why the Fed is looking at/for wage gains

This is Jackson Hole week, when the world’s central bankers convene in Grand Teton National Park in Wyoming to compare notes.  From their meetings, we’ll get a better sense of what the architects of the current emergency-easy money policy are thinking and planning.

Conventional wisdom  is that in times of economic stress the central bank should lower interest rates to a point significantly below the rate of inflation–and keep them there until people and companies borrow the “free” money and invest in large enough amounts to launch an economic rebound.

One indicator that the Fed is watching carefully is the rate at which wages are rising.  In theory, employers only raise wages a lot when they’ve run out of available unemployed workers and can expand only by headhunting away people who are already employed elsewhere.  So wage increases at a faster clip than inflation mean it’s high time to tighten money policy;  sub-inflation wage gains–the kind we have now–mean there’s no rush.

Policymakers appear to be giving this rule of thumb a rethink, however.

For one thing, short-term interest rates have been at effectively zero for over half a decade.  You’d think unequivocal signs of economic strength should have been evident long before now.

There’s no sign I can see that central bankers have any sympathy for the plight of savers (read: the Baby Boom and the elderly), whose desire for safe and stable fixed income investments has been the chief casualty of the economic rescue effort.  However, they do seem to be concerned that the search for yield in a zero-interest-rate world has caused savers to buy exotic instruments (hundred-year bonds, contingent convertibles, for instance) that will likely suffer wicked losses as rates begin to eventually rise toward a normal 3.5% or so.  Is the cure worse than the disease, at this point?

Lately, the money authorities seem to be expressing a second worry.  Suppose the emergence of inflation-beating wage gains isn’t the reliable indicator it’s thought to be.  If so, the Fed may be distorting the fixed income market–and buying trouble down the road–for no good reason.

Why would sub-inflation wage gains be the norm, even in an expanding economy?

Maybe in past economic cycles, high wage gains were caused mostly by the tendency of union contracts to index wages for inflation, not by overworking headhunters.  Maybe the psychology of managements penciling in inflation-plus or simply inflation-matching annual wage increases for the workforce has gone by the boards in a world that has experienced two ugly recessions–the more recent one an epic decline–since the turn of the century.  …sort of in the way inflationary expectations have disappeared from the minds of current workers.  Again, if so, maybe interest-rate normalization should happen at a faster pace than currently planned.

We’ll likely hear more on this topic as this week’s meeting gets under way.

why I don’t like stock buybacks

buyback theory

James Tobin won the Nobel Prize for, among other things, commenting that company managements–who know the true value of their firms better than anyone else–should buy back shares when their stock is trading at less than intrinsic value.  They should also sell new shares when the stock is trading at higher than intrinsic value.  Both actions benefit shareholders and add to the firm’s worth.

True, but not, in my view, a motivator for most actual stock buybacks.

Managements sometimes say, or imply, that share buybacks are a tax-efficient way of “returning” cash to shareholders, since they would have to pay income tax on any dividends received.  I don’t think this has much to do with buybacks, either.  It also doesn’t make a lot of sense, since a majority of shares are held in tax-free or tax-deferred accounts like pension funds and IRAs/401ks.

the real reason

Why buybacks, then?

Years ago I met with the CEO of a small cellphone semiconductor manufacturer.  We had a surprisingly frank discussion of his business plan (the stock went up 20x  before I sold it,  which was an added plus).  He said that his engineers were the heart and soul of his company and that portfolio investors like me were just along for the ride.  He intended to compensate key employees in part by transferring ownership of the company through stock options from outsiders to engineers at the rate of 8% per year!!

Yes, the 8% is pretty extreme. In no time, there would be nothing left for the you and mes.

Still, whether the number is 4% or 1%, the managements of growth companies generally have something like this in mind.  They believe, probably correctly, that they won’t be able to attract/keep the best talent otherwise.

The practical stock option question has two sides:

–how to keep the portfolio investors from becoming outraged at the extent of the ownership transfer and

–how to keep the share count from blowing out as stock options are exercised.  A steadily rising number of shares outstanding will dilute eps growth; more important, it will alert portfolio investors to the fact of their shrinking ownership share.

The solution?   …stock buybacks, in precisely the amount needed to offset stock option exercise.

is there a better way?

What I don’t like is the deception that this involves.

However, would I really prefer to have companies allow share count bloat and have high dividend yields?  What would that do to PE multiples?   …nothing good, and probably something pretty bad.

So, odi et amo, as Ovid said (in a different context).



oil: the view at 30,000 feet

Oil is either a very complex subject or a very simple one.

There’s a wide variation among various types of oil, the kinds of input a given refinery can process, the politics/stability of the countries that provide the different grades of oil to the market, and the regulatory regimes in different countries where refined oil products are used.

Nevertheless, there are general patterns that can be of investment significance.

In particular, I think it’s at least possible that we’re entering a period of extended oil price weakness, due to slow economic growth in the US, and to a lesser extent in the EU, plus the sharp rise in unconventional oil production in the US.

Here’s why:


In the short run, oil supply is relatively invariant.  Major oilfields are very expensive long-term projects designed to bring large deposits of subterranean oil to the surface.  Once the oil starts flowing, it can’t be stopped without risking major damage to the oil reservoirs.  This could mean a lot of extra drilling to reach now-isolated pockets of crude.  So capping wells to reduce supply generally isn’t done.

Same with oil demand.  In the absence of large price moves,  people will continue to use transportation fuel in the same way.  Industrial processes won’t change.  So this major portion of demand is pretty much locked in.  And until a shockingly large heating bill comes in the mail, people won’t turn the thermostat down.

Because both supply and demand are relatively inflexible, small changes in either can result in large changes in price.  We saw this a few years ago when oil spiked above $150 a barrel as desperate users bid up the price of scanty supplies.  But the opposite could equally well occur:  panicked producers, running out of storage space to put barrels of crude customers don’t want, offering large discounts to get someone to take them off their hands.

On the supply side, OPEC is the largest factor, accounting for about a third of world output.

On the demand side, the US is the world’s largest, and most profligate, petroleum consumer.  We use 20% of the world’s oil while representing less than 4% of the globe’s population.  As I invariably try to work into the conversation, the US is also the only developed country not to have an energy policy that promotes conservation.   The intent has been to protect an inefficient domestic auto industry that ended up imploding in the last recession anyway.  One unintended effect has been to help preserve OPEC’s immense economic power.

shale oil

What’s new in the supply/demand story is coming out of the US.  It’s the rapid rise in production of shale oil, which has lifted total US crude output from 5 million barrels a day in 2008 to just shy of 9 million now–with at least another one million b/d gain likely over the next year.

Arguably (read: this is what I think, but have no definitive evidence for), the main reason oil prices haven’t been spiking up despite turmoil in the Middle East is the steady new flow of US crude from places like North Dakota.

The International Energy Agency has just pared a bit from its estimate of oil demand over the coming year, based on slowdown in the EU.  Large-scale purchases of new, more fuel-efficient cars in the US may begin to put a lid on domestic gasoline consumption, which is the biggest part of US oil usage.  China, the #2 world oil user, with about half the consumption of the US, is also growing a bit more slowly than anticipated.

Will all this be enough to tip the world oil supply/demand balance in favor of oversupply (and significantly lower prices)?  Who knows?   …but maybe.


…a shot in the arm for stocks generally (other than the oils).  Lower gasoline prices would mean higher discretionary income for ordinary Americans, which would be a plus for mass-market consumer stocks.

Bet on this?   …no.  Just something to think about, to consider what we’d buy if signs of a weakening oil price began to emerge.


when the gold mine opens…

…the company’s stock falls apart.

a Wall Street parable:

A group of geologists forms a gold mining company and raises money from investment managers at $8 a share.  It goes public a few months later at $10 a share, having bought a bunch of mineral rights with the initial seed money.

Shortly thereafter, the company announces it has identified a potentially attractive ore body on one of its leases and has begun drilling to confirm the presence of gold ore and the extent of the find.  The stock rises to $15.

The company announces that has found gold.  Rumors begin to circulate that the ore body is much bigger than expected.  The company is sending ore samples to a laboratory for analysis.  The stock goes up to $20.

It turns out the ore samples are richer in gold content than initially thought.  Rumors circulate that the ore contains significant byproduct amounts of silver and other metals–which would imply that mining costs will be unusually low.  The stock reaches $30.

The company begins to build a processing plant and says production will commence in six months.  The stock rises to $40.


During this entire period, very little hard and fast information is available.  Analysts fill the void with bullish speculation about the extent of the find, the high purity of the ore grade and the possibility of very high byproduct credits.  Their spreadsheets show “best case” profits rising to the moon as each analyst tries to out-bullish his rivals.

Then the mine opens.

There are initial teething problems with the mine, so production is low.  The ore grade is high, but less rich than analysts’ speculations would have had it.  Byproduct credits are not as great as analysts had typed into their spreadsheets.

The stock falls to $20, as actual data puncture the speculative balloon Wall Street had inflated.  Where the stock goes from there depends entirely on how the numbers pan out.


This is an extreme example of investors letting their imaginations run away with themselves in advance of, and in the absence of, real operating data.

It happens more often than Wall Street would like to admit.   Euro Disney is a perfect example of this phenomenon in action in the non-mining arena.  The stock peaked just as the park opened and the turnstiles started recording actual visitors.  (Note:  if you check out a Euro Disney chart, remember that the stock had a 1-for-100 reverse split in 2007, which the online charts I’ve checked don’t adjust for.  So that 3.4 euro price is really 3.4 euro cents!)

To some degree, every growth stock eventually gets overhyped and reaches an unsustainably high price-earnings multiple.  Normally, the inevitable multiple contraction begins as investors sense the company’s growth rate is slowing.  But sometimes–as in the case of AAPL–it happens earlier.  In the fictional case above, the overvaluation happens right out of the box.  This is also what the 1999 Internet stock boom was all about.

In today’s world, I think Amazon (AMZN) could be another potential case in point.    …attractive concept, lots of whispers, little hard data, a multiple that–even adjusting the company’s (conservative) accounting to make the financials look more comparable to other publicly traded companies–looks very high to me.

Among the “big data’ recent listings, more 21st-century gold mines may also be lurking.

Caveat emptor, as they say.



the Market Basket supermarket feud

I decided to write about my sense of the stock market tomorrow.

Instead, I’m going to write about the struggle for control of the family owned, privately held New England supermarket chain, Market Basket.  That’s both because it says something about the value of supermarkets in the Northeast, and because the fight is typical of what happens in family owned firms in the second or third generation.

The story:  Two branches of the Demoulas family own Market Basket.  One, led by Arthur S. has no involvement in running the business; the other, led by Arthur T., does–or did until a short time ago.

As a result, according to Bloomberg radio, of some past impropriety on the part of the ATs, the ASs have voting control of Market Basket.  Last week the board voted to oust Arthur T. as CEO and replace him with two outsiders who presumably have a mandate to cut costs and prepare the 71-store chain for sale.

Hearing this, warehouse and delivery workers walked off the job, demanding Arthur T’s reinstatement.  Many other workers have staged protests.  Store shelves haven’t been restocked.  The chain is reported by the Boston Globe to be losing $10 million a day.

this is typical family owned company stuff

Many family owned businesses are started by one or two entrepreneurial relatives.  Firms like this tend to have:

–high financial leverage

–lots of family on the payroll

–content to have economic rewards come through salaries/perks for family members rather than paying out dividends

–concerned more about stability than growth.

By the second or third generation, ownership is diffused.  Grandchildren probably don’t want to be in the family business.  Recognizing the value of the stock they hold, they want to cash out.  They come into conflict with other family members, whose lives, heritage and hefty salaries are tied to the business.

New England supermarkets are valuable 

The Globe says Market Basket could be worth $3.5 billion.  There are apparently about a dozen shareholders.  That would imply something like a $100 million payday for even the smallest holders if the firm were sold.  Until recently, the firm had been distributing dividends of about $100 million a year, for about a 3% yield.

I haven’t tried to confirm any of these figures myself.

One important thing about New England, though, is that it’s a mature, heavily developed region.  This has two positive implications for Market Basket:

1.  It’s impossible for Wal-Mart, the ultimate supermarket killer, to get a strong foothold.  It simply can’t assemble parcels to build on or get local planning commission authorization to start construction.

2.  For the same reason, Market Basket’s 71 store locations have immense potential value to a competitor.

A side note:  in my town, the supermarkets are small, dingy and very dated.  Twenty years ago, a major chain purchased a large parcel of land which it thought was zoned for a supermarket, and on which it intended to build a superstore.  The project is still tied up in litigation spurred by “concerned citizens,” funded, I’m told, by the existing markets.

bones of contention with Market Basket

Store employees are reportedly much better paid than typical supermarket workers.  Starting pay is $4 an hour higher than the minimum wage.  Experienced cashiers can earn double the industry average of around $20,000 a year.  Market Basket puts 15% of wages into an employee 401k.  Arthur T. also apparently projects a sincere concern for employees’ welfare.

Employees assume, doubtlessly correctly, that Arthur T.’s ouster spells the end of above-average salary and benefits.  This for two reasons:

–Arthur S’s family understands that a dollar of wages to an employee is money that would otherwise be dividended to shareholders, meaning it’s money that comes directly out of their pockets.  If we assume that the average employee earns $4 an hour more than the industry median and that the 25,000 workers average 20 hours a week, then the  total “excess salary” paid by Market Basket yearly is $107 million.  My suspicion is that this is too low.  Still, a ballpark figure is that dividends to shareholders could double if wages and benefits are chopped back.

–Presumably, a trade buyer would pay less for a company if it had to take the reputational black eye of reducing staff and cutting compensation.  Market Basket could sell to a financial buyer, a private equity firm that would do the pruning.  In my view the equity owners have decided to maximize their personal payout by doing this unsavory task themselves.

To my mind, this is all par for the course for family owned businesses.  What is truly remarkable in this case, though, is how much publicity the ouster of Arthur T. has gotten.  The way employee sentiment has been galvanized is also noteworthy, although workers have a very clear–and large–economic interest in defending the status quo.

Company warehouse workers and truck drivers are playing a key role in the dispute, since their job action is the reason stores can’t restock.  Some press reports have even suggested that Arthur T., who is apparently one of a number of potential buyers of Market Basket, somehow helped them along in making their decision to walk off the job.  I have no idea whether this is correct, or whether it’s part of a movement to deny AT sainthood.