Last spring, retailers Target and Walmart both announced that they were having inventory problems. There were two aspects to the issue: too much stuff, and the wrong kind of stuff to appeal to consumers who had suddenly decided the pandemic was over.

The companies faced two problems with the inventory they had: how to get the unwanted merchandise off the selling floor (and where to put it, once it was gone), and how to get back the money they had tied up in the inventory, either by resale or return. (A side note: my guess, which I haven’t tried to verify, is that during the time of supply constraints, merchants pretty much gave up the right to return unsold merchandise. So turning the gods back into cash mostly meant selling it at a discount). The big trick in doing this is to get the right balance between getting the most money while minimizing the risk that the merchandise goes out of style or is surpassed by newer, better versions.

My sense is that this inventory adjustment is mostly done.

What’s replacing it as a stock market worry is the situation of the producers of stuff that sold like hotcakes during the pandemic. For such manufacturers, demand is returning to normal. This is somehow taking both Wall Street analysts and at least some of the companies themselves by surprise. For example:

Hasbro (HAS), for example, reported overnight. EPS were lower, on sales of traditional toys slowing down. It also appears that the executive in charge of this part of the business has been asked to leave. If so, this suggests top management may have realized the implications of WMT/TGT but other managers decided not to slow production down. HAS was down by about 6% in the aftermarket but has trimmed the decline to -5% as I’m writing this.

Intel (INTC) reported, as well. In a jargon-filled presentation, the CEO basically said the same thing. Sales of the company’s chips for PCs and servers have both been weaker than expected, and are likely to remain so through mid-2023. In this case, the decision to slow down production on the signals customers were sending out may be more complex. Given it takes about three months to fabricate the most advanced semiconductors, keeping production going, not pulling back may have been the profit maximizing (meaning loss minimizing) solution. Also, given the substantial ground INTC has lost to competitors over the last half-decade, management may have thought having inventory on hand may have been more crucial than it might have been if INTC had more market power. Still, INTC was down by about 9% overnight, and is -7% as I’m writing.

What I find most interesting is that announcements like these still have the power to shock. But this is mostly due, I think, to my not having completely adjusted to the fact that stock market trading is controlled by fast-reacting but relatively mindless trading bots.

For anyone knowledgeable, and bullish, about the stocks involved, it seems to me the right tactical decision would be to buy on this weakness. Ignorant, I’m happy to stay on the sidelines, though, rather than dabble in either.

The Wall Street Journal reported yesterday that Twitter held discussions last month with outside investors about a possible new $3 billion equity raising, apparently at the same $54.20/share price he paid for the company earlier last year.

It’s not clear whether this is new news or elaboration of stories about an equity raising that were circulating a few weeks ago. Several things about the article, which Elon Musk has tweeted is not 100% accurate, are interesting, though:

–no successful offering has been announced, suggesting that even Twitter/Musk fans find the $54.20 price too steep. Is a lower offering price possible? Hard to know, since it’s possible Musk has either formal or informal agreements with backers to protect them against dilution of their holding, that is, that is, that he won’t sell new shares below the $54.20 price

–the WSJ says Fidelity has written down the value of the Twitter shares it bought as part of the Musk takeover from $54.20 each to a bit less than $25. This would make it doubly hard for any fiduciary (someone who isn’t friends/family of Musk) to pay more

–the proceeds of an offering would presumably go to redeem a $3 billion variable interest rate bridge loan. This loan has an escalating interest rate that appears to me to be 14.5% now and will rise to something like 16% by the end of its first year. If I’ve read the offering document correctly (no guarantee I have), this loan turns into a seven-year, non-prepayable term loan if it is not repaid during year one. That would be over $3 billion in total interest payments locked in

I wonder, too, what effect Musk’s Twitter problems may have on the brand image of Tesla. There’s the possibility that the Twitter turnaround won’t go well, tarnishing his image as a quirky but ultimately savvy businessman. More important, I think, is a newspaper article that popped up in my email yesterday, expressing outrage at the list of anti-semitic hate writers who have been allowed back on Twitter. Not a good look for someone wanting to sell cars to the general public.

I came across an interview of an academic expert on China in the NY Times. It follows more or less the same line as my recent comments. It is, however, much more forceful about the idea that Xi called off the punishment of non-Party-member tech entrepreneurs late last year.

MSFT, ASML and TXN all reported overnight (I own both of the first two). MSFT was up by about 4% …until the conference call began, in which the company said in effect that the post-pandemic business slowdown is nowhere near over. The stock is down by 4% in early trading. ASML had a strong quarter and said business will be up by 25% or so this year. Its stock is down slightly. TXN said things are unusually weak. Its stock is down by about 2% as I’m writing this.

I find it hard to find a consistent narrative in all this.

I was flipping through sports show talking about the football playoffs while I was having lunch yesterday. I was struck by how, the moderator aside, the panels were made up almost entirely of highly knowledgeable and articulate former professional players and coaches. At times, the conversation turned to the esoterica of player-by-player analysis of the offensive intention behind the construction of a play and how defenders understood (or not) and reacted to the design.

Then I turned to CNBC, which is chock full of “personalities” who have never had meaningful roles in professional money management of any sort but pretend to have industry expertise. The difference between the two genres is stunning.

19th century

Hong Kong has a much longer history than this, but I don’t think it’s important for understanding what’s going on today.

Anyway, in the early 19th century, Hong Kong was a port island used by British trading companies (known as hongs, and which are now pretty much controlled by Chinese interests) selling opium from India to the mainland. This more or less paid for the large amounts of tea the hongs were exporting to Britain. When China banned opium trade in 1839, the resulting outflow of gold from Britain was large enough to create a balance of payments crisis. So Britain invaded China (twice), burned down part of Beijing, restored the opium trade, and eventually extracted from China a 99-year lease on Hong Kong island and surrounding territory.

the 20th

After WWII, Hong Kong became an important haven for refugees from the civil war for control of China between Mao and Chiang Kai-shek.

Soon after Deng came to power, he announced the lease, which was slated to end in 1997 would not be renewed and the British-held territories would revert to the mainland in 1997. The two sides negotiated a 50-year transition period, during which Hong Kong would be a Special Autonomous Zone (SAR), nominally a part of China but with its own government.

The businesspeople I knew at the time, as loyal supporters of the UK, were initially very fearful about what their fate would be once the turnover took place and were eager to obtain UK citizenship. The British Parliament, however, decided that the climate differences were too great for HK Chinese to be comfortable in the UK and would only issue official ID cards, not passports. (The UK is offering a road to citizenship now, though. Global warming can’t be the only reason.)

the opportunity of a lifetime

Hong Kong businesspeople soon realized that Deng’s “Socialism with Chinese Characteristics” was actually an almost unbelievable opportunity to act as middlemen between the mainland and the rest of the world. Almost overnight, they ditched their old-school British suits in favor of Chinese garb, reconnected with friends and family on the mainland and began to learn Mandarin.

Until relatively recently, this has remained true.

the Hong Kong stock market

There are three important stock markets for China: Hong Kong, Shanghai and Shenzhen (for tech stocks). All three are linked through “Stock Connect” in a way that allows any to be traded through the others. What makes Hong Kong stand out to me among the three is that the exchange itself had a major overhaul in the 1980s to make it more open, honest and transparent (by the same official who cleaned up Singapore after the Pan Electric scandal). Also, Hong Kong has had a large community of securities analysts and portfolio managers who have a deep understanding of the Chinese economy and the character of the publicly-traded companies operating there. So it has been the ideal place for China companies to offer large amounts of stock to an international audience.

bringing Taiwan back into the fold

The conventional wisdom until recently has been that, because Taiwan is the far greater prize of Beijing, China would demonstrate through its kid-gloves handling of Hong Kong that reintegration with the mainland wouldn’t be so bad–more of a formality than anything else

Why the crackdown?

I have no idea. From a pragmatic point of view, Xi reneging on the 50-year SAR deal with Hong Kong makes no sense. It validates any fears Taiwan might have about how it would be treated as part of China, and by destroying the human infrastructure of financial firms in Hong Kong, it erases China’s ability to raise public capital from the outside world–like maybe a distressed debt investors who would take property loans off the books of Chinese financials.

When Xi Jinping took on the mantle of Chinese leadership, China was in its fourth decade of extraordinary economic growth. In addition, Hong Kong, a center of entrepreneurial vitality, had reverted to Chinese ownership 15 years earlier, with a third of the 50-year transition period of Hong Kong’s self-rule as a Special Autonomous Region already gone.

There were still significant threats to the primacy of the Communist Party under Xi, although they were far different from the ones Deng faced. The top three:

–many Party officials had used their positions of authority to enrich themselves and their relatives (the princelings), becoming billionaires during the Deng years much in the fashion of the Russian oligarchs. This undermined the legitimacy of the Party in the minds of ordinary citizens

–the state created an immense real estate bubble through a combination of: GDP growth itself, savers’ distrust of commercial banks and their desire to hold physical assets, exchange controls that limited movement of wealth outside China, and the fact that their higher Party rank enabled local officials to coerce banks into making questionable loans for dubious construction projects that burnished the officials’ GDP growth credentials

–a set of entrepreneurs who were Party members more in name than anything else (e.g., Jack Ma?) became successful/powerful enough to begin to question the authority of Party bureaucrats.

Xi had success purging corrupt Party officials.

He also, belatedly, i.e., in 2020, began to rein in construction loans by requiring banks not to cross “three red lines” in property-secured lending: maximum loan amounts relative to assets, equity and cash. He now appears to be making those lines less restrictive as the property market begins to wobble.

In 2020, Jack Ma, the billionaire founder of Alibaba, arranged for a US stock offering of Alibaba subsidiary Ant Financial, a consumer lending company intended to compete with state-run commercial banks in this arena, without getting Beijing’s permission first. Then Ma publicly criticized the inefficiency of the banks and, apparently, said he would use Ant to radically reform the consumer finance market in China. Put another way, he vowed to destroy the most stable source of earnings for the already-shaky state-owned banks. Ma was not heard from again for the next six months, and has recently given up his ownership of Ant Financial. He also triggered a crackdown on Chinese tech entrepreneurs that is only starting to end now.

tomorrow, Hong Kong