Overview
At 77 years of age, one would think a luminary such as Mario Draghi would be enjoying the sun someplace on the Amalfi Coast or on the shores of Lake Como. But no, he has developed a 69-page plan1 to pull the European Union from its malaise and restore prosperity for all. While we applaud his effort, there are a few impediments that are likely to prove nettlesome:
Energy Prices – With the continuation of the Ukraine crisis, readily available, low-priced energy is in the rearview mirror, with little hope of a quick restoration. Prices have settled at 50% to 100% higher than pre-lockdown prices.
Auto Industry Disruption – The EU continues to push green goals, but the solution appears to be found increasingly outside the EU. China and, to a lesser extent, America and Japan are producing appealing electric vehicles and hybrids for the all-important auto industry. The beauty of the auto industry is that approximately €500 worth of underlying materials (i.e., steel, plastic, rubber, and paint) can be converted into a €40,000 automobile, which is typically replaced every five to six years, thereby bringing in massive amounts of foreign currency. Unfortunately, the German princes (Mercedes, BMW, and Volkswagen) appear to be going the way of English, French, and Swedish manufacturers.
Demographics – The once vibrant capitals of the EU are suffering from the low birthrate, which appears to be increasingly a global phenomenon.
A High Quality Problem – Normally, producers view a surplus of demand overproduction as a “high” quality problem, in the sense that there is a ready market for their products and they can typically sell them at little discount. However, conditions in the airframe industry are a bit different, with Boeing suffering through a series of problems, resulting in it losing market share to Airbus. Given the high demand for airframes and the lead time for ramping up new assembly lines, both companies are struggling to meet customer demands while keeping regulators happy. We expect it will be several years before some normality is restored. In the meantime, perhaps we should get used to packed flights.
Flawed Indicators – In earlier times, when the yield curve inverted, it was normal to expect a recession would shortly follow. Higher short-term rates than long-term rates indicated a reduction in the demand for money and, hence, a decline in rates paid. However, that did not happen over the last couple of years. We are now witnessing a flattening of the curve, such that the difference between the 10-year and the 2-year is essentially zero (see below).
So what gives? Well, our view is that the traditional economic measures have lost their validity, courtesy of the hyperactivity of the central banks. Perhaps the most salient indication is the negative interest rates experienced as of several years ago, again courtesy of the efforts of the central banks.
Perhaps the message for sophisticated investors is one of continued vigilance.
Intel’s Strategic Challenges – A time not too long ago, Intel was the dominant firm in the computer chip space. “Intel Inside” was the tagline for most personal computers as of a decade ago but has disappeared. Specialized firms such as ARM (providing the infrastructure for designing chips), TSMC (fabricating chips), and NVIDIA and AMD (designing, marketing, and supporting chips) have assumed leadership. Adding to the mix are the backward integration of Apple (via its own chip designs based on the more efficient ARM architecture) and Tesla (focusing on AI items), making the old ways look increasingly antiquated. The latest wave in the tech space has been AI, which has done little for Intel’s share price, as can be seen below.
China – Marching to a Different Drummer – Concerns for a centrally run economy (such as China) are very different from one which is more decentralized (such as many Western nations). As shown in the chart below, one could argue that producers are in a significant recession in China, with declining prices over the past several quarters. Our sense is that there is something more at play than a simple downturn. Over the past couple of years, there has been a concerted effort to seek alternative suppliers other than those based in China. Additionally, China is struggling through some of the overbuilding experiences and developer defaults, leading many to curtail purchases of second homes. Lastly, the war in Ukraine and the disruptions in the Middle East are changing historic supply chains in ways that are slowly adjusting.
Regardless of one’s market focus, the shifting patterns are likely to affect many.
TV Broadcasting: Someone Moved the Cheese – Historically, watching television videos was simple: turn on the television and watch one of the relatively few broadcast channels. Cable changed much of that with the introduction of many specialized channels, such as several ESPN channels, the Tennis Channel, etc. However, with the emergence of videos via the internet, YouTube, and other alternatives, entertainment habits have changed, and massively so. Our expectation is that YouTube and Netflix are rapidly becoming dominant forces, along with others such as Amazon Prime and TikTok. Added to the mix are the betting venues, such as FanDuel and DraftKings, which have the potential to extract more revenue per view than the typical platforms.
The Long-Discussed Interest Rate Cuts – The common maxim taught in most business schools is that long-term interest rates (e.g., those of 10-year Treasuries) should align with inflation rates. Over the past few years, central banks have been hesitant to lower rates following the rapid increases driven by the COVID-era loose monetary and fiscal policies. However, with inflation now cooling and employment markets showing signs of softening, the long-anticipated rate cuts have finally arrived. The focus now shifts to understanding the potential long-term effects of these cuts on the economy. The graph below provides some support. Stay tuned.
