end of the cycle or the beginning?

I was reading a report earlier this morning that asserted a Wall Street consensus is forming the the current “cycle” is ending–that we would see earnings rising and PEs contracting.

What’s strange about this is not the relatively banal description of earnings growth vs. PEs, but the fact that this behavior, which is characteristic of every cyclical upturn, is being called the end of the cycle.

Imagine a Disney-like theme park and resort complex, call it Xland, that’s a stand-alone business and that caters to middle-class families. In good times, workers get year-end bonuses that they use on an expensive week-long good time at the resort. Recession = no bonus = no family trip to Xland. This cyclical change may mean that Xland goes from gigantic profits to breakeven.

But the stock doesn’t go to zero, even though there are zero profits. Many reasons for this. Maybe Xland has a ton of cash on the balance sheet. It certainly has a brand name and the physical assets of the resort itself. The bottom line is, though, that in bad times earnings contract and, in this case, the PE expands to infinity.

As recession ends and good times return, the stock price usually powers ahead in anticipation of the return of earnings. Then earnings begin to come in, the stock gets a second upward push (assuming the earnings are good) …and the PE contracts from infinity to, say, 20x.

So earnings rising and PEs contracting is just the way the market normally works in the beginning of an upturn.

What reports like this should be saying, I think, is that maybe there’s something qualitatively different about investor behavior in a situation like 2020 where normal life is disrupted and where interest rates turn sharply negative in real terms and are effectively zero in nominal terms. Maybe people go a little bit crazy and do stuff they’ll regret when things return to normal. So some investments people happily made last year are going to look pretty dubious in calmer times–the SPAC universe would be a good place to look for this.

The problem with asserting something like this is that there aren’t many examples in the past, similar to 2020, to point to. I can only think of one–Japan in the very late 1980s.

Even this may be looking in the rear view mirror. Many of last year’s darlings, the stay at home stocks, have lost half their value. SPACs are crumbling. Cathie Wood is no longer the media darling of a few months ago; her flagship fund has lost about 40% of its value over the past three months. So there’s already been a substantial shift away from the 2020 mindset.

I think there are two big current issues we as investors have to deal with:

–the lesser of the two is whether enough of the air has already been taken out of last year’s darlings as a group. The safe answer would be “No” but for me, as someone willing to take an above-average level of risk, I think it’s safe enough to go hunting for bargains

–the more important is the course of interest rates, which are still negative in real terms and close to zero in nominal. Unless the world economy has another serious setback, rates aren’t going to go lower. In fact, they’ve already been rising for about nine months. The issue isn’t whether or not they’re going higher. They are. The questions are when, how high and how does that compare with what’s already factored into today’s stock prices.

more tomorrow

shortages: semiconductors

The semiconductor story is a bit more complicated.


Semiconductor development has always been all about making chips that are smaller, faster and use less energy (or generate less heat).

In the early days, a given company’s engineers designed chips that the firm made in its own fab (factory). By the mid-1990s, the two processes, design and manufacture, began to separate. Two reasons:

–the cost of a fab making state-of-the-art chips has been continually rising as manufacturing technology has become more complex. Today, for example, a cutting edge fab costs about $15 billion. Just as important, it will spew out at least $40 – $50 billion worth of chips a year. Few firms can afford to build one; fewer still have the sales volume to justify doing so alone.

–these factors, the desire of designers to work for themselves rather than in a bureaucratic behemoth, the development of third-party design tools (ARM is the prime example) and the startup of third-party fabs (foundries, TSMC by far the leader) have led to the development of specialized design and manufacturing firms.

–five years ago, Intel was the undisputed chip manufacturing leader, making its own designs, primarily for personal computers and for servers. Today, however, its manufacturing capabilities have fallen behind those of TSMC and its designs behind those of TSMC customer AMD.

–in somewhat similar fashion, there’s no American manufacturing leader in 5G, the latest generation of telecom equipment. The baton has passed to Huawei, which also makes better/cheaper conventional telecom equipment, as well. Huawei does. however, use American-designed chips.

why supply disruption?

The pandemic is the biggest culprit, in two ways. The virus caused the shutdown of chip manufacturing and distribution early last year. At the same time, demand for stay-at-home devices, from PCs to video game consoles to intelligent autos, began to boom.

The collapse of the makeshift Texas electricity grid caused another halt to the manufacture of chips there (a surprisingly large amount).

Also, facing the loss of the next generation telecom market to China, the only counter the Trump administration could come up with was to undermine Huawei by deny Chinese firms access to semiconductors made by US firms or made using US intellectual property, or made on machines that employ US intellectual property.

This action has implications. It reduces today’s effective capacity, since US-linked sources can’t supply China. It also makes the question of where to locate new capacity more problematic–except for TSMC, which has announced a massive expansion program, centered on Taiwan. It may also have kickstarted China’s languishing program to develop its own semiconductor industry. This presumably means eventual global overcapacity, but probably not during any time frame important to stock market investors.

shortages: gasoline and metals

the Colonial pipeline hack

I’ve been noticing recently that the Bloomberg radio presenters on the pre-opening show have become increasingly frantic, emotional and nonsensical in doing their jobs. This is despite the fact that both are experienced and knowledgeable. I presume the attempt to channel their inner Fox News isn’t an accident, but comes from a calculation by management that becoming less fact-based and rational will boost ratings. Weird for a Mike Bloomberg operation.

In any event, the most recent topic is the supposed threat of runaway inflation, on which their sensationalism makes no sense at all, in my view. What I found much more interesting, both on Bloomberg and CNBC yesterday, was interviews with a representative of the Gas Buddy app about the effect of the Colonial ransomware attack–which contradicted the Bloomberg narrative of a rip-roaring shortage rolling its way up the east coast to threaten the Mid-Atlantic states and New England.

The Gas Buddy story: there’s plenty of gasoline in local depot storage on the East Coast. Not at gas stations, though. In Georgia, for example, gasoline purchases for Sunday-Wednesday are 60% above normal. In the Carolinas, the figure is +40%. According to GB, people are not only filling up their vehicles but hoarding by loading up auxiliary tanks and gas cans as well. So many gas stations have run dry. Resupply demand has far outpaced the ability of gasoline trucks to ferry fuel from depot storage.

This is not inflation. If anything, it’s a small addition to the momentum building for a switch to electric vehicles. It’s also a cautionary tale about our reliance on public utilities that have inadequate cyber security protection, despite years of discussion about this vulnerability.


My first stock market job was as a natural resources analyst. I started out with oil and gas, then added gold and diamonds, and finally base metals–which is the supposed inflation culprit today.

The most important thing about mined resources (including oil and gas) is that only oil/gas and iron/steel are big enough to rate their own entries in the national accounts. At the current $10,000+ per metric ton (which is a huge increase over last year), the US will use about $17 billion worth of copper this year. That’s about 0.08% of total US spending this year, up from something like 0.05% in 2020. This is like a rounding error. It’s not runaway inflation.

What’s the most interesting for us as investors about copper, I think, is that, like other base metals, China is by far the largest consumer in the world. So the price rise is evidence of strong growth in industrial activity there. About two decades ago there was a years-long bull market in industrial metals driven by Chinese economic growth. The possibility that we’re in another period like that is probably worth looking at.

My point remains that we’re not in 1970s-style, nor any of the more extreme instances of out-of-control general price rises, as we’ve seen elsewhere in the Americas or in Weimar Germany.

One sore point, though: semiconductors

more tomorrow

inflation and current shortages: kayaks

Years ago, a friend of mine returned with her husband to Vietnam to visit her family and bring them financial help. As was the case in many emerging countries at that time, she was required to declare any items of value–dollars, jewelry, a laptop…–she had on arrival. There was a limit on the amount of cash that could be brought into the country. They would be checked on departure to ensure the non-money items weren’t left behind.

The relatives brought them right away to a moneychanger to convert the dollars into dong (Vietnamese citizens were not permitted to hold dollars). They then used the proceeds to buy a diesel generator and some gold jewelry and gold coins. The gold could be hidden easily, and, unlike a bank account, it was not subject to purchasing power losses from inflation that was running at 5%(?) a month. The family didn’t need the generator, but converting dong into just about any physical object preserved purchasing power better way better than currency.

That’s runaway inflation.


My family has had a cabin in rural Pennsylvania for many years. During the pandemic, I hauled an old kayak out of the basement and began paddling an hour or so a day when I was there. After a couple of months, I started thinking about upgrading to a sleeker model so I could go farther and faster. That’s when I found out about the kayak shortage that’s in its second year, and getting worse.

What’s behind this?

First, a distinction: the least expensive recreational and rental kayaks are made by molding plastic in big machines in large factories, many of those in China. Last year, the onset of the pandemic shut operations like this down (paddle-making firms, too), creating shortages around the world. Because factories have reopened, that shortage is long since over.

Touring kayaks are a different story. This is a cottage industry. Kayaks are made one by one, using relatively small machines to shape the tops and bottoms out of sheets of plastic that are then glued together. There’s still an acute shortage of these in the US.

I’m really talking about the second kind.

the issues

The makers of touring kayaks tend to be smaller, privately-held firms, not stock market-traded behemoths. In contrast to public companies whose goal is to achieve substantial year-on-year sales and profits growth, private companies tend to be more focused on stability–on having this year’s profits not be lower than last year’s and on keeping family, friends and long-time employees at work. A corollary of this is that private firms are loathe to spend the money and take the risk of expanding production capacity.

Growth in demand for sporting goods is, generally speaking, a function of population growth. In the case of the US, that’s one or two percent per year. (I haven’t been able to find kayak-specific statistics, but I haven’t looked that hard, either.) I think the shuttering of gyms, banning of indoor entertainment like movies and flight from cities have raised demand temporarily by at least 20%, or ten years worth of normal market expansion. If a kayak maker expands by an equivalent amount to take advantage of current high demand, it runs the risk of being saddled with excess capacity once people go back to work in offices and demand returns to normal.

More important, there’s a legitimate worry is that recent kayak buyers go back to work, realize they no longer have a lot of kayak time and begin to sell their close-to-mint-condition boats at a discount on E-bay or Craigslist. If so, this activity would depress next year’s kayak market, both in unit volume and in price. In other words, making more kayaks now, makers might actually make the kayak manufacturers poorer, not richer.

Better not to get too greedy. Enjoy the booming market while it lasts–kayaks flying off the shelves, no discounts, no end-of-season sales, no unsold merchandise returned, no risk of overextending the firm or suffering a sharp downturn in demand in 2022. Don’t raise prices, at least not by very much, only to have to reverse course next year and maybe get a publicity black eye in the process.

“Don’t make this Purell all over again” is probably what they’re thinking.

My general point is that for many products in current high demand, the profit maximizing, risk minimizing strategy is not to expand production because the companies with long experience of economic ups and downs know that the demand boost is temporary.

shortages: kayaks, copper, semiconductors

There’s an immense amount of confusion in the financial press about the possibility of runaway inflation.

There are two reasons behind this, I think. The last bout of this kind of inflation in the US happened in the second half of the 1970s. That’s almost a half-century ago, so there aren’t that many people still working who have experienced the phenomenon. Second, for most reporters today, like most politicians, a dramatic presentation is much more important than showing actual expertise or mastery of the facts.

Lots of stuff happened in the 1970s: two oil shocks; overall price controls; sharp increases in food prices. The overall rate of increase in Personal Consumption Expenditures index (PCE), the Fed’s preferred measure of inflation, during the second half of the 1970s was:

1976 +5.0%

1977 +5.9%

1978 +7.8%

1979 +9.5%

1H1980 +11.0%.

That was bad, but not the worst. That’s because a considerable number of workers at that time had contracts that adjusted their wages up for inflation. Many, though, didn’t.

The really bad thing happened when inflation began to seriously erode the purchasing power of savings in bank accounts or in fixed income instruments. Seeing their purchasing power erode, individuals–and even big publicly-held companies–started to put their cash as fast as they could into tangible assets, like gold, or jewelry, or real estate, or coins and stamps, or timberland, or comic books or just big stashes of stuff they might need one day (or hoped they could resell at a higher price).

That was the really bad thing, the change in expectations about inflation, and resulting loss of confidence in the currency. It took about a decade of very high interest rates (and resulting economic pain) to subdue these there’ll-be-ever-higher-inflation impulses.

The important question, I think, is whether we’re on the verge of a rerun of the late 1970s. Personally, I don’t think so. The experience of the past forty+ years have instilled the idea that high levels of inflation won’t happen. In fact, today’s inflation “problem,” if there is one is that for six of the past eight years inflation has remained below the government target of +2.0%.

Recent US figures, using the CPI (which overstates inflation a bit):

2013 +1.5%

2014 +1.6%

2015 +0.1%

2016 +1.3%

2017 +2.1%

2018 +2.4%

2019 +1.8%

2020 +1.2%

2021 through March +1.9%.

To sum up, the most important question for assessing inflationary tendencies is are we seeing the kind of panic buying and hoarding that characterized the late 1970s in the US?

more tomorrow