements expected Monday

The move will mean new stress on the Fed’s reverse repo operation which hit a staggering new record on Wednesday: $813.57 billion in overnight purchases from 73 counterparties. The bank’s recent rate move on the program -- increasing payouts to 0.05% -- has backfired, sending more cash than ever out of bank coffers. The coming capital offload could mean up to $3 trillion in new demand for deposit parking every day, raising concerns of a 2019-style liquidity crunch for major banks in the near future. 

Revolutionary sites pay big for China 

The 100th anniversary of the Communist Party of China is coming up on July 1 and “red tourism” is taking off, providing an extra jolt to the economy while borders are still closed due to COVID. Red tourism -- historical sites and museums commemorating the country’s revolutionary heritage -- could bring in $153 billion in annual revenue by 2023, according to one estimate.

Overall, red tourism is up by 35 percent before its pre-pandemic level. But it’s about more than just business. The CPC has in recent years designated hundreds of different sites across China as “patriotic education bases,” with living reenactments at World War II battle sites, costumed actors in Eighth Route Army gear, and robotic guides that teach communist history on video screens. This, according to the party, can help “direct and rally the masses’ patriotic passions to the great cause of building socialism with Chinese characteristics.”

One possible inspiration: American colonial heritage towns which top CPC political theorist and Standing Committee member Wang Huning visited in the 1980s. “In these places, there are full-time personnel to manage and provide the convenient measures needed for public visits, such as parking, shops, restaurants, and various instructions,” Wang wrote. “In fact, to spread the American spirit is a kind of socialized ideological and political education.”

Thiel stashes tax free billions 

Billionaire venture capitalist Peter Thiel has stashed $5 billion in a tax-free Roth IRA, according to investigative journalism site ProPublica. The PayPal and Palantir founder grew his account by depositing proceeds from large stock sales first bought cheap from nascent companies such as Facebook.

For most people, Roth IRA contributions are capped at $6,000 per year, and intended for those who make less than $139,000 per year in 2020. At PayPal, Thiel drew an income of $73,000, but purchased 1.7 million shares of his own company with his Roth IRA at $0.0001/share, later selling them for $28.5 million. Once Thiel reaches retirement age, he can withdraw that -- and billions more accumulated in the past 20 years -- tax free.

ProPublica estimated that Thiel’s Roth IRA could be worth a combined $263 billion by 2087, when he will be 120 years old. The billionaire is attempting to live that long on a diet of human growth hormones and millions of dollars in investments in human life extension research.


Our only investment advice: Remember the reason for the season

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