Edward Conard

Top Ten New York Times Bestselling Author

  • “A full-throated defense of economic dynamism.” - The Wall Street Journal
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “…a very valuable contribution.” - Larry Summers, former Secretary of the Treasury and director of the National Economic Council, president emeritus, Harvard University
  • “…a comprehensive explanation of the modern economy.” - Julian Robertson, Founder, Tiger Management
  • “…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
  • “Unintended Consequences is full of substance, it is one of the must-read books of the year, and once I finish it I will be giving it a second read through right away.” - Tyler Cowen, Professor, George Mason University
  • “…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
  • “…a very valuable contribution.” - Larry Summers, former Secretary of the Treasury and director of the National Economic Council, president emeritus, Harvard University
  • “…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
  • “…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
  • “Unintended Consequences should be read by anyone who takes for granted the superiority of progressive taxation and has not thought carefully about the trade-offs involved.” - The New Republic
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
Upside of Inequality Oxford Unintended Consequences

Macro Roundup


Monday, October 31, 2022

AI Summary. Wage growth remains too fast to be consistent with the Federal Reserve's inflation target, but would likely slow if the economy weakens, and past wage and rent increases may partly reflect a one-time adjustment to pandemic-related shocks. The author argues considerable future disinflation is already in the pipeline.

Paul Krugman Krugman Wonks Out
Date Posted:

Citing a slowdown in the Employment Cost Wage index, @paulkrugman argues there is a “strong case to be made there’s considerable disinflation in the pipeline” and admits, “Over the past year, optimists like me were wrong, while pessimists were right.”

Is considerable disinflation already in the pipeline despite fast wage growth?

Core argument: Wage growth remains too fast to be consistent with the Federal Reserve's inflation target, though wage growth will probably weaken if the economy weakens.

Wages are still rising too fast to be consistent with the Fed’s inflation target, but if the economy is really set to weaken, wage growth will probably weaken too. Furthermore, you can argue that past wage growth, like surging rents, partly reflected a one-time adjustment to pandemic-related shocks, which will go away over time. I’d argue, a strong case to be made that there’s considerable future disinflation already in the pipeline. Over the past year, optimists like me were wrong, while pessimists were right. But past results are no guarantee of future performance.

Takeaways by Macro Roundup® AI

  1. Wage growth remains too fast to be consistent with the Federal Reserve's inflation target, though wage growth will probably weaken if the economy weakens.
  2. Past wage growth and surging rents partly reflected a one-time adjustment to pandemic-related shocks that will fade over time, an argument implying considerable disinflation is already in the pipeline.
  3. Inflation optimists were wrong over the past year while pessimists were right, but past results are no guarantee of future performance.

AI Summary. High inflation should spur deregulation that both lowers prices and improves economic performance, including easing shipping-cost rules like the Jones Act, strategic tariffs, restrictions forcing oil and gas onto trucks rather than pipelines, and punitive zoning limits. Restoring price stability at low cost is necessary but not sufficient.

Lawrence Summers Washington Post
Date Posted:

@LHSummers argues that the current inflationary environment should spur regulatory reforms “that will both reduce prices and make the economy work better.”

Should high inflation prompt deregulation that lowers prices and improves growth?

Core argument: Regaining price stability at as low a cost as possible is necessary but far from sufficient to maximize American economic performance.

The crisis of inflation should not be wasted. A bright spot in the dismal inflation period of the 1970s was the collaboration of Stephen G. Breyer (then counsel to the Senate Judiciary Committee), Sen. Edward M. Kennedy (D-Mass.) and the Carter administration on airline deregulation. In this era, high inflation should be a spur to regulatory changes — from addressing Jones Act increases in shipping costs, to strategic tariffs, to rules that force oil and gas to be transported via truck rather than pipeline, to punitive zoning restrictions — that will both reduce prices and make the economy work better. Regaining price stability at as low a cost as possible is far from sufficient to maximize American economic performance, but it is necessary.

Takeaways by Macro Roundup® AI

  1. Regaining price stability at as low a cost as possible is necessary but far from sufficient to maximize American economic performance.
  2. Airline deregulation, produced by collaboration among Stephen G. Breyer as Senate Judiciary Committee counsel, Sen. Edward M. Kennedy (D-Mass.) and the Carter administration, was a bright spot of the inflationary 1970s.
  3. High inflation should spur regulatory changes that both reduce prices and improve how the economy works, including addressing Jones Act shipping costs, strategic tariffs, rules forcing oil and gas onto trucks rather than pipelines, and punitive zoning restrictions.

AI Summary. Goldman Sachs economists estimate the household, nonfinancial corporate and small-business sectors ran a surplus of income over spending equal to 1.1% of gross domestic product, and on a three-year average the measure is healthier than before any US recession since the 1950s. Federal Reserve economists estimate households hold roughly $1.7tn in excess savings.

Nick Timiraos Wall Street Journal
Date Posted:

American households still have $1.7 trillion in excess savings, $350 billion of which are in the hands of the lower half of the income distribution. @NickTimiraos @WSJ

Do strong private sector finances keep interest rates higher for longer?

Core argument: Goldman Sachs economists calculate that U.S. households, nonfinancial corporations and small businesses ran a combined surplus of income over spending equal to 1.1% of GDP in April through June.

Household, nonfinancial corporate and small-business sectors ran a surplus of total income over total spending equal to 1.1% of gross domestic product in the quarter of April to June, according to economists at Goldman Sachs Group Inc. Using a three-year average, the measure is healthier than on the eve of any U.S. recession since the 1950s. U.S. households still have around $1.7 trillion in savings they accumulated through mid-2021 above and beyond what they would have saved if income and spending had grown in line with the prepandemic economy, according to estimates by Fed economists. Around $350 billion in excess savings as of June were held by the lower half of the income distribution, or around $5,500 per household on average.

Takeaways by Macro Roundup® AI

  1. Goldman Sachs economists calculate that U.S. households, nonfinancial corporations and small businesses ran a combined surplus of income over spending equal to 1.1% of GDP in April through June.
  2. On a three-year average basis, Goldman Sachs finds this surplus measure healthier than on the eve of any U.S. recession since the 1950s.
  3. Fed economists estimate U.S. households still hold about $1.7 trillion in savings accumulated through mid-2021 beyond prepandemic trends, with roughly $350 billion as of June held by the lower half of the income distribution, about $5,500 per household on average.

AI Summary. Treasury securities with similar maturities are trading at larger-than-normal price differences, with newly issued Treasurys commanding a growing premium over older notes that come due at the same time — a sign the older securities have become harder to sell. Big banks and asset managers that have long been significant buyers are in retreat.

Matt Grossman and Sam Goldfarb Wall Street Journal
Date Posted:

.@WSJ reports, “Treasury securities with similar characteristics are trading at larger-than-normal price differences” as large buyers like big banks and asset managers reduce purchases.

Are older Treasurys becoming harder to sell than newly issued ones?

Core argument: Treasury securities with similar characteristics are trading at larger-than-normal price differences, while big banks and asset managers that have long been significant buyers are in retreat.

Treasury securities with similar characteristics are trading at larger-than-normal price differences. Major players, including the big banks and asset managers that have long been significant buyers, are in retreat. One problem is a growing difference between yields on the newest Treasurys in the market and older vintages that are still traded among investors. Theoretically, a five-year note sold this year should trade at the same yield as a five-year-old 10-year note, because both come due in 2027. But fresh Treasurys are trading at a growing premium to older notes, a sign the older securities have become harder to find buyers for.

Takeaways by Macro Roundup® AI

  1. Treasury securities with similar characteristics are trading at larger-than-normal price differences, while big banks and asset managers that have long been significant buyers are in retreat.
  2. Newly issued Treasurys are trading at a growing premium to older vintages with the same maturity date, a sign the older securities have become harder to find buyers for.
  3. A five-year note sold this year and a five-year-old 10-year note both come due in 2027 and theoretically should trade at the same yield.

AI Summary. An American co-chief executive of a China-based kitchenware and grilling-tools manufacturer with six mainland factories says every customer is pressuring the company to build factories outside China. He adds that the supply chain built in China over 30 years remains unmatched.

Jason Douglas and Stella Yifan Xie Wall Street Journal
Date Posted:

“There’s not a customer that we have that isn’t pressuring us, suggesting, hoping that we will build factories outside of China,” an American manufacturer in China reports @WSJ 

Are customers pushing manufacturers out of China despite unmatched supply chains?

Core argument: Jacob Rothman, co-chief executive of Velong Enterprises, which operates six factories in mainland China, says every customer is pressuring, suggesting or hoping that the company will build factories outside China.

It took Jacob Rothman two decades to build a Chinese manufacturing business with his friends and family. Now the 49-year-old American executive says customers want him to make some of his grilling tools and kitchen products elsewhere. He knows it isn’t going to be easy. “There’s not a customer that we have that isn’t pressuring us, suggesting, hoping that we will build factories outside of China,” says the co-chief executive of Velong Enterprises Co., which has six factories in mainland China and serves big retailers and consumer brands such as Walmart Inc. and grill maker Weber Inc. Yet “there’s nothing like China,” he added. “We’ve built this supply chain for 30 years to work like a Swiss clock. There’s just nothing like it.”

Takeaways by Macro Roundup® AI

  1. Jacob Rothman, co-chief executive of Velong Enterprises, which operates six factories in mainland China, says every customer is pressuring, suggesting or hoping that the company will build factories outside China.
  2. Velong Enterprises supplies grilling tools and kitchen products to large retailers and consumer brands including Walmart and grill maker Weber.
  3. Rothman, who spent two decades building the business with friends and family, says shifting production will not be easy, citing a supply chain built over 30 years "to work like a Swiss clock.".

AI Summary. China's direct and, especially, indirect subsidies to manufacturers exceed those of any other country, and their scale explains China's large domestic imbalances and persistently weak domestic demand. Manufacturers stay because subsidies and costly upgrades to energy, transport, logistics and communications infrastructure make production in China cheaper than elsewhere.

Michael Pettis @michaelxpettis
Date Posted:

.@michaelxpettis notes that decoupling from China will be hard because, with subsidies in “energy, transportation, logistical and communications infrastructure, they can effectively produce more cheaply in China than elsewhere.”

.@michaelxpettis notes that decoupling from China will be hard because, with subsidies in “energy, transportation,...

Do manufacturing subsidies explain China's competitiveness and weak domestic demand?

Core argument: Pettis argues Chinese subsidies to manufacturers — direct and especially indirect — exceed those of any other country, which is why China-based producers are so competitive internationally and why decoupling will be difficult.

Decoupling won't be easy because there is a reason China-based manufacturers are so "competitive" internationally. Chinese subsidies to manufacturers – not just direct but, especially, indirect – are far greater than those of any other country. The extent of these subsidies explains China's huge domestic imbalances and the persistent weakness in its domestic demand. Manufacturers are in China because as long as China subsidies them directly and indirectly, with constant (and expensive) upgrades to energy, transportation, logistical and communications infrastructure, they can effectively produce more cheaply in China than elsewhere. Even rising Chinese wages won't matter because as long as the total income of Chinese workers – and households more generally – doesn't exceed, or even lags, the growth in total production, China will always be a relatively "low wage" economy.

Takeaways by Macro Roundup® AI

  1. Pettis argues Chinese subsidies to manufacturers — direct and especially indirect — exceed those of any other country, which is why China-based producers are so competitive internationally and why decoupling will be difficult.
  2. Pettis attributes China's large domestic imbalances and persistently weak domestic demand to the extent of these manufacturing subsidies, which include constant and expensive upgrades to energy, transportation, logistical and communications infrastructure.
  3. Rising Chinese wages will not erode that cost advantage, according to Pettis, because as long as total worker and household income lags growth in total production, China remains a relatively low-wage economy.

AI Summary. US earnings inequality has plateaued because wages at the bottom grew rapidly, with the 10th percentile up 14% in real terms versus 9% at the median and under 10% at the 90th percentile. The authors link this compression to higher pay premiums in low-paid occupations and tighter labor markets rather than worker composition or minimum wage increases.

Nathan Wilmers Proceedings of the National Academy of Sciences
Date Posted:
Is Database:
Database

US earnings inequality has plateaued since 2012, driven by rapid wage growth among low-wage workers, not median-wage workers catching up with top earners.

Has rapid wage growth at the bottom halted rising US earnings inequality?

Core argument: From 2012 to 2018, US earnings at the 10th percentile grew 14% in real terms, outpacing the median's 9% and the 90th percentile's growth of under 10%.

Since 2012, US earnings inequality has plateaued, primarily due to rapid wage growth among low-wage workers rather than median-wage workers catching up with top earners. The variance in labor earnings has stalled or decreased, with the variance of log hourly earnings stabilizing around 0.35 and log weekly earnings showing a slight decline. From 2012 to 2018, the 10th percentile of earnings grew by 14% in real terms, outpacing the median's 9% increase and the 90th percentile's under 10% growth. This compression in the bottom two-thirds of the earnings distribution has offset rising inequality, despite persistent top-end inequality. The trend is linked to increased premiums in low-paid occupations and tightening labor markets, rather than changes in worker composition or minimum wage hikes. Consequently, the gap between the 10th and 50th percentiles has shrunk, while the 90 to 50 gap continues to grow more slowly.

Takeaways by Macro Roundup® AI

  1. From 2012 to 2018, US earnings at the 10th percentile grew 14% in real terms, outpacing the median's 9% and the 90th percentile's growth of under 10%.
  2. US earnings inequality has plateaued since 2012, with the variance of log hourly earnings stabilizing around 0.35 and log weekly earnings declining slightly.
  3. The compression in the bottom two-thirds of the US earnings distribution is linked to higher premiums in low-paid occupations and tightening labor markets, rather than shifts in worker composition or minimum wage increases.

Overall US earnings inequality has plateaued in the last decade, driven by fast earnings growth among low-wage workers, rather than median-wage workers catching up with those at the top

Key Finding

"…Our main finding is that variance in labor earnings has stalled or decreased since around 2012.As shown in Fig. 1 A-C, this finding holds across all of the household surveys and all of the earnings quantities we examine—hourly, weekly, or annual. The variance of log hourly earnings increased in the CPS-ORG from 0.25 in 1982 to about 0.35 in 2012 before stabilizing. The variance of log weekly earnings has actually decreased in recent years; the CPS-ORG and the ASEC both show a slight decline from 2012 to the end of the decade, by about 1% in the case of the CPS-ORG. Inequality in annual earnings has also stabilized in the last decade—although the level where this stabilization occurred depends on the data source, with the ASEC plateauing at a lower level and slightly earlier than the ACS. The similarity in trends across surveys and earnings concepts supports the claim that earnings variance has stopped increasing in recent years…."

Clem Aeppli and Nathan Wilmers, "Rapid wage growth at the bottom has offset rising US inequality,"Proceedings of the National Academy of Sciences, October 3, 2022, https://www.pnas.org/doi/10.1073/pnas.2204305119

"… By contrast, labor markets across the country tightened over the last decade. Workers at the bottom of the national earnings distribution were, therefore, able to benefit from the declining local unemployment rate.The unemployment rate counterfactual (Fig. 4, Lower Left) confirms this description; increasing local unemployment rates to 2018 levels would have boosted earnings at the bottom of the national distribution and helps to explain the earnings compression that we observe…."

Changes In demand

"…Fig. 3 showed that from 2012 to 2018, workplace premiums increased slightly more for lower-paying workplaces than for higher-paying workplaces. However, this pattern is similar to 2002 to 2012, and changes to workplace premiums are relatively small. In contrast, the lowest-paid occupations enjoyed rapid premium increases from 2012 to 2018, following decreases in 2002 to 2012…."

"…The variance of earnings could decrease as all workers’ earnings converge, or it could reflect compression in a single part of the distribution. Fig. 2 shows the trends in the 10th, 50th, and 90th percentiles of hourly (Fig. 2A), weekly (Fig. 2C), and annual (Fig. 2E) earnings. This figure shows that in the 1980s, disparities between the bottom and the middle and between the middle and the top were both increasing. Since the 1990s, however, the gap between workers in the bottom and the middle stabilized, while the gap between workers in the middle and the top of the distribution continued to grow. These patterns are consistent with prior research…In the period since the recovery from the Great Recession, trend differences between top and bottom inequality intensified. Growth in the 10th percentile of earnings accelerated in the last decade—in log weekly earnings from 5.38 in 2012 to about 5.51 in 2018, a 14% boost in real dollars. While earnings growth has been robust during this period, its magnitude has not been uniform across the distribution; median weekly earnings have increased by only 9%, half as fast as the bottom 10th percentile. The 90th percentile has grown in pace with the median—increasing by under 10%. As a result of these different rates of earnings growth, the gap between the 10th and 50th percentiles has shrunk since 2012—shown by the solid lines inFig. 2 B, D, and F. In contrast, the 90 to 50 gap has continued to grow (dashed lines inFig. 2), although more slowly than in the earlier period of stagnant median earnings growth. Earnings in the bottom 10th percentile have advanced toward the median, while earnings at the top remain consistently above the median. InSI Appendix, section B, we directly link these changes in percentiles to the overall variance trend. The change in inequality trends after 2012 was largely due to compression of pay in the bottom two-thirds of the distribution rather than in the top third. The part of the earnings distribution that dominated rising inequality from the 1990s through the 2000s is not the part that explains the recent reversal of the trend since 2012. After decades of rising inequality, overall earnings inequality stopped growing, and possibly declined, since 2012. This fact raises two related questions. How can this unexpected departure from the trend be reconciled with prior research on earnings inequality, which focused on secular drivers of inequality? Additionally, does the recent break in rising inequality mark a new era of labor market conditions, as did the increase in earnings inequality in the early 1980s? We find little evidence that the last decade reversed the main drivers of rising inequality, like shifting worker and occupational composition, union decline, or unequal workplace premiums. Additionally, the top-end inequality that these drivers contribute to has persisted. However, this top-end inequality has been offset by rapid earnings growth for workers at the bottom of the earnings distribution. This earnings growth is not mainly driven by worker composition change, workplace-specific changes, or rising subnational minimum wages. Instead, it is associated with broadly increased premiums in the lowest-paid occupations: occupations that had faced particularly slow wage growth from 2002 to 2012. At the local labor market level, pay increases for low-wage workers were associated with tightening labor markets. These dynamics delivered a period in which earnings growth has been higher for workers at the bottom than at the middle or the top….”

Distributional Changes

"…First, in the dashed line in Fig. 1A, we show the variance of hourly wages based on theOEWS. The OEWS has a top code that increases in nominal terms throughout the period, at around the 98th percentile. However, it shows a decline in inequality similar to, and even sharper than, the household survey sources. Second, the short-dashed line in Fig. 1C shows the variance of annual earnings in the LEHD (from ref. 29 and top coded at the 99.999% level). Unlike the ACS and the ASEC, the LEHD has no information on weeks or hours worked. As a result, the level of inequality is higher in the LEHD, inflated by partial year and marginally labor market-attached workers. However, notwithstanding the level differences, the initially rising trend, subsequent leveling, and small decline are similar to the household sources. Third, in Fig. 1D, we use administrative data without top codes to show another measure of inequality: the share of US labor income going to the top 50%. The SSA shows different levels than PSZ and AS; in 2013, the share is 0.86 in the SSA data and 0.83 in PSZ. However, all three exhibit similar trends; the share of labor income going to the top half increased until about 2012, when it stabilized and even began to drop. This trend was interrupted in the SSA series in 2020, but this is likely due to COVID-19-related unemployment spells, which strongly affect annual earnings inequality measures that do not adjust for partial year employment. Overall, these distinct data, with a distinct inequality concept, also show a stabilization in inequality starting around 2012…"

Tuesday, November 1, 2022

AI Summary. The average S&P 500 stock has outperformed the NYSE FANG+ index of mega-cap technology shares, reflecting renewed investor focus on cash flow and balance sheets, with Meta Platforms losing $676bn in market value. Technology shares are more sensitive to rising interest rates than value-oriented old economy stocks.

John Authers Bloomberg
Date Posted:
Is Database:
Database

Tech stocks have weighed down the S&P 500, while the average stock has performed well. A return to fundamentals is driving this shift. @JohnAuthers.

Are mega-cap tech stocks underperforming the average stock as rates rise?

Core argument: Meta Platforms' market value has fallen by $676bn this year, which the article ties to investors returning to fundamentals such as cash flow and balance sheet analysis.

Since the March 2020 trough, the average S&P 500 stock has outperformed the NYSE FANG+ index, highlighting a shift in market dynamics as investors reassess the valuation of mega-cap tech stocks. The S&P 500 Equal Weight Index, where each stock has a 0.2% weighting, shows that tech shares have weighed down the index, while the average stock has performed well. This divergence is partly due to a return to fundamentals like cash flow and balance sheet analysis, as seen with Meta Platforms Inc., whose market value has dropped by $676bn this year. The tech sector's vulnerability to rising interest rates contrasts with the stability of value-based old economy stocks, which are less sensitive to rate hikes. As central banks signal a potential slowdown in rate increases, the market is recalibrating, with capital shifting towards sectors that benefit from a return to normalcy post-pandemic.

Takeaways by Macro Roundup® AI

  1. Meta Platforms' market value has fallen by $676bn this year, which the article ties to investors returning to fundamentals such as cash flow and balance sheet analysis.
  2. Since the March 2020 trough, the average S&P 500 stock has outperformed the NYSE FANG+ index, with tech shares weighing down the S&P 500 Equal Weight Index, where each stock carries a 0.2% weighting.
  3. The tech sector is vulnerable to rising interest rates while value-based old economy stocks are less sensitive to rate hikes, and capital is shifting toward sectors benefiting from a return to post-pandemic normalcy.

Since the March 2020 sellout, the average S&P 500 stock has outperformed the NYSE FANG+ index. “It is only now that investors have fully grasped that shouldn’t be valued as though the pandemic conditions would continue forever.”

“…This incident is very much about mega-cap tech and the premium it deserves over the rest of the market. Looking at the ratio between the S&P 500 Equal Weight Index, in which each stock has a 0.2% weighting regardless of its size, and the standard S&P 500 benchmark, illustrates just how much tech shares weigh down the index when the average stock isn’t doing so badly. The average stock has comfortably beaten the index so far this year. The average S&P 500 stock has now outperformed the NYSE FANG+ index since the nadir of the Covid-19 selloff in March 2020….”

John Authers, "Wile E. Coyote Moment as Tech Goes Off the Cliff,"Bloomberg, October 28, 2022, https://www.bloomberg.com/opinion/articles/2022-10-28/tech-s-fangs-plummet-in-wile-e-coyote-moment-on-earnings

Wile E. Coyote Moment as Tech Goes Off the Cliff

Crash Landing

There is no character in the entire canon of world literature and drama more useful for explaining markets than Wile E. Coyote. In the Roadrunner cartoons, he would run off the edge of a cliff, and continue running into midair. Only once he stopped, looked down, and realized that he was in midair, did he fall. He thus gave the market the invaluable concept of a Wile E. Coyote moment, when investors realize they’ve been running without support for a long time, and prices that should have long since been gradually coming down suddenly collapse.

The laws of physics make what the coyote does impossible. But markets are driven by human nature and crowd psychology. Coyotes can defy gravity for years in the markets — but generally there comes a point when the game is up. And this week has seen the FANGs (the acronym for the huge internet platform groups that originally stood for Facebook, Amazon, Netflix and Google when coined) respond to gravity at last.

Netflix had well-received results last week; but Microsoft Corp., Google-owner Alphabet Inc., Amazon.com Inc. and even Apple Inc. have all this week suffered sharp writedowns, while the treatment meted out to Meta Platforms Inc., the Facebook parent, has been savage. Since Tuesday evening when its results came out, Meta’s stock has been punished horribly for a disappointing revenue forecast, despite Mark Zuckerberg asking for patience given the social-media giant’s growing investments, particularly in the metaverse. The stock has plunged 25% Thursday and 70% year-to-date:

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 1


The fall from grace has been staggering. As of Thursday’s close, Meta has underperformed the benchmark S&P 500 since it went public, even excluding dividends. The following graph shows the performance of the social media giant, the benchmark index and the S&P 500 Total Return Index, which is calculated intraday by the S&P based on both price changes and reinvested dividends. For investors who thought they were betting on the next big thing, it won’t be surprising if they are starting to think twice.

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 2


Or let’s put that another way. After Thursday’s carnage, Meta trades at just over nine times trailing earnings (having traded as high as 37 times earnings little more than a year ago). The S&P 500 as a whole trades at 18. One of the most exciting growth stocks on the planet, with all its greatest days still ahead of it, is somehow now regarded as so weak that it should only trade at half the market multiple. That kind of judgment is a recognition that Meta should never have been valued so richly in the first place.

Another important way to illustrate the scale of what’s going on involves comparing market capitalizations. The market value of Meta has slipped by $676 billion this year, pushing it out of the world’s top 20 largest companies. At one point it was the fifth-largest in the US, valued at more than $1 trillion, and almost three times the size of the biggest US bricks-and-mortar retailer, Walmart Inc. Now, for the first time since 2015, Meta is smaller than Walmart:

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 3


Naturally Meta’s numbers and predictions were disappointing, but its greatest problem was a sudden return by investors to the basics of cash flow and balance sheet analysis. The decline in Meta’s free cash flow drew an apology even from previously ardent backer Jim Cramer on CNBC. And Neil Campling of Mirabaud Equity Research made this telling observation: “For every $1 Apple spends on operating costs, it generates $6.80 in revenue. For every $1 Meta spends on operating costs, it generates $1.17 in revenue.”

This is all a tad reminiscent of the period of a few weeks in early 2000 when dot-com investors suddenly moved from metrics like “clicks per eyeball” to “burn rate” — an old metric with a new name, referring to how quickly startup companies were burning through their cash flow. Meta has become a vastly more substantial and tangible concern than the entities that evaporated 22 years ago, but the sudden and swift realization that it had been valued far too generously still rings those bells.

The FANGs’ crisis of confidence is all the more interesting because it comes just as bond yields are falling and optimism is growing that central banks will soon relent (of which more below). In fact, the pessimism from Meta, given the company’s sheer size, even overshadowed the positive gross domestic product data Thursday, according to Nicole Webb, SVP and financial adviser at Wealth Enhancement Group. The stock’s slide has had “such a global impact” that it may prompt a broader market recalibration: "I appreciate seeing a slowdown in the mega-cap tech companies. I have always had this thesis that trades don’t grow from the sky. And I think Silicon Valley is showing a bit of its age in that they really ever had to be thoughtful about hiring, layoffs and restructuring."

She may be right. This incident is very much about mega-cap tech, and the premium it deserves over the rest of the market. Looking at the ratio between the S&P 500 Equal Weight Index, in which each stock has a 0.2% weighting regardless of its size, and the standard S&P 500 benchmark, illustrates just how much tech shares weigh down the index when the average stock isn’t doing so badly. The average stock has comfortably beaten the index so far this year:

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 4


Perhaps even more impressively, the average S&P 500 stock has now outperformed the NYSE FANG+ index since the nadir of the Covid-19 selloff in March 2020. For more than a year, investors worked on the assumption that these companies would benefit from the pandemic, which they unquestionably did — but it is only now that investors have fully grasped that they shouldn’t be valued as though the pandemic conditions would continue for ever:

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 5


Strategically, Webb suggests that the selloff could offer a good point to enter tech again, although tactically it appears to be a good time to stay in the bricks-and-mortar stocks that are reviving at present. Today’s defensive trades are more about existing in a lower-growth environment for a time, which will create a more sustainable market “and gives us a launching pad to the next wave of growth.”

For Anthony Saglimbene, chief market strategist at Ameriprise Financial, what’s happening is simply the divergence between the old economy and the new economy.

Old economy stocks, he said, comprise those that are value-based, which typically perform better due to their stable earning streams. This is where investors are gravitating now, especially since they are less sensitive to rate increases. The new economy, on the other hand, include high-growth tech names that are prone to fears of rising interest rates, since many of them are valued based on their projected profits far into the future. And as the Fed forges on with its most aggressive tightening monetary policy in decades, the future profits of tech firms will be worth far less.

Unfortunately for the tech sector, the bad news continued at the end of the day, when it was the turn of Amazon.com Inc. to feel the market’s wrath in after-hours trading. Its third-quarter earnings were above prior expectations, but a particularly sanguine warning that the coming holiday season isn’t going to be a good one for sales prompted investor flight. The stock plummeted 20% at one point in extended trading.

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 6


The numbers involved are vast. The price at which Amazon’s shares came to rest implied a fall of $159 billion in market cap. This would leave it in the club of trillion-dollar companies, but only just, at $1.02 trillion. This seems like quite a reckoning, as the tech companies fall coyote-like toward the canyon floor. But to Saglimbene, who is overweight tech, the headwinds are only temporary until interest rates find their equilibrium.

For now, other parts of the market are enjoying a boost — companies that warmly fill tummies, bring us to exciting places, and entertain us with endless movies. To Webb, it’s simply a matter of everyone getting their time, as companies that were hurt by the pandemic return to normal: "McDonalds is such a great story in the psyche of the consumer as is Chipotle as is Boeing... When you think about the world today, kids are back in school so it’s not surprising Netflix has new subscribers again. Well now we are back to the school year, winter is coming. Everyone is back to normal activity. Return to normalcy will prevail the trade."

More telling still was the judgment of Louis Navellier, a veteran growth investor who has cheered fast-growing tech stocks in the past, and has made a fortune by looking at growth prospects rather than valuations. He pointed out that Meta’s spending on the metaverse would likely have a long payback, and that the Dow Jones Industrial Average was still up for the day thanks to strong numbers from McDonald’s Corp. and a range of other old-world names that earn their money from making things and selling them to people, including Honeywell International Inc., Caterpillar Inc., Boeing Co. and Merck & Co. Inc. Amid the bloodbath for tech companies, McDonald’s shares have somehow managed to rise slightly for the year so far.

Navellier suggests that assumptions about tech that have survived for the best part of a quarter century are at last being revised: "Consider that both Microsoft and ExxonMobil are currently generating roughly the same amount of free cash flow yet Exxon has a market value of only 25% of Microsoft. If the economy continues to slow as the Fed intends, the leadership that tech has enjoyed for many years may be brought back down to earth by valuation adjustments."

And as the Wile E. Coyote moment demonstrates, now that those valuations are at last being examined critically, not even the prospect of lower interest rates can keep the FANGs levitating.

Cruise Path to a Soft Landing (???)

While the FANGs made a crash landing, the top-down macro world is providing much news that investors had been hoping to hear. The European Central Bank met and hiked rates by 75 basis points as expected, but President Christine Lagarde signaled very clearly in her press conference (which you can see here) that we should expect the rate of increases to slow down from now on. Previously, the ECB had alerted that it expected to raise rates at “the next several meetings.” Now, under questioning, Lagarde was much more hedged: "Our sense is that we have already made significant progress, as I said. We are not done yet. There is more ground to cover, and the question of what that pace will be — what will be the magnitude of future rates — will be determined meeting by meeting and will be data dependent."

That had an immediate impact on the implicit path of interest rates projected by the overnight index swaps market. Expectations had risen sharply over the summer, but Lagarde’s words helped cut projected rates for next year by 25 basis points:

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 7


This isn’t a “pivot” toward lower rates. Lagarde said inflation was “far too high, and will stay high for a while,” and predicted an economic slowdown, but it’s plainly a deceleration and it makes it that much easier for the Federal Reserve also to start paving the way to slow its pace during next week’s meeting. It also weakened the euro, which had just exceeded parity to the dollar for the first time in a month.

Shortly after, US GDP numbers for the third quarter were released, and were almost perfectly “Goldilocks” (not too hot, not too cold) as far as the market is concerned. GDP is growing, but consumption is slowing, a combination that should allow some kind of “soft landing.” Bond yields did reduce, with the 10-year Treasury yield dropping below 4% for the first time in two weeks, but not in a way that saved the stock market from a tough day.

One reason for this is that the third quarter’s GDP number of 2.6% is already well in the past. Friday’s release of Personal Consumption Expenditure inflation data, the Fed’s favorite measure and within days of a monetary policy decision, promises to be far more important. Expectations for PCE are widely dispersed, but everyone thinks that they will show a rise. If the number comes in at the bottom of the range of expectations, that could have a much powerful effect on bond yields:

Wile E. Coyote Moment as Tech Goes Off the Cliff: Extended Excerpt Image 8


Friday also brings the employment cost index, which comes out only quarterly and is closely monitored by the Fed for any sign of an incipient wage-price spiral. That could have a major impact on the central bank’s flight path from here. Tom Hainlin, national investment strategist at US Bank Wealth Management, said by phone: "Is it a shallow glide lower? Is it a big stair step lower in terms of the outlook for 2023? That’s still unknown. GDP was backward looking. It's not really going to be a key driver of the market. That employment cost number is going to be a key driver."

As the FANGs continue their crash landing, there are still hopes of a soft landing for the bond market. That could yet translate into one for the stock market as well, as some ludicrous valuations are corrected, and capital diverts to some places that have been starved of it but could use it. The readjustment from the pandemic seems to be over — but bonds and tech stocks are reassessing assumptions that have stood for a couple of decades or more. This is tricky to engineer. The path to a safe landing might exist, but it’s a perilous one.

AI Summary. The U.S. prison population doubled from 800,000 to 1.6m alongside a 50% decline in violent crime, which the author attributes to incapacitating a small group of habitual offenders who make up roughly 1% of the population but commit a large share of violent crime. The author argues that later reductions in incarceration contributed to rising crime.

William Barr Wall Street Journal
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@WilliamBarr @WSJ Btw 1991-2013 total prison population in the US doubled from 800,000 to 1.6mm; during that period, violent crime was cut in half.

Do incarceration rates drive violent crime up or down?

Core argument: The U.S. prison population doubled from 800,000 to 1.6m between 1991 and 2013, coinciding with a 50% reduction in violent crime to levels not seen since 1970.

From 1991 to 2013, the U.S. prison population doubled from 800,000 to 1.6m, coinciding with a 50% reduction in violent crime, reaching levels not seen since 1970. This period of crime reduction was driven by policies that focused on incarcerating a small, hard-core group of habitual offenders, who, despite being roughly 1% of the population, were responsible for a significant portion of violent crime. The strategy of incapacitation, which involves keeping these offenders off the streets, proved effective in reducing crime rates. However, the resurgence of progressive policies in the Obama era, which favored a revolving-door justice system, led to a decline in incarceration rates and a subsequent rise in crime. The economic implications suggest that maintaining public safety through targeted incarceration is cost-effective compared to the societal costs of unchecked crime.

Takeaways by Macro Roundup® AI

  1. The U.S. prison population doubled from 800,000 to 1.6m between 1991 and 2013, coinciding with a 50% reduction in violent crime to levels not seen since 1970.
  2. The article attributes the crime decline to incapacitation, incarcerating a hard-core group of habitual offenders who make up roughly 1% of the population yet account for a significant portion of violent crime.
  3. The article argues that Obama-era progressive policies favoring a revolving-door justice system lowered incarceration rates and brought a rise in crime, and that targeted incarceration is cost-effective relative to the societal costs of unchecked crime.

"...Studies have repeatedly shown that most predatory crime is committed by a small, hard-core group of habitual offenders. They are a tiny fraction of the population—I estimate roughly 1%—but are responsible for between half and two-thirds of predatory violent crime. Each of these offenders can be expected to commit scores, even hundreds, of crimes a year, frequently while on bail, probation or parole. The only time they aren’t committing crimes is when they’re in prison. For this group, the likelihood of reoffending usually doesn’t recede until they reach their late 30s. The only way to reduce violent crime appreciably is to keep this cohort off the streets…By 1992, as more violent offenders were incarcerated, the trajectory of violent crime started falling for the first time in decades. Presidents Bill Clinton and George W. Bush continued these policies, andfrom 1991 to 2013, the total prison population in the U.S. doubled—from roughly 800,000 to 1.6 million. At the same time, violent crime plummeted, dropping for 23 years. By 2014 it had been cut in half—to a level not seen since 1970..."

William Barr, "Rising Crime Rates Are a Policy Choice,"Wall Street Journal, October 26, 2022, https://www.wsj.com/articles/safe-streets-are-a-policy-choice-incapacitation-incarceration-state-federal-prison-violent-crime-1990s-reagan-bush-barr-obama-sentencing-bail-11666785403

Rising Crime Rates Are a Policy Choice

The violent crime surge was preventable. It was caused by progressive politicians reverting to the same reckless revolving-door policies that during the 1960s and ’70s produced the greatest tsunami of violent crime in American history. We reversed that earlier crime wave with the tough anticrime measures adopted during the Reagan-Bush era. We can stop this one as well.

Studies have repeatedly shown that most predatory crime is committed by a small, hard-core group of habitual offenders. They are a tiny fraction of the population—I estimate roughly 1%—but are responsible for between half and two-thirds of predatory violent crime. Each of these offenders can be expected to commit scores, even hundreds, of crimes a year, frequently while on bail, probation or parole. The only time they aren’t committing crimes is when they’re in prison. For this group, the likelihood of reoffending usually doesn’t recede until they reach their late 30s.

The only way to reduce violent crime appreciably is to keep this cohort off the streets. We know with certainty that for each of these criminals held in prison, there are hundreds of people who aren’t being victimized. This “incapacitation” strategy requires laws, like those in the federal system, that allow judges to detain repeat offenders before trial when they pose a danger to the community, and that impose tough sentences on repeat violent offenders.

History shows this strategy works. Before 1960, violent crime in the U.S. was modest and stable. In the early ’60s, however, liberal reformers pushed to turn state justice systems into revolving doors, with violent offenders quickly released on parole or probation. Predictably, violent crime exploded, going from 160 crimes per 100,000 population in 1960 to 758 per 100,000 in 1991.

In the 1980s, the Reagan administration and several large states started locking up violent offenders, and the nation’s prison population rose from about 300,000 to almost 700,000. This radically flattened the rate of violent crime, which rose only 11% during the ’80s. By 1991, when I first became attorney general, the revolving door was in overdrive in many states. Nationally, murderers served less than six years on average; the average time served for rape was three years. In Texas, offenders typically served only 15% of their sentences. Five of 8 felons released from prison were arrested for new crimes within three years.

The George H.W. Bush administration initiated the doubling of federal prison capacity, pushed states to do likewise, and launched a broad movement to toughen up state justice systems. It also greatly expanded joint federal, state and local task forces to target the worst violent criminals for stiff sentences under federal gun, gang and drug-trafficking laws.

The results of these policies were stunning. By 1992, as more violent offenders were incarcerated, the trajectory of violent crime started falling for the first time in decades. Presidents Bill Clinton and George W. Bush continued these policies, and from 1991 to 2013, the total prison population in the U.S. doubled—from roughly 800,000 to 1.6 million. At the same time, violent crime plummeted, dropping for 23 years. By 2014 it had been cut in half—to a level not seen since 1970—and homicides of black victims were down by about 5,000 a year.

Nevertheless, progressives complained: Why were we imprisoning record numbers when crime was receding? They missed the point. Crime was dropping precisely because we were keeping violent criminals in prison. Progressives call this “mass incarceration,” but their rhetoric is deceptive. It implies people are being locked up indiscriminately. On the contrary, incapacitation is a precision strategy. It targets and uses prison space primarily for violent criminals who pose the greatest threat to public safety.

Unfortunately, 23 years of successful crime reduction came to an end with the resurgence of progressive policies in the Obama administration, which saw a return to the revolving door and the demonization of police. Incarceration rates started falling again, and by 2014 crime rates were headed back up. This reversal was temporarily halted by the Trump administration, which succeeded in driving violent crime down until the summer of 2020. It started to climb in the wake of the Covid pandemic and the Black Lives Matter riots. It continues to rise without any end in sight.

Progressives have no solution. As in the ’60s, they call for more social spending to address the supposed “root causes” of violent crime. But even if we knew how to address the root causes effectively, which we don’t, implementing the solution would take decades. People are entitled to protection now. Even the best-designed social programs have no chance of success in neighborhoods strangled by violence and fear. Law and order is a prerequisite for social progress.

Progressives say we can’t afford to keep violent predators in prison. On the contrary, we can’t afford not to. A 1992 Justice Department report, “The Case for More Incarceration,” showed that the cost of keeping a chronic violent criminal in prison is small compared with the costs of letting him roam the streets.

In other contexts, we spend huge amounts to reduce the risk of premature death or injury to members of the public, including billions on highway safety or environmental quality. If we started using the same cost-benefit analysis for law enforcement, we would be spending many times more than we do today on police and corrections.

The very purpose of government is to secure a peaceful society—making life safe for law-abiding citizens by protecting them from violent predators. Progressive politicians are doing the opposite, blighting the lives of the law-abiding with their warped solicitude for the criminal few. We can stop the swelling crime wave only by rejecting these politicians and their destructive policies. It is time for a return to sanity.