Wealth Porn: Elon's Monopoly Money

Forbes' Matt Durot recently wrote about Elon Musk's monster December paydays which, given their scale, almost doesn't feel like real money. Early in December, SpaceX launched a tender offer for insider shares that valued the satellite maker at around $800 billion, up from $400 billion in August (private markets be wild!). This new valuation made Elon's 42% stake in the company worth $336 billion and made him the first person ever worth $600 billion. It also meant SpaceX, not Telsa, was the biggest source of his wealth...Challenged accepted. Four days later the Delaware Supreme Court overturned a lower court ruling that in 2018 voided a Tesla options pay package worth $56 billion. That verdict was source of great consternation for Musk; so much so, he re-domiciled both Telsa and SpaceX in Texas which promised him more favorable treatment. So now, a chastened Delaware (possibly fearing other business may do the same) made things 'right.' That options package is now worth $139 billion after gains in Tesla stock, bringing the total value of Elon's holdings in Tesla to $338 billion and restoring balance to the Musk empire. It also made Elon the first person ever worth to be worth $700 billion (at least on an unadjusted basis). 

So, what does that even mean? People have tried to make sense of this outrageous number by making comparisons. Here's one attempt by CNN: weighing Elon's estimated net worth against the economies of entire nations. It shows that (as of December 21) Elon's wealth exceeded the annual GDP of more than 170 countries (there officially 195 countries in the world, including Palestine and Vatican City).

Does this help to put Elon's wealth in context? Perhaps. Or do such comparisons just serve to further glorify and gamify staggering concentrations of wealth in society? Moreover, comparing an individual's wealth to a country's economic production is not exactly apples to apples for several reasons. First when it comes to wealth, there's cash and then there's paper valuation. Elon doesn't exactly have $749 billion of cash lying around in banks; what he does have is lots of shares of Tesla and SpaceX which are valued principally by investors based on what they see is the present value ("PV") of the future earnings of each company into perpetuity. Based on investors' sentiment of future growth that 'value' can fluctuate day-to-day; e.g., if investors wake up tomorrow and start to value Telsa more 'rationally' then Telsa's market valuation could drop from approximately $1.5 trillion to $200 billion (or, for the sake of argument, rise to $3.0 trillion) without any meaningful change in the company's actual operations. It really comes down to the story investors want to believe and Elon is an inspiring narrator. What it doesn't mean is that Elon is 'richer' than any of those 170 countries. Let's take the case of Belgium, one of the countries whose GDP lags Elon's net worth. Belgium's annual (nominal) GDP of $717 billion represents the sum total of all of its actual economic output (domestically) for the past 12 months (and not the PV of the country's expected economic growth forever into the future). It also doesn't mean Elon can pay for everyone in Belgium to take a year-long holiday. He just doesn't have that much money available; sure, Tesla is publicly traded...and he could probably sell billions worth of shares before its market price (and his wealth) starts to precipitously drop. Although Elon can, and does, regularly borrow against his shares, it would still be a drop in the bucket. So, the country comparison doesn't tell us much. So, Elon's not that wealthy? No, no...he's incredibly wealthy, just not (yet) 'richer' than entire nations based on how we are calculating value. 

Is there a better way to depict Elon's staggering wealth and put it into context? Yes, there is, and it was posted by Senator Bernie recently when he railed against billionaires (as he is wont to do). It compares wealth against (shocking) wealth. Based on analyses by economists at Realtime Inequality Sanders' chart shows that the bottom 50% of Americans aged above 20 years (roughly 125 million people) hold approximately $1.2 trillion in total wealth (savings, stock, real estate, etc. which can fluctuate in value, particularly if more of it is in financial assets rather hard cash). That comes to an average wealth of about $9,600 per working American. I another words, on paper, one person--Elon--holds more wealth than 78+ million Americans! 

Wealth inequality is a natural part of society and may even be inevitable...but Elon level of inequality can be both dangerous both socially and financially. Studies show the concentration of wealth today is the highest since the 1920, right before the Great Depression. There are no easy solutions (and that's a whole new post); particularly when society's/civilization's (?) definition of success is so closely intertwined wealth accumulation. So, we all play the game and wait in anticipation for when Elon's net wealth crosses the $1 trillion mark, like casually moving to the next level in the Legend of Zelda. And we may not have to wait long. As Durrot notes--in centi-billionaire speak--Elon is  "roughly one Larry Page away from achieving that milestone." 

The Three Types of Inflation

Inflation is dominating the news. While the price of everyday goods, including food and energy—naturally—grab the headlines, the ever-interesting Visual Capitalist reminds us of the other forms inflation within the economic system that impact our lives.

The first is monetary inflation, which occurs when the U.S. money supply increases over time. This represents both physical and digital money circulating in the economy including cash, checking accounts, and money market mutual funds. In the U.S. the Federal Reserve typically influences the money supply by printing money, buying bonds, or changing bank reserve requirements. The Fed controls the money supply in order to boost the economy or tame inflation and keep prices stable. 

Nobel Laureate Milton Friedman once posited that "inflation is always and everywhere a monetary phenomenon." That's because, in theory at least, increasing the money supply faster than the growth in real output may cause consumer price inflation (# 2 below); more money chasing the same amount goods should eventually lead to increases in prices.

                                               Source: Visual Capitalist, New York Life Investments

Next is consumer price inflation ("CPI"), which occurs when the prices of goods and services actually increase. It is typically measured by the Consumer Price Index (CPI), which shows the average price increase of a basket of goods, such as food, clothing, and housing. Supply chain issues, geopolitical events, monetary supply, and consumer demand may all affect CPI. When CPI is persistently increasing at rate above 2% per annum, the Fed may increase interest rates to curtail spending and allow prices to cool down, and vice versa.

Lastly, asset price inflation ("API") represents the price increase of stocks, bonds, real estate, and other financial assets over time. One measure of API is the ratio of household net worth to GDP. Often, a low interest rate climate creates a favorable environment for asset prices by lowering the total cost of asset ownership. This has been evident over the past decade as low rates were met with rising asset prices. In 2021, household net worth as a percentage of GDP stood at 620%. Rising asset prices can sometimes be a misleading sign of a strong economy since no real output is produced—the stock market is not the economy. Instead, it may indicate an asset bubble, which is dangerous because it contributes to rising inequality (as typically the very rich own the vast majority of economic assets). But when bubbles burst, the government has to step in with taxpayers' (i.e., everyone's) money to save the economy (and thereby the rich). The moral hazards in a laissez-faire capitalistic system can give rise to demagoguery.

The Remarkable Rise of Bangladesh

When people think of the Indian Subcontinent, they think of, well, India, and secondarily Pakistan, two rival nuclear powers. Often lost in the mix is another populous country with a long, shared, and bloody history: Bangladesh.

The end of British colonialism in India was associated with a rushed and botched partition of the country by Viceroy Mountbatten (better known to Americans as Prince Charles' ambitious uncle in Netflix's The Crown). In any case, at the stroke of midnight on August 15, 1947, two countries were born: Hindu-majority India, and Muslim-majority Pakistan. Pakistan itself was divided into two parts, East and West, separated by over a thousand miles (the two green sections, as shown below). In 1971, Bangladesh declared its independence from the richer and more powerful (West) Pakistan.

At the time, there seemed to be little hope for the new nation, reeling from a brutal war and a terrible famine. Henry Kissinger, then National Security Advisor, famously called it a “basketcase.” Oh, how times have changed! Fifty-years on, Bangladesh has emerged as an unlikely economic success eclipsing its two larger neighbors. In a fascinating piece for Bloomberg, Mihir Sharma argues that Bangladesh is South Asia's standout star. Per Sharma:

Bangladesh's GDP per capita grew by 9% over the past year, rising to $2,227 [in 2020-21]. Pakistan’s per capita income, meanwhile, is $1,543. In 1971, Pakistan was 70% richer than Bangladesh; today, Bangladesh is 45% richer than Pakistan. One Pakistani economist glumly pointed out that “it is in the realm of possibility that we could be seeking aid from Bangladesh in 2030.”

India — eternally confident about being the only South Asian economy that matters — now must grapple with the fact that it, too, is poorer than Bangladesh in per capita terms. India’s per capita income in 2020-21 was a mere $1,947.

Bangladesh’s growth rests on three pillars: exports, social progress and fiscal prudence...Between 2011 and 2019, Bangladesh’s exports grew at 8.6% every year, compared to the world average of 0.4%. The success is largely due to the country’s relentless focus on products, such as apparel, in which it possesses a comparative advantage. Meanwhile, the share of Bangladeshi women in the labor force has consistently grown, unlike in India and Pakistan, where it has decreased. And Bangladesh has maintained a public debt-to-GDP ratio between 30% and 40%. India and Pakistan will both emerge from the pandemic with public debt close to 90% of GDP. Fiscal restraint has allowed Bangladesh’s private sector to borrow and invest.

But Sharma also notes that success brings its own set of problems. For one, Bangladesh's exports benefit from the country’s participation in various mechanisms that allow tariff-free access to developed economies, such as the U.S.’s Generalized System of Preferences. These groupings are only open to the world’s least developed countries. Thanks to its growth, Bangladesh will likely have to give up these privileges by 2026 or so. Structurally, as its economy matures, its comparative advantages will also change. Like Vietnam and others, it will then have to shift emphasis away from garments to higher-value exports. The transition will test Bangladesh as it has those other nations.

These are good problems to have, and Bangladesh has demonstrated an ability to meet challenges. Moreover, the country isn't content to just be a local success story. It aims to be a developed economy by 2041. Ambitious? Yes. But as Sharma notes, "the past 50 years have shown how unwise it is to bet against Bangladesh."

Do Deficits Matter?

There is a lot of hue and cry of going on about raising the debt ceiling. On the one hand, not paying America's contractual obligations would be very bad. On the other hand, is spending out of control and hurting future generation's prospects? Hmm...The Peterson Foundation tracks the U.S. national debt in real time and as of 11:00 am today, it was...

That seems a large number, like a really, really large number. Nearly $100,000 per American. The three main drivers of the U.S. national debt are:

1. Demographics. The U.S. population is aging which puts pressure on the federal budget, in particular on vital programs that serve older Americans like Social Security, Medicare, and Medicaid.

2. High healthcare costs. The U.S. healthcare system is the most expensive in the world, but we don’t really get what we pay for.

3. Inadequate revenues: The U.S. tax system does not generate enough revenues to cover the spending policymakers have enacted. For example, 39 U.S. corporations reaping over $120 billion in profits paid no federal income tax from 2018-2020!

The U.S. debt-to-GDP ratio is now over 100%. That sounds bad, is it though? The chart below (click to enlarge) shows the level of debt of most of the world's countries. If we assume green is good, dark red as bad, well things get confusing. Some of the richest countries in the world have very high debt-to-GDP ratios: look no further than Japan (257%), Italy (157%), U.S. (133%), Canada (116%), France (115%), etc., while developing countries like Afghanistan (9%), Nigeria (32%), Bangladesh (40%), Indonesia (41%), Vietnam (48%), etc. have low debt ratios. Sure, there are rich countries like Norway (42%) and Denmark (42%) with low debt % but also poor countries like Sudan (212%) and Sri Lanka (105%) with high debt %. So the big takeaway is it that there is no strong relationship between debt levels and economic strength.   

In fact, perhaps countries like the U.S. and Canada should be borrowing more. A research paper by prominent economists Jason Furman and Larry Summers determined "that the burden of debt is best measured by annual inflation-adjusted interest payments as a percentage of GDP and that anything under two percent should be sustainable." At present, it is negative...suggesting we should be binging on debt. Savers will effectively pay the U.S. government to borrow. And if nothing else, we should be trying to lock in low interest rates for longer periods. The average maturity of U.S. Treasury debt is just 63 months, so it might be good idea if future bond issues lean into longer duration debt--20 or 30 years.

As long as the money is put to productive use, there should be no issue...growth solves all problems. Of course, the Left, the Right and everyone in between have different opinions on what constitutes good use of money...but at least when real interest rates are negative those decisions should be easier. So, I guess Dick Cheney, of all people, was right?

Apple is a Massive Company

Apple is the biggest company in the world with a market capitalization with $2.4 trillion, as of yesterday. That's a lot of company. How much is a couple of trillion of dollars? This chart from the Visual Capitalist puts Apple's size into context:

In fact, Apple's market cap is bigger than the economies of all but seven countries, according to the IMF:

And it's not just the company's market cap that's hard to contextualize. The company just generates so much cash...it's a veritable money machine. As of Q1 2021, Apple was sitting on ~$200bn of cash and bonds!! Again, how big is that? How many companies can Apple buy?... Umm, Apple's cash pile can be used to buy 460 of the S&P 500 companies!

All the more reason this story about Elon demanding to be Apple CEO in return for receiving rescue financing to save Telsa is just so outrageous, but also just so "on brand" for Elon.

Krugman vs Summers: Round 2?

The yield on the 10-year Note has risen 89% YTD as of 3/19 (from 92 bps to 173 bps) and 223% since a low of 54 bps back in July. Obviously % changes from such a low base are going to be dramatic. But it's got market analysts and economists somewhat freaked out about the "i" word.

To be sure, the rise in yields has tracked the progress of vaccines approvals and improvements in the economy...but has risen sharply in recent weeks as the Democracts successfully pushed through a massive $1.9 trillion stimulus. While Republicans predicatably blasted the deal, one of its harshest critics has been Larry Summers who believes the recently passed $1.9 trillion stimulus will "set the economy on fire." Err, that's economist speak for 'are you outta your f***ing minds?'

Last month we highlighted a fascinating discussion or "debate" between Paul Krugman and Summers concerning the yet-unpassed stimulus package. Essentially, both agreed that more support for the economy and, in particular, vulnerable groups was needed, but disagreed on the size of the package. Krugman wanted Biden to go big or risk a weak recovery, while Summers thought the size of proposed stimulus was overkill and risked stoking inflation, if passed.

Well, the stimulus did passed (surprisingly? shockingly?), giving the Democracts a huge political win. But what does it mean for inflation? Bloomberg's Wall Street Week invited both Krugman and Summers to make their points again this week: 

Krugman dismissed worries of 1970s-style inflation saying the latter did not transpire overnight, but took hold gradually over a decade of poor policies and oil shocks. His big argument continues to be that the bigger risk is not doing enough to support the economy. The fiscal stimulus had to be massive because with short-term interest rates near zero, stimulatory monetary policy options are limited. However, precisely because rates are so low the Fed has a lot more options should the economy heat up. And Krugman believes the Fed is up to the job of managing price stability. Period. So, he sees an asymmteric risk-reward here.

Summers, on the other hand, sounds even more critical than he did a few weeks ago, calling the stimulus package the "least responsible fiscal macroeconomic policy we've had for the last 40 years." Blaming the instransigent Democratic left and all Republicans. He was also pointedly critical of Krugman for bringing political analyses into what should be a rational economic discussion. We've covered all this previously. But what was surprising here was Summers' conviction that it would go all wrong; starkly warning that he thinks there is a 1/3 chance Fed will be behind the curve and we become an inflationary country, 1/3 chance the Fed surprises the markets, reacts hard and puts the economy in recession, and 1/3 chance that by some miracle he's wrong. 

So, I can see where Summers is coming from. Goldman Sachs and much of Wall Street is expecting 2021 GDP growth to about 8%, the fastest rate in 56 years! Unemployment at under 4% by end of 2021 and 2022 GDP growth at 4.5%! Whoa! Of course these are sell-side research forecasts which are always bullish ("...economy is growing, buy stocks!!" and Krugman has a wicked burn to just that point in the full version). But this chart from Blackstone does make that point, as does research from Summers and Furman. The BX graph (click to enlarge) shows the $2.2 trillion economic contraction Covid caused last year was largely (but not fully) offset by more than ~$3.5 trillion of federal aid even before the latest $2 trillion of stimulus. So, all this money is going juice growth and cause prices to rise, right?

Yes and no. The chart below shows the difference between nominal GDP and 10-year yields over the last 60 years. When the spread has been 5% or more, you've had a sharp rise in inflation (late '60s, '70s)...and based on analysts' forecasted 2021 GDP growth, the expected spread today is more than 6%!

Ergo, inflation? Summers is right?

...Not so fast. Analyses from the (leftish) Brooking Institution suggests growth will be transient. Their study projects the U.S. economy will experience moderate above trend growth in the short-term, 2H 2021 and 1H 2022, but revert back to pre-Covid trends by end of 2022. However, without the Biden package, Brookings estimates the economy would not fully recover for a long time...just like after the Great Recession. So Krugman "wins"...again!

What's more, the biggest boost to the economy will come from aid to financially vulnerable households. Yeah, this set of analyses defintely favors Krugman. Ding! Ding! Ding! 

But what about short-term inflation...how bad can it get? Meh, probably not that bad. The Fed's biggest problem the last three decades has been not enough inflation. Another $2 trillion won't make much of difference against the generational forces of an aging population, shrinking workforce, and deflationary technology as discussed previously. As for bonds...well those same forces will continue to ensure that private savings>private investments across the OECD and keep interest rates low.

I'll say this again. The best rebuttal to Summers comes from Summers, who very persuasively made the exact same argument when he famously revived the "secular stagnation" thesis. So, Treasuries at 1.73% may actually be a buying opportunity! I'm sure European and Japanese pensions will be thinking so.

Inflation Head Fake?

The financial markets freaked out last week as yields rose on fears, yet again (sigh), of growing inflationary pressure. The benchmark 10-yr Treasury yield briefly crossed 1.6% Thursday, the highest level in a year, sparking a sell-off in Growth and Momentum stocks. But so what? The 10-yr was back at only pre-Covid levels, and everyone knew those stocks were grossly overvalued...Yes, the 12-month CPI came in at 1.4% in Jan vs the average of 1.2% for 2020. And true, there is another $1.9T of stimulus on the way even as the economy is poised to take-off (Goldman Sachs is forecasting ~7% GDP growth for 2021). From that angle, you might expect some handwringing in the media about inflation... though sell-side research loves to cheerlead remind clients rising yields is good for stocks as it reflects strong fundamentals (there's never a bad reason not to own stocks).

But, what seemed to really have panicked the markets was the disorderly nature of the bond sell-off. The magnitude of the move last week was more than 2 standard deviations, which is typically associated falling equity prices. So last week both bonds and stocks lost value together. The nightmare scenario from a portfolio construction perspective! Anyways...continuing with what happened...Goldman Sachs' Portfolio Strategy team notes that long-duration growth stocks fared especially poorly, including a 15% sell-off in a basket of non-profitable tech stocks that had risen by 230% since the start of 2020. In contrast, cyclicals with falling sales in 2020 have returned +25% YTD. There was also the chart below, which got a lot of attention showing the 10-yr was now yielding as much as stocks and signaling potentially more outflows out of stocks as investors re-think their income source:   

But we've been here before...as the above chart shows, including famously in 2013 with the "Taper Tantrum." Each time growth has been slower than expected and inflation way lower than anticipated. I'm with PIMCO's Dan Ivascyn, who continues to see "powerful disinflationary trends. [And] after an initial recovery there is likely a world of excess capacity." In Ivascyn's opinion, inflation will remain contained due to secular trends in demographics, technology and weakness of organized labor. The upshot is a material risk of an "inflation head fake." 

Stock Market Bubble? Yes!! No!! Who Knows?!

January saw a wild ride in stocks, particularly junk stocks. Widescale vaccine rollouts, permanently dovish monetary policy, massive stimulus with direct cash payments and the possibility of more government aid to come...are pushing equities to record highs. But how much higher can markets go?

Some say we are in a massive bubble and face a reckoning...not if, but when. Others are more bullish, rationalizing reasons why markets fundamentally will go up (a slight tangent here, but most sell-side research are typically self-servingly bullish---at a brokerage house you're never penalized for being bullish and wrong, just for being bearish and wrong. You can't really blame them...."research" is really just marketing...part of ibanks' expenses to get trading commissions; and over two-thirds of the time, the market goes up...so it's a numbers game).

Which brings us to Warren Buffett's "favorite" valuation metric: the market cap/ GDP ratio. A good description is available at the Current Market Valuation blog. The intuition is that stock market growth reflects underlying economic growth. Over the long term it should be roughly 1:1. So, below 100%  stocks are undervalued; above 100% they are overvalued. Currently the ratio stands at 288% ($48.7 T/ $21.7 T) or nearly 3 standard deviations from the historical average...something you'd expect to see once every 300 years. The U.S. is only 244 years old (and GDP data has only been collected for ~100 of those)...so hmm, something to think about. 

Mind you, it's NOT a market timing tool; as they say, "the market can stay irrational longer than you can stay solvent." Another big deficiency of this indicator is that it does not take into account the level of interest rates. Rates influence borrowing and profit margins of companies (and thus their valuations) as well as the the attractiveness of bonds relative to stocks---two competing investable asset classes.

The chart below shows GDP and stock market growth trends. Taken by themselves...clearly the market seems to be running ahead of itself, by a lot.

Now, compare the ratio with interest rate trends (click to enlarge chart below)...historically, when rates are low, the Buffet Indicator is high and vice versa. So as long the Fed keeps liquidity flowing, stocks will run hot. That's the tsunami that overwhelms everything else. And we've written about the empirical evidence of the Fed put. While proping up the stock market is not a part of the Fed's mandate...the Fed pays very close attention to it...believing a drop in stock value creates a negative "wealth effect" that feeds into a cycle of negative consumer sentiment and lower economic demand. And market participants know it and hold the Fed hostage to it.

But if there is one thing that does scare the market it's the spectare of uncontrolled inflation forcing the Fed's hand. Price stability is a Fed mandate. And if the Fed has to choose between controlling inflation and propping the stock maket, its going to choose the former... But inflation is not really a problem for the Fed right now...on the contrary deflation is probably the bigger worry. In fact, a little inflation is good for "greasing the wheels" of commerce. And depsite providing oceans of liquidity over the past decade, the Fed has not been successful at bringing inflation up to the 2% per year that's considered "good." 

If inflation expectations remain low then investors are being rational in choosing stocks over bonds. Currently the benchmark 10-year Treasury bond is yielding 1.2%. The widely followed Shiller CAPE ratio for stocks currently stands at 35.8; in another words, stocks are yielding 2.8% (1/ 35.8) or 2.3x bonds. Sure stocks are riskier, but at such low rates bonds are risky too. So the "equity premium" or spread over bond yields is compressed and investors favor stocks. 

Why has inflation stayed so low despite record low unemployment (at least pre-Covid), massive tax cuts and very accomodate monetary policies? No one really knows...

The net effect is all this probably ends very badly at some point...but only when inflation rears its head. Until then, companies will contine to binge on debt and investors will likely continue to reward them with higher valuations and keep the cycle going...so keep buying Growth and Momemtum stocks and Bitcoin.