First, a check-in on that most foolish habit of mine, making predictions. Last year, I predicted:
That leads to my economic predictions for the year, which are largely the same as last year:
Corporate margins will continue to compress indicating the relative power of labor over capital in a shrinking employable population.
Inflation will slow and the Fed will stop raising rates sometime this year. If they start cutting, inflation will pick up again, somewhat slowly, and we will eventually have a double top in inflation like in the 1970’s. This will become noticeable sometime in 2024.
Basic economic players, like energy, will outperform more abstract sectors like tech, both in earnings and likely to a larger degree in stock market returns.
Wages at the bottom may exceed inflation, but we’ve yet to see it.
How did I do? On #1, it appears corporate margins in 2023 were lower than 2022, though the trend has slowed:
On #2, this indeed happened and most commentators expect rate cuts in 2024. With Biden struggling in the polls, the bias to cut and goose the economy will probably lead the Fed to cut too much, almost guaranteeing a double top in inflation, with the next round, probably emerging in late 2024-2025, returning to double digits. The federal debt service will only exacerbate this.
#3 most definitely did not happen. S&P energy earnings in 2023 were lower than 2022, and tech outperformed yet again. It strikes me as a huge unknown how oil prices have stayed low despite the cessation of sales from the SPR and the increase in miles driven, and the negligible number of electric cars. I think the answer is that operating energy companies continue to spend too much on capital expenditures due to the principal-agent problem, which further reinforces the value of royalties over operating interests. But how did this happen on the other side with tech, when 5% risk-free returns are available in treasury bills? I’ll comment below.
#4 did happen, in that November 2023 wage growth was at 6% for the lower two quartiles while inflation was tamed to 3% or so.
So 75% this year!
On Tech Stocks
Benjamin Graham famously declared that the value of an investment is the net present value of its future cash flows. I think he’s still right, but a major shift in my thinking is realizing that all things called investments are not investments.
I live about an hour east of Lake Charles, which is full of casinos helping Texans making the short drive from Houston dispose of their money. Given the expected cash flow of gambling is negative, why do casinos exist? Plainly, for entertainment, most charitably, but they couldn’t exist without problem gambling.
In surveying, a few years ago, the popularity of everything from meme stocks to cryptocurrency and NFTs, it occurred to me that these “investments” were simply more efficient forms of gambling, which demonstrably has some hedonic value to the consumer. More broadly, I think some stocks trade like collectibles.
What is the value of a baseball card? It produces no cash flow and has no intrinsic value. It is simply an artifact of someone’s affection for an athlete, made more special by its scarcity. Likewise, I think many “investors” like to own stocks based on their affection for the products a company produces, regardless of price or valuation.
Given that both the gambling and collectibles markets are permanent features of human economic activity, the ease of investing via apps like Robinhood should cause one to expect that some stocks will and can become permanently elevated in their popularity. Some people might make money predicting these trends, but it’s a different art, and a more irrational art detecting subjective vibe shifts, i.e. zero-sum speculation, than value-based investing.
My financial advisor and I try to stick to what we call “Argentinian accounting.” Someone asked a successful Argentinian businessman how he knew if he was getting richer despite the instability of the currency. He responded that he counted acres of land and numbers of apartments rather than net worth in terms of currency. The same approach to value investing, especially in real assets, is key to sanity, as we seek to turn third and second-class fortunes into first-class ones. Do I own more barrels and acres and cash flow than I did last year, regardless of what Mr. Market thinks?
The Astounding Economics of Work from Home
Elon’s glorious revolution at Twitter showed the intemperate waste in most businesses. Engineering, production, and sales teams unlock value and create cash flow in a core business, but without a strong leader various hangers-on and deadheads accumulate like parasites in the body of the business. But there’s a danger sometimes in running too lean.
A business executive I respect has an interesting theory. He says all businesses sometimes need available trained labor for surges. So it's not entirely irrational for many businesses to have some people who are idle some of the time.
But if you're going to pay for that, you don't need people 100% productive all the time either. If they're going to be idle some of the time, it doesn't really matter much if it's on-site or off-site, as long as they can reliably contribute to surges. In other words, if work-from-home workers are less productive, it doesn’t matter as long as they can be productive during highly focused all-hands-on-deck sprints.
I'm less bearish on remote work than I used to be, because the economics are undeniable, and some of the economics are hidden.
I estimate that newly hired equivalent talent is willing to do remote work for 2/3 of on-site cost, but with a 20% hit to productivity. The worker is willing to work for a lot less, and the company can end the relationship much more easily when work runs dry. The relationship can be more transactional. The worker can easily find new work since they’re already remote, and the business can drop people more easily whose output does not match expectations. In addition, the business doesn’t have to worry as much about cultural fit or conflicts with coworkers over politics. The output is either there or it’s not, and everyone moves on quickly if it’s not.
Given the difficulty in predicting worker output with even the best pre-hiring tools (e.g. aptitude tests), which can easily vary by 100% between equally qualified workers, just the ability to more easily hire and fire overcomes the baseline 20% productivity hit. Unproductive workers will accumulate in businesses asleep at the wheel (many such cases!), and smart businesses that track output can systematically accumulate the productive ones, for not much of a premium. This also implies that the most valuable on-site labor is that which helps unlock the value of offsite labor through conscientious supervision.
Then there’s the subjective value to the worker. It turns out people really hate the office. The popularity of Office Space and Dilbert show how much people hate offices. I hate them too, which is why my personal office doesn't look like one. There's a lot of labor out there that's not super ambitious and values flexibility, esp. if a spouse or parent or someone else pays most of the bills and provides benefits. It *might* be the long-promised equivalent to extending the weekend, which everyone expected as productivity rose but didn’t happen. Once people experience WFH, they realize being a bit poorer in nominal terms is preferable to being in an office, at least for many.
It's interesting to do the math at the median wage of around $25 per hour. Cooking, for example, is an activity many people enjoy and it also saves money. I spent $105 the other night to eat out for my family at a fast-casual restaurant; those same ingredients would have cost maybe $20. Normies have a surplus of time (i.e. TV watching) so their leisure time has zero marginal value. Cooking then saves $80 per meal with no opportunity cost, and then discounted 20% for after-tax gets you to $100 in pre-tax earnings. Just not commuting saves people ~4 hours a day in median wages if they cook. Add wear and tear on a car on top of that, or public transport costs (including non-economic unpleasantness of dealing with the underclass on the streets), and there's tremendous pressure for every job that can be WFH to be WFH, which would include many entry-level to moderately skilled white collar jobs. I would not want to own commercial real estate right now in commuter-heavy downtowns.
Predictions for 2024
Given the inflection point in interest rates, I don’t have firm predictions for 2024, so I will decline to make all but one this year: I do predict a housing market correction despite lowered interest rates. As I wrote in one of my posts last year:
I continue to believe we are headed for a reckoning in the housing market. The housing consumer can best be modeled as a spendthrift who will borrow as much money as allowed. Higher rates mean they can borrow less, which means each home has fewer potential buyers at the margin. Buyers aren’t satisfied with their buying power, and sellers aren’t satisfied with the prices necessary to move homes. We have a three-way Mexican standoff between buyers, sellers, and the Federal Reserve which continues to hold rates high to mitigate inflation. In almost every market nationwide, for the first time on record, it is cheaper to rent than to buy, and rents are held down partially because so many potential sellers are becoming landlords instead of selling.
At the margin, however, there will always be more forced sellers (deaths, moves, financial problems) than buyers (who can rent). Right now buyers are held down by one limitation, their incomes relative to mortgage payments. But soon, as it takes about 18 months for prices to correct, more forced sellers will come into the market after attempting to wait it out for the past year. Once a few forced sellers cut prices to move their inventory, a new limitation emerges: comps.
Appraisers, who had their hands slapped and are now heavily regulated after the 2008 crisis, will see these new comps and lower the loan-to-value allowances when buyers try to get their contracts approved. The buyers, who largely don’t have much cash to close, will be forced to withdraw or modify offers. At the same time, once word gets out that new, lower comps have hit the market, the shadow inventory of waiting sellers will get spooked to list, to sell before prices fall further. I think this could begin to happen after the summer season, through the winter, as a few sellers take lower offers and reset comps, which would result in a glut of new inventory next spring.
I do not think the Fed will lower rates quickly enough to offset this, and even if they do, the feedback cycle is again too long to prevent a correction in prices. It takes 18 months for prices to fall, and at least 18 months for them to come back again, as timid appraisers rely on comps in the old interest rate environment.
The tragedy of all of the bailouts and money printing is its effect on young people. When I graduated from college in 2001, mortgage rates were about where they are now, which no one considered particularly high. We purchased a new construction three-bedroom starter home with an unfinished basement for $140,000, a value less than three times my salary. Our payment was around $1,000 per month.
Since then, the Fed has printed money such that home prices and tuition have doubled while wages are only up about one-third, all so rich Boomers who have over-borrowed and overspent their entire charmed lives don’t have a reckoning on their net worth spreadsheets. For parents of younger adult children with means, there is no shame for them or you in helping out with a home purchase if they’re forming families. They do not have the same opportunities thanks to the unending bubbles.
The other X-factor here is that the oldest and richest Baby Boomers turn 78 this year. Many of them are approaching an age where large homes are not sustainable, which will put more inventory on the market for young people.
I wish all of my readers a prosperous 2024 and we’ll check in next year on my very foolish prediction!