Economic Policy Critique – The Investment Journal

It accounts for 70% of the country’s GDP.

Consumer spending.

Makes sense. Healthy consumers are obviously necessary for a healthy economy.

But good health isn’t always apparent on the surface. Trouble can be quietly developing under the surface.

Like the heart disease candidate whose arteries are filling with plaque. They may look perfectly fine… until they’re lying on the ground clutching their chest.

Today’s economy is something like that.

Last October, the BEA announced that real GDP rose at an annualized rate of 2.8%.

That is an impressive number.

To take it at face value (much like the Fed has been insisting we do) you’d have to say that the economy, and consumers in particular, are doing just fine. So have another piece of cheesecake.

The reality underlying the situation, however, isn’t so good.

A Shift in Buying Preference

In a broadly healthy economy, a rising GDP should lift all boats. (Or most anyway.) You expect to see retailers posting great numbers across the board. Blood is pumping through those arteries.

But that’s not what has been happening. And it hasn’t been happening for some time…

All the way back in November 2022, the Wall Street Journal reported:

“Walmart gains more shoppers” sounds like good news. But article reported strains in the consumer sector:

The country’s largest retailer by revenue said Tuesday that households continue to face pressure from rising food prices, and lower-income shoppers are eating into savings.

Inflation was still roaring at the time and CPI for that month came in at 7.1%. And you’d expect that kind of news from lower-income shoppers. But what you might not expect…

During the most recent quarter, households earning $100,000 or more helped push Walmart grocery sales higher, executives said.

Sales data had indicated that higher-income consumers had begun to trade down searching for bargains. When inflation begins to reach the middle to upper income brackets, stress is beginning to build.

Still, with prices soaring over 7% annually, it’d be reasonable to argue that most households would be looking to save a buck or two.

But now with inflation “well on track back to 2%,” if you believe the Fed, things should be shifting back to normal. But they’re not.

In fact, they’re going in the opposite direction…

The Trade Down Continues

This November Walmart released its earnings. Not only did they beat revenue and earnings estimates, they raised their forward guidance.

In particular, management noted…

While average transaction growth slowed, customers are buying more at each visit, driving ticket sizes. A lot of that growth was driven by upper-income households making $100,000 a year or more as increasingly more affluent households trade down. That cohort made up roughly 75% of share gains for the quarter.

Two years later, the $100K and up cohort is still shopping at Walmart. And they’re doing it more and more.

This suggests clear strains in the economy. In a recent webinar, Goldman Sachs noted:

Our focus on the webinar centers around discussing high-end and low-end consumers trading down. This phenomenon occurs as macroeconomic headwinds mount, including elevated inflation and high interest rates due to backfiring ‘Bidenomics.’ More importantly, trading down occurs when incomes don’t keep up with inflation or when purchasing power decreases.

So the trade down phenomenon itself is suggesting trouble. But there’s more…

The bargain hunting isn’t carrying across the board.

Target, who released their earnings the same day as Walmart, missed everywhere with their stock dropping 21% on the news.

This suggests that the trade down to discount stores isn’t even widespread. (Even Dollar General collapsed on its latest earnings report.)

The bottom line: The trade down and concentration of retail customers suggests they’re taking a seriously defensive position as economic conditions become more and more uncertain.

Could be tough times ahead.

There’s something to be said for government investments…

They’re stupid.

Nearly every foray into industrial policy by a government ends up creating serious unintended consequences.

But that doesn’t mean they’ll stop trying.

This latest government go-round involving the tech industry will likely be no different.

Launching a Giveaway Program

Quick story… When global governments shut down the world during the pandemic, the US became painfully aware of just how dependent its economy was on foreign production of certain key materials. One notable dependency was in the semiconductor segment.

The shortage that followed sent shockwaves through multiple industries that relied on access to these tech components.

In the face of this realization, the government did what it does best.

It threw money at the problem.

In 2022 the Biden Administration (in cahoots with the US Congress) passed something called the Chips Act. The White House assured us that this $280 billion handout would:

…accelerate the manufacturing of semiconductors in America, lowering prices on everything from cars to dishwashers. It also will create jobs – good-paying jobs right here in the United States. It will mean more resilient American supply chains, so we are never so reliant on foreign countries for the critical technologies that we need for American consumers and national security.

In addition to targeting semiconductor manufacturing capability in the US, it would fund R&D in various “leading edge” technologies. (In other words, technologies that don’t have a viable commercial market of their own.)

One of the first to step up to the trough was the former heavyweight champion of the chip industry — Intel.

_{Source: CNBC}

According to the article:

Intel said it would spend its CHIPS Act funds on fabs and research centers in Arizona, Ohio, New Mexico and Oregon. The company previously announced plans to spend $100 billion on U.S. programs and facilities. Intel has announced a plan to catch up in leading-edge manufacturing by 2026.

Intel’s Ohio fab will cost more than $20 billion and Intel said it is expected to start production in 2027 or 2028. Intel is also expanding manufacturing operations in Arizona and New Mexico. Intel says the projects will create jobs for 20,000 people in fab construction and 10,000 people in chip manufacturing.

The company’s stock popped on the news.

Spending Down a Black Hole?

But that was six months ago. And oh how things have changed.

Early last month, Intel released a disastrous Q2 earnings report. Revenues missed expectations and resulted in a $1.6 billion net loss. EPS came in at $0.02 vs a $0.10 expectation.

The company announced it was suspending the dividend it’s been paying since 1992.

And now rather than creating tens of thousands of jobs, they announced they would be laying off 15,000 beginning this year.

The company’s stock is down over 60% year to date.

Intel Corp. (INTC) Year to Date.

_{Source: Barchart.com}

Intel CEO Pat Gensler said, “Our revenues have not grown as expected — and we’ve yet to fully benefit from powerful trends, like AI. Our costs are too high, our margins are too low.”

That may be the scariest statement of all.

For all intents and purposes the AI boom has been fueling the market since late 2022. If they’ve missed the bus for the past two years, it’s hard to imagine how they plan to catch up.

Intel has a bit of a history of being on the wrong side of industry trends. (Like when it opted not to provide Apple with chips for its iPhone.)

There’s always hope to right the ship. (Meta managed to do it after a disastrous investment in the metaverse.) But right now, Intel is nowhere near equipped to spend $100 billion on anything.

And given all this, is this where the government should be spending $20 billion of your money?

Today’s investing landscape may be as difficult to navigate as it’s ever been.

This is in large part due to changes that have taken place over the past decades.

Two important distinctions investors should be aware of today.

First…

The Stock Market Is Not the Economy…

Not so long ago, when the US economy was a value-based engine, the stock market could be considered a decent measure of economic activity.

Manufacturing companies who produced and sold more products earned more money. And investors in those companies were rewarded with higher share prices and often dividend payouts.

Everyone’s a winner.

Today we no longer live in a traditional value-based economy. Sure, we have industries that produce stuff that’s sold here and around the world. But more and more that continues to change.

Today, and for the past roughly 50 years, the stock market has turned from a measure of an industrial economy into a tool of financial elites.

A means to make money from money. Period.

If you want the big picture, think of the golden age of the corporate raider — the time associated with the “Go-Go 80s” and personified by Gordon Gekko in the movie Wall Street.

The strategy back then was to acquire distressed manufacturing companies and drain whatever cash flow they could. Corporate raiders cut capital and operating expenditures and sold off assets. In the immortal words of Gekko himself, they’d wreck a company “because it’s wreckable!”

It wasn’t about investing to grow a company. It was about spending money for a fast return.

But the financialization wasn’t limited to the corporate vultures.

Manufacturing companies themselves even got in on the “make money from money” craze.

General Motors Acceptance Corporation and Ford Motor Credit were both established decades ago to finance car purchases. But during that same time they began to expand their interests into all sorts of other financial services including mortgages, insurance, banking and commercial finance.

Their financial efforts eventually began to eclipse their main businesses…

In 2004, GM reported that 66 percent of its $1.3 billion quarterly profits came from GMAC; while a day earlier, Ford reported a loss in its automotive operation but $1.17 billion in net income, mostly from its financing operation.

Today, stock buybacks are all the rage.

After a shaky start earlier this year, Apple announced it would buy back $110 billion of its shares. Without changing a thing in its operations, its share price suddenly exploded making them once again the most valuable company in the world.

Much of the stock market has become addicted to this financialization. And that’s why cheap capital (low interest rates) is so important.

This is an important fact to understand. Stock indexes do NOT represent the economy.

…And Neither Are Economic Reports

The second thing to understand is that “economic reports” don’t accurately represent the economy either.

Case in point.

GDP for the second quarter was just revised upwards to 3% — over doubling the first quarter’s report of 1.4% growth.

If you believe these numbers, business should be booming.

Yet in the first half of this year, corporate bankruptcies are soaring.

According to the June S&P Global Market Intelligence report: “The 346 total filings so far in 2024 is also higher than any comparable figure in the prior 13 years.”

Personal consumption expenditures (the fancy name for consumer spending) rose 0.7% in the second quarter as well. But sales numbers for many consumer-facing companies like General Mills…

MINNEAPOLIS – General Mills (NYSE: NYSE:GIS) has confirmed its financial targets for fiscal year 2025, expecting organic net sales to be flat to up 1 percent, and an adjusted operating profit ranging from a 2 percent decline to flat in constant currency.

…Hershey…

The stock of iconic US chocolate maker Hershey tumbled after the company slashed its sales and earnings outlook for the year as shoppers continue to reduce purchases of higher priced chocolates and candies.

Q2 sales plunged 17% to $2.07 billion, sharply missing the $2.31 billion estimate. Adjusted EPS of $1.27 per share also missed expectations.

…even dollar stores…

Shares of Dollar Tree plunged nearly 12% in premarket trading in New York after the discount retailer, which operates thousands of stores nationwide, posted fiscal second-quarter earnings that fell short of Wall Street expectations. The company also slashed its full-year outlook, pointing to mounting financial pressures on middle-income and higher-income customers. This comes less than a week after major rival Dollar General reported a “financially constrained core customer” that sent shares crashing the most on record.

…have been struggling as well.

And then there are all the jobs that have been added to the economy…

Today, given all the potential for revisions and seasonal adjustments, economic reports really don’t mean much where the future of a stock — or even an entire index — goes.

Heck, they don’t even accurately represent the economy.

These financial and economic “dislocations” can create havoc for investors.

But we make them our business here, to make sure our readers are the best-informed investors they can be.