Inside this Issue:
- Mystery of the Treasury: Why Won’t Bond Yields Rise?
- Inflation Anticipation: Coming this Week… June’s CPI reading
- Yearnings for Earnings: Also this Week, the Start of Q2 Earnings Season
- Earnings from Learnings: A Look at For-Profit Universities
- Robin Good? Or Bad? The Raging and Praising about Robinhood.com
- Mother Trucker: Knight-Swift has a new daughter company
- Wake Up! Coffee Costs Surging
- The Evolution of Revolutions: Five Great Waves of Innovation (and maybe a Sixth)
- The Malady of Inequality: A Princeton Professor Explains
- Train Campaign: Amtrak Wants to Add Tracks
- Tied to Tuna: American Samoa’s Fishy Dependency
- North Star: A Civil War-era Economic Boom
- And This Week’s Featured Place: Santa Fe, New Mexico, Old City Attracts Old People
Quote of the Week
“Physical stores remain an important part of our business to build awareness and connect with consumers in a meaningful way, including driving higher loyalty member enrollment.”
-Levi Strauss CEO Chip Bergh
Why won’t interest rates rise? It’s a central question for the economy as the second half of 2021 gets underway.
Yields on newly issued 10-year Treasuries dropped again last week, at one point sharply before a partial recovery. This was not what the market expected earlier in the year, when clear signs of rapid GDP growth and inflation began to drive rates higher. Is the bond market becoming more pessimistic about GDP growth and more skeptical of non-transitory inflation? Perhaps it signals heightened concern about the new Delta variant of the Covid virus. Some are perhaps concerned about the less-than-stellar recovery in labor markets. Perhaps the heightened appetite for safe Treasuries reflects unease about an earlier-than-expected Fed pullback on monetary stimulus—newly-released details of the last FOMC meeting show that talk of tapering has indeed begun. Or maybe, the recent retreat in bond yields merely reflects some near-term technical factors, like idiosyncrasies in the Treasury Department’s cash management.
To be clear, government bond yields should logically increase if GDP and inflation are expected to grow strongly. Or put another way, demand for government bonds should decrease. But it’s not decreasing. And the big question is: Why not?
What does the stock market say? Prices momentarily sank during the week, as those falling bond yields made equity investors think twice about the economy’s prospects. Labor market reports showing 9m unfilled jobs and higher unemployment claims added to the pessimism. But stock prices ultimately recovered, enough to cement yet another weekly gain in major indices.
Oil prices, on the other hand, declined last week amid OPEC squabbling. But interestingly, U.S. shale producers—always quick to pump more supply in the past—are behaving more conservatively this time. As a reminder, oil prices are way up from last year’s depressed levels but still—at $75 per barrel—well below their averages in the early 2010s (see chart below). For the U.S., high oil prices are not nearly as harmful as they once were (thanks in part to the 2010s resurgence in U.S. production). But they still induce a significant transfer of wealth from American households to overseas oil producers. They also have the power to curtail the current recovery in leisure travel.
Rising prices, therefore, aren’t a trivial threat to the recovery. Nor are the severe droughts afflicting western states. That’s a threat to agriculture. It’s also a fire hazard. According to the National Interagency Fire Center, federal wildfire suppression costs in the U.S. have spiked from an annual average of about $425m in the 1980s and 1990s, to $1.6b in the last two decades. It’s one manifestation of the perils associated with climate change. And it underscores the epic challenge of transitioning to a carbon-free economy, even while carbon sources of energy remain supremely cost-efficient.
Covid resurgence, a subdued labor recovery, the potential impact of Fed tightening, an oil shock… What else to worry about? Asset bubbles, perhaps? Enormous highly leveraged bets in the crypto market? Hack attacks from abroad? Volatile short-term money markets? U.S.-China tensions? The chronic dysfunctions of the “Three H” markets (see below)? Inflation fears still linger, for sure. And growing in Washington are concerns about concentrated corporate power. Last week, President Biden signed an executive order designed to protect consumers and small businesses from industry giants. Many states, meanwhile, are now suing Google for app store practices no different from those criticized at Apple.
But the American economy—or any economy for the matter—has never been free of worries, threats, risks and fears. Hopefully, Corporate America will ease anxieties as firms start presenting their Q2 earnings reports this week. Tuesday is opening day, with JP Morgan and Goldman Sachs taking center stage. Outside the banking sector, others to watch this week include United Health, PepsiCo and the railroad Kansas City Southern, currently in the process of selling itself to Canadian National. Also reporting in faraway Asia, meanwhile, will be Taiwan Semiconductor (TSMC), a kingpin in its strategically vital industry. Most importantly, earnings season will unveil whether corporate profits are consistent with rising stock prices, and whether corporate sales show any indications of weaker consumer spending. It’s ravenous consumer spending, after all, that’s most responsible for the vigorous recovery in GDP.
It’s not just earnings though. There’s something else the market will be watching this week—watching with even greater interest. On Tuesday, the Department of Labor will publish its consumer price index for June. Will it show inflation cooling off? Or will readings once again be far above the norm?
- Robinhood: Charlie Munger of Berkshire Hathaway calls it a “gambling parlor.” Others celebrate its efforts to tear away at the costs and barriers of entry for everyday traders. Hate it or love it, the online financial trading site Robinhood is on its way to becoming a publicly traded company. In its IPO documents filed on July 1, the eight-year-old Silicon Valley firm showed a modest $14m pretax profit for 2020. But that’s after losing $108m in 2019. Known for its zero-commission trading, much of Robinhood’s revenue comes from a controversial practice (banned in many countries, incidentally) called “payment for order flow.” That means getting paid for routing its customers’ trades to market-making firms like Citadel or Virtu instead of stock exchanges. The issue is, this doesn’t always get traders the best price for what they’re buying or selling. It’s far from the only controversy that’s landed Robinhood in the headlines this year. It’s a primary platform for retail traders, often congregating online in forums with names like “Wall Street Bets,” to buy so-called meme stocks that institutional investors are betting against. Some traders engaged in complicated options trades that blindsided established Wall Street short sellers. Robinhood has been criticized—and sued—for allegedly making trading feel like gaming, attracting inexperienced young traders gambling on stocks and options. It’s been a platform for engaging in speculative cryptoasset trading as well. Another area of reproach? The company’s lack of customer support. Management says it’s addressing this, while also pursuing areas of growth like peer-to-peer lending and increasing online trading outside the U.S.
- Knight-Swift, a trucking company, agreed to buy Alabama’s AAA Cooper, a Southeast-heavy player in the LTL space. LTL stands for “less than truckload,” which means packages and shipments that—as the term suggests—aren’t large enough to take up a whole truck. This includes many e-commerce shipments, a big growth area. AAA Copper, which is profitable and on track to generate nearly $800m in revenue this year, will continue to operate independently using its own brand. But now it will have more access to growth and investment capital, new customers, more data and a wider geographical network. Knight-Swift, meanwhile, intends to make further acquisitions, building on what’s already America’s largest tractor fleet (Swift became part of the company via acquisition in 2017). After the AAA Cooper acquisition, Knight-Swift expects to generate 14% of its total revenue from the LTL business, complementing its core truckload business. Intermodal freight and logistics are important revenue sources as well.
Tweet of the Week
- Housing: In a recent virtual discussion hosted by the National Association of Business Economists (NABE), Molly Boesel of Core Logic reminded viewers that the U.S. is at the 15th anniversary of its housing price peak in 2006. At the time, she said, the average 30-year mortgage rate was 6.5%. Right now, it’s 2.9%. Separately, she notes that the average U.S. homeowner with a mortgage currently has more than $200,000 in home equity, a figure up significantly thanks to rising house prices—Idaho is the state with the largest increase in y/y home equity. The significance is that high home equity gives distressed borrowers an option to sell their homes rather than incur a foreclosure or short sale.
- Housing: In that same NABE discussion, Robert Dietz of the National Association of Home Builders highlighted a shortcoming of great national significance: Residential construction, he said, isn’t seeing much productivity improvement. One problem he mentioned was the fact that just 3% of home construction workers are female, limiting the industry’s labor supply. On another note, Dietz and Redfin’s Daryl Fairweather are in general agreement that the housing market will likely cool from its red-hot levels. But prices won’t come down much given extremely tight supply.
- Housing: One more item on the housing market: Though home sales are hot, the rental market hasn’t been, at least not in big cities. But as the Washington Post reports, that’s starting to change as people, especially younger people, flock back to cities. In addition, “the hot home sale market has caused some baby boomers to sell their family homes and rent again now that their kids are grown.” Nationwide, rental prices are now up almost 8% this year. And housing rent is a major component of inflation measurements like the consumer price index (CPI). The article cites Zillow in naming some of the top cities for soaring rents: Boise, Idaho, Riverside, Calif., Spokane, Wash., Tucson, Stockton, Calif., and Las Vegas. All are in areas that realtors have dubbed the “Inland West.”
- Education: Paul LeBlanc is the president of Southern New Hampshire University, a school you might have noticed in last week’s issue—it was on the chart ranking America’s largest colleges by enrollment. He recounted the school’s history on the New Books Network podcast, from the time it first attained university status in the early 2000s. Back then, SNHU was just starting to offer some online degrees to supplement its small on-campus population in Manchester. It would go on to model its growth on another for-profit school, the University of Phoenix, today one of its top rivals. LeBlanc said enrollment spiked during the pandemic, reaching 170,000 students. He credited the school’s success to smart use of data, effective pursuit of potential student leads, good customer service, heavy use of adjunct rather than tenured professors, accountability to investors and efforts to avoid mistakes that got University of Phoenix into trouble (in 2019, the latter settled a federal lawsuit alleging deceptive advertising claims). SNHU’s profits also enable it to charge less than $6,000 per student per year. Many of its students are adult learners for whom online convenience carries great importance. LeBlanc says Southern New Hampshire University might have been better off had it adopted a less regional-sounding name when it was still small. But it’s not a big deal—the initials SNHU resonates well enough, he said. He’s naturally watching the rise of all-online universities like Coursera, noting 2U’s recent $800m acquisition of edX, a nonprofit platform run by Harvard and MIT. SNHU in fact has a partnership with edX.
- Autos: here’s an update on U.S. auto sales from Kristin Dziczek, Senior Vice President for Research at the Center for Automotive Research: At a NABE virtual event, she said trucks, SUVs and CUVs now account for 70% of U.S. auto sales. Americans really don’t like small cars.
- Coffee: The Financial Times highlights coffee as a symbol of the spiking commodity prices now eating into consumer wallets. “At the start of June, the futures benchmark in New York for arabica, the high-end coffee bean, hit a four and a half year high of almost $1.70 a pound, up almost 70% from a year before.” Prices have since dropped some but remain far above 2020 levels. As with so many other items right now, coffee supplies are constrained. And like more than a few supply constraints these days, this one has a climate-related cause, specifically a major drought in Brazil, the world’s top coffee producer. Civil unrest in Colombia has affected exports as well. The FT explains that many coffee buyers have been temporarily shielded from the price jumps thanks to contracts that run for about three to nine months. In addition, some buyers have extra supplies still on hand after Covid crushed demand from restaurants and cafes. As these contracts expire, new ones will surely feature higher prices, which in turn could lead to higher prices for consumers. The reopening of economies, meanwhile, is driving more activity on the demand side. So too is hedge fund activity in the arabica futures market.
- Shipping: The world’s widespread supply shortages and price spikes are also the consequence of shipping bottlenecks. The Wall Street Journal, citing an index published by Drewry Shipping Consultants, says the average price worldwide to ship a 40-foot container has more than quadrupled from a year ago, to $8,399 as of July 1. The measure has surged 53.5% since the first week of May. The big question: Is all of this just transitory, and if so, how soon before relief?
The Inflation Debate
- Ray Dalio, founder of the famed hedge fund Bridgewater Associates, remains worried about future demand for Treasuries, never mind the strong demand that’s currently driving down yields to extremely low levels. He tells the Bloomberg Stephanomics podcast that the U.S. will have large volumes of bonds to sell to a world that already has a lot of them. While there are many reasons why an investor or government might want more Treasury bonds, their negative inflation-adjusted yields are hardly a great lure. Dalio thinks emerging market bonds, including those from China, will become increasingly attractive Treasury alternatives in the future. If so, the Fed might find itself compelled to sustain its Treasury purchases to keep rates from rising too sharply and disruptively. Speaking more directly on inflation, he’s not terribly worried about 1970s-style price increases.
- In that same interview, former Treasury Secretary Larry Summers sounded more cautious about inflation, noting how prices are already rising a lot faster than almost anyone including the Fed expected. Labor shortages in parts of the economy add to the concern, as does fiscal stimulus at a time of extraordinarily low interest rates and strong GDP growth. Summers says the economy right now is like a car driving a hundred miles per hour down an empty highway. Things are fine for the moment, but risks of a bad accident are elevated. Both Dalio and Summers, by the way, worry about excessively high asset prices. Summers adds that globalization, far from a deflationary force as many assert, on the contrary increases the likelihood of inflation—if the dollar starts to lose value, the U.S. will quickly see prices rise due to costlier imports.
- Inequality: Princeton University’s Atif Mian, co-author of a 2014 book called “House of Debt,” calls for government policymakers to push for a restructure of the U.S. economy. The problem is inequality, he explained on the university’s Policy Punchline podcast, and inequality’s connection to high levels of debt throughout the economy. With more and more national wealth in the hands of a small super-wealthy elite, large pools of savings start to accumulate (since the very rich have a low marginal propensity to consume). Where does all that savings go? Much of it winds up getting lent to households and governments, he argues, creating high levels of debt. (It’s perhaps comparable to the 1970s buildup in savings that petro-economies like Saudi Arabia experienced when oil prices spiked, which led to an unsustainable buildup in bank loans to Latin American governments). The savings glut also drives down interest rates, which have been trending down since the 1980s. And lower interest rates enable the debt accumulation to persist without serious trouble. But Mian asks: How much lower can interest rates go from here? One side effect of low interest rates, he adds, is that investors tend to overvalue assets. Simply put, they’re now calculating the present value of an asset’s future returns using a lower denominator, in other words, a low interest, or discount rate. The economic restructuring Mian wants to see would involve wealth taxes, higher minimum wages, more public investment in research and infrastructure and more aggressive antitrust enforcement.
- Passenger Rail: The GAO looks at two multi-billion-dollar proposals for investment in intercity passenger rail. Amtrak, owned by the federal government, wants roughly $75b to add or initiate service on dozens of routes across the country by 2035. The privately-owned North Atlantic Rail Alliance (NAR), meanwhile, wants $105b to construct a new high-speed rail alternative to the existing Northeast Corridor (NEC) line from New York to Boston. In Amtrak’s case, all routes, schedules and other service matters would be decided jointly with state governments and freight railroads, the latter in control of the rails Amtrak uses outside of the northeast corridor. The GAO report says some new Amtrak routes are likely, i.e., new extensions of current lines in Vermont and Virginia. Others like a proposed Atlanta-Nashville line seem less likely. As for the NAR proposal, among its visions are more electrified passenger rail lines and a rail tunnel underneath downtown Boston. Naturally, both proposals are a topic of negotiation as Congress works on infrastructure legislation. But it’s not yet clear what a final bill, if there is one, would include.
- Passenger Rail: In other Amtrak news, the government company just ordered up to 83 new trains from Germany’s Siemens, with options for an additional 130. Some of the new trains (to be built in Sacramento, California) will wind up in the Northeast Corridor, Amtrak’s most financially viable market.
- Santa Fe: Within its own neighborhood, New Mexico’s economy is distinctively undynamic. GDP grew an inflation-adjusted 13% during the 2010s, as the state’s population increased less than 2%. During the same period, all four states surrounding New Mexico—Arizona, Texas, Colorado and Utah—saw their real GDPs increase at least 26% and their populations rise between 14% and 16%. Albuquerque is New Mexico’s largest city. The state’s Southwest includes the oil-rich Permian basin most often associated with West Texas. Much of northwest New Mexico is home to Native American lands. The state is known for its federal research labs, including Los Alamos, originally established during World War II to develop an atomic bomb. And then there’s one of the most unique places in the entire United States, with an economy no less distinctive. Santa Fe, the second oldest city in the U.S. after St. Augustine, Florida, was founded more than 400 years ago. Today it’s home to just 85,000 people, or 150,000 including its surrounding area. But lots of tourists come to visit, making leisure and hospitality a staple of the local economy. The sector accounted for 18% of all jobs in 2018. And tourists underpin a vibrant retail trade that generates a sizeable portion of the city’s tax revenue. But Santa Fe is also New Mexico’s capital, which means government is a major economic force, responsible for perhaps a quarter of all jobs. The state is by far the area’s largest employer. Health care is a big sector, in part because Santa Fe is a popular retirement community—a quarter of all metro area residents are over the age of 65 (the figure statewide and nationwide is 18% and 17%, respectively). Unlikehotspot retirement communities in Arizona and Florida, however, Santa Fe’s population growth during the 2010s was just 4%. That was double the lowly state average but still indicative of one important deterrent for prospective retirees: It’s a rather expensive city, with home values above the national average. Many retirees, in fact, have highish incomes and come from wealthy states like California and Colorado. And sure enough, real estate is big business in Santa Fe. There’s some nearby gold mining. Santa Fe is known for its vibrant art scene, one aspect of its tourist appeal. The tourists tend to come during the summer and fall, which makes for a highly seasonal economy. But they are coming again now that Covid is less of a threat, driving up tax revenues this year. Like most communities, Santa Fe is doing what it can to lure startups and technology companies. It’s a site for some television and movie production too. Due to its topography, Santa Fe long ago lost its role as a major trading center connecting Mexico with Missouri. The Santa Fe railroad, despite its name, bypassed the city because of the engineering challenges associated with its mountainous terrain. The country’s largest railroad today, Berkshire Hathaway’s BNSF, doesn’t have “SF” in its initials for nothing. Santa Fe, incidentally, also saw the closure of a federal military base in the 19th In the 21st century, the challenges are quite different—one at random is the difficulty laying broadband cables in areas of archaeological significance.
- Truth or Consequences, NM: A discussion about New Mexico wouldn’t be complete without mentioning Spaceport America, in the news this week for hosting Sir Richard Branson’s blastoff into space. The facility is located in a sparsely populated desert region. The nearest town is Truth or Consequences, oddly named after an old television game show. If space travel does ever become mainstream, might an obscure southwestern area of New Mexico become its new Atlanta?
- American Samoa: There are five permanently inhabited U.S. territories, the largest of which is Puerto Rico. The U.S. Virgin Islands is another, also located in the Caribbean. The other three are Pacific Islands: Guam, the Northern Mariana Islands and American Samoa. A new GAO report looks at the economies of each, highlighting their most important industries. Puerto Rico has a rather diversified if troubled private-sector economy, led by finance, insurance, tourism and manufacturing (pharmaceuticals, textiles, petrochemicals and electronics). Tourism is top billing for Guam, the Virgin Islands and Northern Mariana. (Guam is also a major U.S. military post). But no tourism for American Samoa. Its seven islands are rugged, remote and lacking tourist infrastructure. So what’s its dominant industry? Tuna, both processing the fish and canning it.
- Innovation Cycles: Visual Capitalist, a website, has a graphic depicting five waves of innovation during the past two centuries, starting with the advent of cotton mills in England during the late 1700s. This first wave saw the advent of textiles, iron and water power. Then came wave two, featuring railways, steel and steam power. Electricity, chemicals and the internal combustion engine characterized the third wave. Wave four was an age of petrochemicals, electronics and aviation. We’re now in a fifth wave, shaped by digital networks, software and new media (including social media). Are we on the verge of a sixth long-wave business cycle? The Visual Capitalist graphic portrays an emerging era of artificial intelligence, the internet of things (IOT), robots, drones and clean tech.
- The Civil War: Eric Foner’s renowned book “Reconstruction” begins with a description of the North’s economy during the period just before Reconstruction, in other words, the Civil War. “If economic devastation stalked the South,” he writes, “for the North the Civil War was a time of unprecedented prosperity.” He makes clear that it wasn’t prosperous for everyone—not the average unskilled worker whose real income fell due to inflation. But industry profits boomed. Investors earned handsome returns speculating on stocks and gold. Railroads benefitted not just from carrying military troops and supplies, but also the closing of the Mississippi River trade due to the war. Chicago’s thriving meatpacking industry boomed, helping to make the city a major metropolis. Wool mills in New England and Mid-Atlantic states worked day and night to meet the military’s demand for uniforms and blankets. Agriculture flourished as machinery replaced men sent off to war. Before he built his oil empire, a young John D. Rockefeller was profiting handsomely from wartime government food contracts. Foner describes the Civil War era as a transition point from an age of competitive capitalism featuring traditional craftsmen to one defined by large-scale, heavily concentrated industry. At the time of the war, most northern manufacturing was still small-scale. But that was already starting to change. As industry amassed big profits, furthermore, they became less dependent on merchant banks for finance. The federal government, meanwhile, played an active role in the economy during the war, creating a national paper currency, fostering a national banking system, expanding the national debt and encouraging western settlement (with the Homestead Act and land grants for the creation of a transcontinental railroad). Washington and Big Business, more generally, began imposing organization on what was a loosely decentralized economy.
- Geothermal Energy: The world is trying to kick its fossil fuel habit. But frustratingly, fossil fuels are so cheap relative to the energy they provide. Fortunately, alternatives like solar and wind are becoming less expensive. And there’s geothermal energy, gleaned from the heat naturally existent beneath the earth’s surface. In places like Iceland, where such heat isn’t so deep and thus rather easy to retrieve, geothermal energy is widely used. But with new drilling techniques borrowed from oil frackers, geothermal could potentially fulfill a more meaningful portion of the world’s energy needs. Like many other efforts to decarbonize the economy, however, using geothermal energy at scale remains an expensive endeavor. One thing it does have going for it: The heat beneath the ground is always available; it’s not an intermittent source of power like the sun or the wind.
- Household Wealth: The Wall Street Journal calls it the “greatest transfer of wealth in modern history.” It’s referring to the $35 trillion that older Americans have accumulated throughout their lifetimes, which is starting to pass to their heirs. The Baby Boomer generation’s wealth, in fact, accounts for 27% of all U.S. wealth, the report notes. The economic implications are major. As their heirs inherit the wealth of their parents, they’ll likely take more risks when it comes to their careers, which could result in more new startup companies. But one thing to watch: Tax policy. President Biden has proposed higher taxes on inheritances.