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[csen]

Disappointed

Until Atlanta United kicked its first ball, I was pretty indifferent to club soccer. I didn’t grow up with it and never had a reason to care.

Atlanta United changed that. From the way they sold the club as a connective tissue for the demographics of Atlanta that were relevant to me — transplants, urbanites, and Millennials in particular — to the style and quality of the product on the field, to the ambition and communications from the front office, it was exhilarating to get swept away in those first few years.

That’s changed in a major way. The results on the field speak for themselves. Over the years players who were fan favorites left one way or another and were replaced by players who in many cases are skilled and hardworking but largely “beige” as personalities, particularly off the field. The front office has seemingly been hollowed out and over time has become more insular and less willing to communicate with the public, at first using the pandemic as an excuse but increasingly it’s become the way they choose to operate.

I’m not mad the way a sports fan is traditionally mad when their team is bad or the coach or GM has done a bad job. I’m disappointed that this cultural asset that came out of nowhere and became an important part of my life has withered, and been allowed to wither.

For a league that has struggled to grow its fan base and in a city that tends to be pretty fickle when its teams aren’t winning, Atlanta United retains an unusual level of support. Attendance figures are overstated because of no-shows but even this year they really do continue to draw 30,000+ people to games. In their occasional flashes of quality play there’s a palpable buzz at Mercedes-Benz Stadium — the club might be stuck in a rut but the fan support comes rushing back whenever there’s a glimmer of hope. You still see Atlanta United gear around town — the brand remains relevant as a vibe if nothing else.

What I want from ownership and the front office is knowing who’s in charge and accountable for what we see, honest communications about why the standard at the club has fallen so far, what they intend to do to fix it, or if that’s the intent at all.

[csen]

Why Housing is About to Eat the US Economy

One of the most influential business op-eds of the decade was Marc Andreessen’s August 20th, 2011 piece in the Wall Street Journal entitled, “Why Software is Eating the World.” It was written during a period where business/economic people were still focused on the financial crisis, while European government debt was imploding, and while the US Congress was contemplating defaulting on the national debt. Not many people were focused on tech.

Fast forward 5 years, and “software is eating the world” and “disruption” have become business/tech gospel akin to expressions from the late ‘90s like “new paradigm.” Over that time period the stocks of Apple and Microsoft are up over 100%, Google and Netflix 200%, Amazon 300%, Tesla 800%, and Facebook IPO’ed to become a $300 billion company. Uber has a private market valuation of over $60 billion. The combined market caps of those 7 companies is over $2.3 trillion. Collectively they still have much growth ahead of them, but from a business power standpoint these companies have become like Wal-Mart and GE in the 1990′s, and they’re best thought of as incumbent titans rather than small upstarts with a large greenfield in front of them. Regulators have begun kicking the tires on the business practices of most of these companies. Even “Twitter eggs” are talking with confidence about self-driving cars and drones and virtual reality. Marc should declare victory.

The bigger business story over the next 5 years is going to be a capacity-constrained US economy where the housing sector is taking “inputs” like labor and capital from all other sectors. Ergo, housing is set to eat the US economy.

One way to show how much more growth housing, and construction more generally, has in front of us is to look at construction’s share of total employment. It’s currently 4.6%, and in every cycle ever it’s gotten to at least 5%. Given 1) the size and hence housing needs of the Millennial generation in years to come, 2) the lack of construction, of single family especially, since the financial crisis, 3) the potential for infrastructure spending from the next president, whether it’s the Hillary/Dem version or the Trump “build a wall” version, 5% seems like a reasonable conservative target for how high this will go over the next 3-5 years.

At a current total employment level of 143.9 million people (establishment survey), this means we need an additional 550,000-600,000 construction workers.

This is a problem because we’re already near record lows for construction unemployment:

How are we going to find them? 87-88% of construction workers are men, a ratio that hasn’t changed in 25 years. So we’re largely talking about men that we need.

I’ll also make the assumption that the missing male construction workers are going to be under the age of 55. Maybe it’s a bad assumption, feel free to correct me. But anyway, here’s a chart of unemployed men under the age of 55:

There are currently 3.3 million unemployed men under the age of 55. The low in the last cycle was 3.2 million in Q3 2006. In the late ‘90s it was around 2.6 million, so that provides more hope. However, the late ‘90s labor force was generally younger and less educated than today, making the pool of potential construction workers arguably larger than it is today.

The educational composition of the labor force has changed in a dramatic way over the past 20-25 years. Since 1992, the number of college grads in the labor force has gone up by 25.8 million while the number of workers with a high school degree or less has fallen by 5.5 million.

Putting it all together:

-The economic shortfall in the US right now is mostly on the housing side. Because of how important housing is to the US economy, this is why 4.7% headline unemployment doesn’t feel like full employment.

-Construction employment as a share of total employment is likely going to rise at least another 0.4% to get to a level of 5% in this cycle.

-At the current level of employment, this means we need another 550,000-600,000 construction workers.

-Construction unemployment is already near record lows.

-Demographic trends in the US -- an aging workforce, a workforce that’s growing more educated, the changing mix of immigration towards Asian knowledge workers rather than Hispanic blue collar workers (29% of construction workers are Hispanic) -- all act as headwinds towards finding more construction workers.

-From a labor slack standpoint, the pool of potential construction workers is probably well-represented by unemployed men under the age of 55. To get back to late ‘90s levels of male unemployment (from a level standpoint, not an unemployment % standpoint), we would need essentially every single male unemployed worker who finds a job in the coming years to go into construction. This doesn’t take into account skill, desire, education level, geography, etc.

If we had to find 500,000 construction workers tomorrow, from a math standpoint it would be impossible. The slack isn’t there. But this isn’t the way things work in the real world. Time and market forces allow for adjustments. So here’s what that means:

-Over time, as construction employers become more aggressive they will bid away workers from similar fields -- agriculture, oil & mining extraction, manufacturing. New entrants to goods-producing fields will be drawn overwhelming to construction, so as workers quit or retire from agriculture/oil/manufacturing-related industries it will create increasing scarcities in those industries.

-Goods-producing/blue collar workers will increasingly bleed from the Midwest/Northeast to the faster-growing southeast and west coast, where increasing numbers of construction jobs will be. This will put more and more of a strain on Midwest/Northeast goods-producing firms.

-With construction-friendly immigration flows not being what they were, the globalization solution will be to move ever more numbers of agricultural/manufacturing activity overseas to free up their domestic workers for construction. Neither California farm owners nor Midwest voters and governments will be happy about this.

-Construction wages/costs going up will mean higher housing/real estate costs for households and firms, leaving less of a spending pie available for the rest of the economy. If you’re spending an extra 3% of your pay on housing that’s taking business from a grocery store or a movie theater or Amazon.

-Capital will flow increasingly towards the housing sector, starving other sectors of capital. If construction can’t achieve productivity gains then labor shortages in other sectors (agriculture, manufacturing, entry level services/fast food) will mean more and more incentives to automate labor-intensive tasks to free up those workers to work in construction.

“Software eating the world” implied that digital upstarts were going to create low cost solutions to take demand away from older, high cost analog firms. Amazon eating big box stores, Facebook eating print and TV. Demand was going to shift. “Housing eating the US economy” implies that housing is going to steal your inputs. They’re coming for your workers and capital on the supply side. It’s a different dynamic but a similar outcome -- housing is poised to reassert itself as the main driver of the US economy.

[csen]

Economic and Political Challenges of Stranded Suburban Commercial Real Estate Assets

This transition is going to be hard, much harder than the last big one.

As retail stocks get pummeled again today it feels like we’re one step closer to the majority of the country’s malls being functionally obsolete, with many of them on the way to becoming “stranded assets.”

We’ve been through this transition before.

The last time this happened, when we transitioned from walkable downtowns and Main Streets to booming suburbia, before sprawl was a dirty word, the politics were relatively easy. There was a lot more growth in the growing places than there was decay in the declining places. The Atlanta metro area is roughly 6 million people while the city of Atlanta’s population is around 450,000. If the city of Atlanta stagnated it didn’t matter politically, because the people in the much larger suburbs were pretty happy and had more votes. And the percentage of the nation’s infrastructure stock that was obsolete was becoming a smaller and smaller percentage of the nation’s total infrastructure stock.

Today there are fewer and fewer communities that are well-functioning and thriving, perhaps 15-25% of the country. With the way things are trending, wealthy suburbs and walkable town centers will be fine, and on the whole communities in the southeast and Pacific northwest have demographic tailwinds at their back. But more and more communities are going to be left behind, whether they be lower-income suburbia or regions with poor demographic trends like states in the northeast and midwest.

There’s also the challenge of how cities will fund themselves. Residential property taxes don’t get it done. Most communities rely heavily on sales taxes and commercial real estate property and income taxes for their budgets. What happens if more and more retail sales are powered by Amazon? How will that budget shortfall be made up if 60-80% of malls go dark?

The political choice society made last time was to ignore the plight of small towns and downtowns. Not enough votes to matter. Tough luck for Detroit and Memphis.

But there are too many votes in suburban Ohio and Pennsylvania to ignore. The social and economic future of the US might be e-commerce and Sun Belt/West Coast suburbia. But the political system will have to answer to the 70% of communities for whom market forces will be insufficient to solve their problems.

[csen]

The Post-Recession World Doesn’t Scale

The bumps we’ve seen over the past 12-18 months stem from a reality that the post-recession world we’ve built doesn’t scale beyond its current size. Consider the following:

-Chipotle wanted to be this era’s McDonald’s. Turns out scaling organic, freshly-prepared food isn’t as cheap or easy as they thought.

-Fintech lenders promised to disrupt big banks. Turns out the lending business requires a lot of capital, and that in jittery markets that capital doesn’t like funding a growing lending business. Maybe the big bank model isn’t so bad.

-The San Francisco Bay Area is the economic center of the early 21st century. But it’s finding that scaling housing and infrastructure for workers is a lot harder than scaling servers and storage. So jobs and people have to move to cheaper metros.

-On demand startups were the solution to mass unemployment and megacity renters who demand services immediately. But they’re finding that as the labor market tightens those workers are getting harder to find, and maybe the unit economics never worked to begin with.

-Tesla wants to disrupt the auto industry. But it’s never produced more than 50,000 cars in a year, and suddenly has to meet demand for as many as 500,000 cars a year. That won’t be cheap or easy, and it’s unclear how much shareholders and lenders will be willing to finance that growth. It’s not as cheap to scale atoms as it is to scale bits.

-Uber and Facebook are the 800-pound gorillas in their respective industries. But as they grow, they’re running into problems of scale. For Uber, it’s finding drivers and fighting regulation. For Facebook, it’s eating too much of the revenue pie for content, and maybe as it grows it’s going to come under greater and greater scrutiny given its media clout. Both will argue they’re not utilities, but the vision and scale they aspire to would make them exactly that.

-Conservatism is finding that the demographic groups that believe in conservatism no longer scale to form a viable national party. Trump will soon find the same to be true for his white working class coalition. The Republican Party needs a new ideology or constituency that can scale to compete with Democrats.

It’s time to let Steve Jobs and Ronald Reagan rest in peace, and find new leaders who can build the world of the 2020′s.

[csen]

Why Facebook Will Start Sharing Revenue With Its Content Partners

Facebook wants you to think it’s going to be a leader in drones and VR, distracting you from the reality that its business model is just a newfangled Comcast, or a sibling of Netflix -- a content distribution platform fighting for the attention and dollars of consumers and/or advertisers.

There have been a lot of stories lately that, when combined, paint a picture of what Facebook actually is, which isn’t what the company wants you to think it is. This is what Facebook wants you to think it is.

Social! Sharing! Messaging! Pictures! Virtual reality! Wow!

This is what Facebook actually is -- a massive content referral platform, the best in the world:

Content referral is becoming a more and more important part of their business as organic sharing of personal content declines.

Original sharing of personal stories -- rather than posts about public information like news articles -- dropped 21 percent year over year as of mid-2015, The Information, a tech news site, reported Wednesday.

As personal sharing declines and article sharing increases, and Facebook continues to grow, it stands to reason that Facebook will come to rely upon the biggest content platforms in the world to keep its users engaged. So who are they? The usual suspects.

Hey, Buzzfeed! Second-most pageviews in the world! How are they doing? Oh, not so great?

Buzzfeed missed its $250 million revenue target last year, according to the Financial Times, and generated only $170 million.

Because of this, Buzzfeed has also halved its revenue prediction for next year from $500 million to $250 million.

Hmm.

There’s another digital media company that got its start by acquiring cheap content created by others, and then, as it got bigger, the supply of that content available to it started to shrink and it was forced into a company-altering pivot.

That company is Netflix.

Netflix’s pivot involved shifting from content created by others to content that it created and controlled. It hasn’t been cheap.

Another direction it could go in is to look at what its dinosaur peers did -- the cable companies. Comcast et al are content distribution platforms. Consumers pay Comcast a monthly fee to access content that Comcast either owns (its cable channels) or buys from others (ESPN, etc), for which it pays networks an affiliate fee. Also not cheap.

The bottom line is that the current trajectory of Facebook seems to be unsustainable. Personal sharing is down, Facebook is relying upon the content of Buzzfeed et al more and more, and yet, as those companies struggle to achieve the revenue growth they were hoping for (and their VC’s/investors need for the business models to work), those companies will be forced to cut back their production of content.

At least one of three outcomes is probably inevitable:

-Facebook starts buying content companies (Buzzfeed, Vox, Business Insider, etc).

-Facebook starts investing in its own organic content.

-Facebook, which is better at advertising than its content partners, from whom it’s arguably stealing ad spend, starts sharing revenue with those content partners to support them and invest in their growth.

In any case, the mid 2010′s could end up representing a peak in Facebook’s profit margins, at least for awhile, as it starts to invest in the content on which it depends.

[csen]

Why A Struggling Community Might be Pro-Local Control/NIMBY

In the wonkosphere there’s a nearly unanimous view that “NIMBY” (not in my backyard) residents, typically homeowners, are greedy, self-interested people merely interested in their own property values and keeping out poor (often non-white) residents. This view is too often unchallenged, and I wanted to throw out one example to provide a different perspective.

The metro Atlanta area has a variety of communities and neighborhoods, some of which are thriving, others of which are not. Some are improving, some are getting worse. This is no different than most metro areas.

One of the things Atlanta has going for it is the infrastructure catalyst known as the Beltline, a repurposing of dormant railroad tracks that promises to connect the city in a 20+ mile loop of trails, parks, and transit. The Beltline corridor has some neighborhoods that are already thriving, and others, particularly on the south and westside of Atlanta, that are struggling and need a lot of public and private sector investment to become the sorts of places that attract residents and development.

So the question is who’s going to invest in these neighborhoods to get the ball rolling? What incentives do they have, what motivates them, what levers do they have to pull?

One easy incentive/motivation is financial -- the potential for real estate appreciation. The issue, however, is that the housing stock in these communities needs a lot of work. Some of the neighborhoods have houses with “good bones” but have fallen into such a state of disrepair that they need $50-200k+ of work to become livable.

So let’s say we buy one of these houses for $25-50k and put $100k into it. We now have a livable house on a broken/abandoned street. What’s our next course of action? We’re probably going to show up to neighborhood meetings and ask to meet with local elected officials to see what can be done to make the neighborhood better.

NIMBY might mean crime -- get crime out of my neighborhood. Get those broken sidewalks and streets and streetlights out of my neighborhood. Get blight and unmaintained properties out of my neighborhood. Maybe it means replacing elected officials.

After some work, maybe a community has fixed its streetlights, fixed roads and sidewalks, elected new officials, and there’s now a trickle of new residents coming in for the first time in ages. At this point the private sector takes notice and a check cashing store wants to come in. Are hardworking young families that have invested in the community supportive of this? No -- so they show up to a meeting to block the check cashing place from coming in. “NIMBY!” they cry. But the community feels that it’s worked too hard to let seedy commercial elements come in.

Other developers apply for permits. A corner grocery comes in, though only after promising to provide fresh food and vegetables in addition to chips and candy. A dollar store comes in. Okay, fine. Another dollar store comes in. Then a third applies for a permit. The community petitions this one -- “we have enough dollar stores” they say. The same happens with fast food applicants -- the first two are approved but the third is denied. All the while, the community starts to ask when it can get a proper grocery store, and maybe a coffee shop.

I think I’ve gone on long enough to make my point. Not every community is Palo Alto, not all homeowners are limousine liberals (or the conservative equivalent), and sometimes making a community better requires empowering that community to make decisions for itself, and give it the power to block things it doesn’t want.

[csen]

Economic Analysis by Decade: 1970′s-2010′s

With markets slowing down for the first time since last summer I’m trying to step back from the day-to-day and extend my time horizon a bit.

It’s the second quarter of 2016 now, and the decade is almost two-thirds over. At this point in a decade “themes for the decade” have often emerged. So what’s the theme of the 2010′s, and what from the 2010′s will be impactful as we head into the 2020′s? To think about that, I went back and thought about the past few decades. This is more of a journaling/brainstorming activity than one of my normal snappy posts, so apologies if it’s a bit meandering. This is based on my own limited knowledge and others will have their own perspectives and/or find problems with my interpretations.

1970′s:

Key cheap/plentiful input: Infrastructure. The interstate highway boom was ongoing, Atlanta/DC/SF Bay were opening new transit lines. Suburbia and the Sun Belt were newish and booming, and there was no such thing as the Rust Belt yet.

Key expensive/scarce input: Almost everything. Labor, capital, energy, “bureaucracy.”

Major capex theme: Investing to keep up with booming demand from the young Baby Boomer generation and to beat back the inflation strangling the economy.

US policy themes: “FDR Democrat excess” which started to unwind at the state/local level in the late ‘70s (CA Prop 13 passed in 1978)

Global highlights: Rise of Japan

Legacy: Middle East/oil problems, Japanification of the auto industry, massive capex spend paves the way for end of inflation in the early ‘80s, beginning of the decline of the American manufacturing worker, American cities in crisis

1980′s:

Key cheap/plentiful input: Asian labor. Asset prices. After inflation peaks, credit gets cheaper, commodities get cheaper.

Key expensive/scarce input: American labor.

Major capex theme: Plunge in inflation/interest rates/energy creates even more consumer demand from 30-something Baby Boomer generation, and corporations race to keep up. Rise of the personal computer.

US policy themes: Supply side-ism. Tax cuts and deregulation.

Global highlights: Japan peaks, commodities bust

Legacy: Many of the problems the US is dealing with today stem from forces that accelerated in the ‘80s. The hollowing out of manufacturing and the Rust Belt, the rise of Wall Street and elites, rigid GOP ideology.

1990′s:

Key cheap/plentiful input: Chinese labor. Commodities. Credit/leverage. Personal computers.

Key expensive/scarce input: American labor.

Major capex theme: suburban infrastructure (houses, malls, office). Personal computer technology. Telecom infrastructure.

US policy themes: neo-liberalism

Global highlights: the decade of the American Baby Boomer, rise of China

Legacy: Financial sector innovation/deregulation and tech/telecom investment paved the way for the 2000′s

2000′s: 

Key cheap/plentiful input: Leverage, emerging market labor, bandwidth/computing power

Key expensive/scarce input: Suburban homeownership, risk assets

Major capex theme: China/commodities, EM infrastructure, exurban US housing, digital infrastructure (mobile/servers/cloud)

US policy themes: neoconservatism/neoliberalism excess

Global highlights: China/commodities/leverage boom ends in a global financial crisis

Legacy: The world is still recovering from a global bust.

2010′s:

Key cheap/plentiful input: Just about everything. Labor/credit/increasingly commodities/digital infrastructure

Key expensive/scarce input: Physical infrastructure, end demand, well-functioning government

Major capex theme: A commodities boom goes bust, digital infrastructure/software, infrastructure for high-earning 20-something Millennials without families, increasingly perhaps transportation/self-driving vehicle capex

US policy themes: Austerity turns to gridlock, possibly populism

Global highlights: Struggles everywhere as the financial crisis and post-crisis regulatory changes lead to demand shortfalls and inadequate government response, aging of the Baby Boomers

Legacy: As we enter the latter part of the decade commodities have become cheap, credit is still cheap (with many DM government yields now negative), labor is getting increasingly scarce, and in the US a housing/infrastructure shortfall is becoming more painful. 

More 2010′s/2020′s thoughts:

Trump/Sanders primary surprises suggest a growing demand for a different policy direction, yet with the likelihood of a Clinton victory it’s unclear if this will happen in the near future. What’s notable is that it’s not clear either the public or private sector has made investments this decade that will lead to growth in the 2020′s. The 1980′s were powered to some extent by the heavy capex of the 1970′s. The 1990′s consumption/tech boom was powered by investments made in the 1980′s. The broadband internet/tech boom of the 2000′s doesn’t happen without the telecom investments of the 1990′s. And FANGs/Uber/$30-40 oil don’t happen without investments made in the 2000′s.

Demographics suggest a Millennial family formation boom in the 2020′s plus acute infrastructure and healthcare needs for Baby Boomers approaching their 70s-80s, and infrastructure needs are undeniable, yet the key “investments” being made this decade seem to be corporate stock buybacks, infrastructure for a phase of life Millennials will soon outgrow, and software development at “unicorns.”

The one “output” of the 2010′s worth thinking about is gushing corporate profits that could fuel a future investment boom. If the 1980′s were fueled by the capex of the 1970′s, the 1990′s consumption fueled by the wealth generation of the 1980′s, 2000′s tech fueled by the telco/dot com boom, and 2010′s “Facebook/Uber on a smartphone” fueled by tech investments of the 2000′s, perhaps 2020′s capex/infrastructure needs will be funded by all the cheap capital generated in the 2010′s.

[csen]

Manufacturing Employment Shrunk YoY Because the Job Market’s So Strong

For the first time in this employment expansion, in March the manufacturing sector showed lower payrolls year-over-year. This contraction will probably continue for the rest of this expansion and into the eventual recession.

This must be because of all the global problems we’ve heard about lately, what with the strong dollar, export weakness, and the oil depression, right? Surely this is bad news for manufacturing workers.

Actually, it’s not. The unemployment rate for manufacturing workers (not seasonally adjusted) is still near this cycle’s lows.

And the unemployment rate for manufacturing workers is still falling year-over-year.

We haven’t seen a major decrease in hours worked for manufacturing workers...

And overtime hours are holding steady...

Wage growth is actually stronger for manufacturing workers than it is for private sector workers as a whole, and it’s accelerating:

What about at the state level? Michigan’s one of the most important states for manufacturing in the country:

And yet in a reversal from the last cycle, Michigan unemployment has been falling faster than the country as a whole. The Michigan unemployment rate is lower than the overall unemployment rate for the first time since 1999-2000.

So what’s going on? My view, 3 things:

-The manufacturing workforce is older and more prone to retirements than the workforce as a whole -- this is putting downward pressure on the unemployment rate.

-On the margin, some manufacturing workers are finding better employment opportunities in other sectors (especially for younger/less-specialized workers).

-New entrants to the workforce are finding better opportunities in other sectors, making it harder for the manufacturing sector to find workers. Especially, say, the construction sector.

It’s a lot easier to move manufacturing jobs to other countries than it is to bring construction workers to the US right now, so maybe we’ll see the manufacturing sector in the US shrink faster to support growth in the construction sector. That’s the way markets work. Life goes on.

[csen]

Why I’m No Longer an Economic Bull

It’s finally happened. I’m starting to look for signs of economic overheating, overly aggressive monetary policy tightening, and eventually, recession.

First, overheating. Despite continued drags from dollar appreciation and the decline in energy prices, core PCE has ticked up strongly in recent months, in part due to rises in medical care costs, which have a bigger weighting in core PCE than core CPI. The 2% target is in sight.

Second, below is a chart looking at what percentage of new employees last month came from outside of the labor force (vs unemployed). It hit a new all-time high of 72%, vs 56% at the lows of 2009-10. To find workers employers are having to look harder than ever. At some point even this shadow slack will run out and wage increases will be the last option available to them.

This has been the case in the construction industry for awhile. Unemployment for construction workers is non-seasonally adjusted, but we saw in February that construction unemployment nearly matched its low for this data series set in February, 2006. If we’re going to find more construction workers we’ll have to find them from outside the industry.

My view is that the housing cycle is the business cycle, and on this basis “potential output” should be much, much higher than it is today. We’ve underbuilt housing, particularly single-family, for years, and Millennial housing needs will be immense for the next two decades.

But because of how much damage occurred in the housing sector and how slow and long the recovery took, other industries absorbed housing sector resources. And now we’re nearing overall US economic resource utilization levels that typically makes the Fed uncomfortable.

Over the next several months as energy and currency-related headwinds subside and the US hits full employment the Fed will begin to snuff out this expansion, which is what they see their job being. Economic growth in 2016 should be pretty good, and there’s a good chance 2017 will be as well. But by 2018? There’s a reasonable chance that by then, if the economy doesn’t fall into recession on its own the Fed will put us there. So that’s beginning to make me cautious in my outlook.

[csen]

Lehman and Trump

I’ve been saying for awhile now that I thought 2016 had the potential to be a “political 2008/Lehman event,” and with Bernie fading it seems like the only way that plays out is if Trump gets the nomination/wins in November, so I’ve been thinking some more about this.

After Lehman fell an older friend and I were talking about the turn of events, and he said that what Lehman represented was the economy failing for the top 1%. The poor are always poor, the manufacturing class had been hollowed out for decades, the middle class had peaked in 1999-2000, and the housing/credit markets by 2008 were already in recession, but Lehman was the event that put fear into economic elites, at which point policy responded.

And I think that analogy works for what we’re seeing now. Many people are outside of the political system and perennially feel voiceless. Post-2010 confidence in government has been very low. Wall Street has remained on edge due to subpar fiscal policy and occasional threats of not raising the debt ceiling or government shutdowns, but all along the political system has mostly worked for the top 1%, a point on which all of the major candidates would agree and are campaigning on. But a Trump nomination/election represents the political system failing for the top 1%. Their control, their sense of entitlement, their pro-immigration/trade/tax cut agenda would all be threatened by a Trump win.

It’s interesting how in a perverse way Trump “solves the equation” of so many issues that people have identified in the political system over the past several years. He’s defeated corporate Super PACs and the Bush dynasty. He scrambles the deck on partisan polarization and what constitutes left/right. He speaks to the white working class. He represents a chance of addressing income inequality and getting fiscal policy moving again. He’s the first Republican actually willing to talk about doing more on healthcare than just repealing Obamacare. And if you’re a media/academic liberal taken aback by campus safe spaces, you’ve probably got an ally there in Trump.

We’ll see where this goes.

[csen]

ETF Charts Showing a Market in Transition from Momentum/Tech to Value/Industrials?

In a past life I was primarily a technical analysis guy. Now I’ve mostly gone in the opposite direction, but I still find charts helpful to see what’s actually happening and to test out if our fundamental/tops-down views are being validated or refuted by the market.

We’ve been of the view for awhile that momentum/growth/tech factors were over-extended relative to value factors, and have been waiting for those to reverse. Given the large market cap weightings of large tech stocks we expected that this reversal would put pressure on the overall market just from a cap weighted/arithmetic/deleveraging standpoint, but ultimately was what we’d need if some of our value positions had a chance of working. From that standpoint, this week’s losses were well worth it. The hope is that this churn and change in leadership is ultimately a sign that markets won’t continue to head straight down, but are building the foundation for something new/different.

The best news of yesterday was the severe underperformance of momentum tech growth names.

MTUM/VLUE got crushed:

As did QQQ/SPY:

Even within tech, the “safe tech” of the S&P 500 outperformed the riskier/momentum names in the Nasdaq 100, continuing a YTD-long pattern:

It may be confusing to see consumer discretionary get crushed on a strong wage growth print, except for the fact that the XLY ETF is loaded by popular momentum names like AMZN, HD, MCD, NKE, and SBUX, all of which got crushed with its momentum peers yesterday.

While MTUM/VLUE may just now be reversing, small cap value has been outperforming small cap growth for awhile:

There are no safe stocks, only safe prices -- people rushing for the “security” of consumer staples may be forced to learn this lesson:

Same goes for utilities:

Two of the most promising signs of yesterday were the extreme outperformance of the materials sector:

And the industrials sector. This was not a run of the mill “risk off” day:

The Dow outperforming the S&P so strongly has a lot of information embedded in it. It’s loaded with a combination of value stocks, industrials, large caps, and “defensives.” The part I trust is the value/industrials portion, whereas technical/macro bears would probably lean more towards value/large cap/defensives.

And finally, small caps continue to underperform.

If we’re to break this bear panic and enter into a new sustained bull market what I’d like to see would be outperformance by small caps, financials/housing, industrials, maybe energy/materials, and “value factor” more broadly, with tech, expensive consumer staples/utilities, and “momentum factor” underperforming. Yesterday was a sign that some of this transition could be underway, and while tech/momentum deleveraging may be nowhere near complete gives me hope based on market factors for the first time in awhile.

[csen]

On Being Appointed to the Brookhaven Planning Commission

I'm honored to have been appointed to the Brookhaven Planning Commission tonight. I've never served in any kind of official government capacity before, so I’m looking forward to learning a little about what it entails and making an impact. The commission’s decisions are non-binding, so if there’s a learning curve hopefully city council in its wisdom will compensate for our shortcomings.

These are the topics that matter to me when I think about planning for Brookhaven's future:

-Enhancing and protecting the assets that long-time residents love about Brookhaven -- its neighborhoods, its parks, and its tree canopy

-Creating a sense of place in the city -- what do we want our city center to look like? When visitors come to the city, where will they want to go?

-Understanding that both now and in the future, Brookhaven will have to plan for multiple modes of transportation. Driving for getting to jobs and around the region, walking in and around town, public transportation (MARTA), and also emerging forms of transportation like Uber and potentially self-driving cars

-Knowing what pays the bills. A vibrant commercial tax base both allows our city to fund itself, and enables us to keep property tax rates for homeowners low

I look forward to serving, and as warranted and if allowed I’m sure I’ll write up some thoughts occasionally.

[csen]

Process Amidst the Panic

As someone who began managing client money 3 years ago, this is the first teeth-chattering panic I’ve felt in markets. There have been other blips -- the Ebola low in October, 2014 or the margin call crash last August, but in terms of sustained liquidation of assets this is the worst.

Managing client money brings up different issues and emotions than managing your own. The two questions you have to ask yourself are, “Am I managing risk in accordance to the stated goals and tolerances of clients?” and “If things go bad or I’m wrong, am I comfortable explaining to clients what happened?”

These are the questions that dictate decision-making. My process is a combination of tops-down business cycle analysis and bottoms-up fundamental/valuation analysis. I used to be entirely tops-down/macro in nature, which kept my bearish way too long in 2009 because I didn’t know how to value companies.

What has made the current crash so difficult is when I survey the environment I see the following:

-US econ data points coming in more or less in accordance with my expectations

-The beginning of earnings season looking more or less okay (banks, NFLX, a few others)

-Monetary policy that remains accommodative

-Valuations, at least for names and sectors that interest me, that I’m comfortable with

-Still at the point in the business cycle, especially on the housing side, where a consumer/housing-led expansion could continue for years to come

At the same time I get why there’s panic out there:

-The China/oil/high yield interdependence is creating a lot of fear and confusion, and possibly more systemic damage to credit markets and banks than I’ve priced in

-Selling in some areas, like mREITS, that’s far beyond what most people had in their risk models. When you think something’s worth $1 and you can pay 80c for it you think it’s cheap. When it goes from 80c to 50c there’s a combination of “wow, I should really buy more!” and “holy crap what if I’m wrong?”

-The selling has been so indiscriminate that you could’ve come into the year with what you thought was a value portfolio. When you’re down 10% in less than 3 weeks you get more and more nervous about allocating that marginal dollar.

-If corporate credit markets keep deteriorating, then even if I’m right about the earnings on the companies I follow, valuations should adjust downward accordingly.

I’m of the belief that you can chase other people’s ideas, but it’s chasing their process that is the path to ruin. In times like this I wish I were a global macro energy trader who did all sorts of fancy stuff and was up 2-3% for the year, but that’s not who I am or what I do. Times like this force you to think about, “Who am I and what am I trying to accomplish?” It’s necessary at times but not a fun process to go through.

[csen]

The Next Tech Cycle

As this tech cycle draws to a close one can’t help but feel disappointed. A handful of winners -- Facebook, maybe LinkedIn/Twitter, probably Uber/Airbnb/Pinterest -- and a lot of busts, from commodity wearables like Fitbit and GoPro to flash in the pans like Groupon and Zynga to companies with dubious unit economics and value propositions like Square and Yelp. This, despite lots of VC money and cultural enthusiasm for startups and entrepreneurship, at least among certain demographics.

I’m actually more hopeful about the next cycle. After getting burned on the false promises of unicorns, employees and investors alike, we’ll probably see fewer people rushing gung ho into startups, and more focus on building sustainable business models on the part of founders rather than the growth-at-all-costs zeal of this cycle, with everyone trying to be the next Jobs/Bezos/Musk.

Additionally, it’s likely that the next wave of technology companies will need more growth capital for real, physical world applications than this cycle’s companies. Whether it’s transportation/self-driving cars, robotics, solar/energy storage, or smart home applications, atoms are a lot more costly to scale than bits. This is good for a couple of reasons -- first, more costly growth means a bigger thrust for the overall economy, and hopefully means more jobs, especially beyond brogrammers in megacities. Second, for investors, it means more IPO’s from companies that actually need the money rather than those just trying to cash out.

And unless housing costs drop significantly in megacities, it’s likely that the next generation of companies will need to hire people and exist in a broader geographic footprint. The Tesla gigafactory might be a good leading indicator of this.

If the epitome of this generation’s tech company is a social/mobile monopolistic platform that has no employees and exists entirely in the cloud with poor unit economics and no regard for shareholders, the epitome of the next will probably be something both Main Street and Wall Street can get more behind.

[csen]

Five 2015 Themes That Will Carry Over Into the Rest of the Decade

Some musings from a tropical Christmas Eve in Boston...

1) “FANG” [Facebook, Amazon, Netflix, Google] and Apple are the Detroit Big Three of the early 21st century. Much ink has been and will be spilled over the fate of unicorns. There will be a handful of winners and a lot of losers as there always are with these things, but I’m more interested in the actions of the big guys, who increasingly seem to be consolidating their grip over the digital world. Once the unicorn shakeout happens this will increasingly be the case. What will these titans do to shape the future of e-commerce, media, advertising, communications, and perhaps transportation?

2) National security and immigration have replaced the economy as the biggest issue in American politics. This flip happened after Paris and San Bernardino. We haven’t had an election in this new world yet, so it’s too soon to say what the political impact will be, but so far it feels like it will benefit the Trumps and Cruzes of the world at the expense of the Elizabeth Warrens.

3) The GOP is now the party of Ted Cruz. Pre-2008 the GOP was best understood as a three-legged stool of social conservatives, fiscal conservatives, and national defense Republicans. In 2015 it’s more muddled than that. You have tea partiers, evangelicals, quasi-libertarians personified by Ron and Rand Paul, secular downscale whites that Donald Trump has unearthed, and the Wall Street establishment. Ted Cruz is seemingly the only Republican with the potential to unify all of these constituencies. He may not be the most electable Republican in the party’s presidential field but this is Ted Cruz’s party and he’s probably best positioned to be the voice and representative for the party on the top of a national ticket.

4) The roar of secular downscale whites. I’m less interested in what Donald Trump says than what he’s revealed. Neither party really wants these people. They can’t find a home in the Democratic party because they’re the cultural antithesis of what the Democratic party stands for now, and in the GOP the establishment thinks they hurt the party’s electability, they’re not particularly socially conservative, skeptical of foreign engagement, and not necessarily for lower taxes and lower spending. But they represent a significant portion of the American electorate, perhaps 20-25%, and any faction that comprises 20-25% of the electorate is going to get significant political representation. It used to be that they’d have to go along with what the GOP Wall Street establishment wanted, but increasingly it appears that the GOP establishment will have to go along with what this group wants. TBD.

5) Democrats in 2015 are where the GOP was in 2007, a party one presidential loss away from being torn apart internally. Hillary Clinton is the only thing standing between the Democrats fighting an internal war between Black Lives Matter, a Bernie Sanders/Elizabeth Warren faction, and an electability/establishment faction. Anyone handicapping the presidential race right now would give Democrats a 55-60% chance of winning next November, but if a macro wave carries a Trump or a Cruz to victory it’ll be interesting to see the minority party’s conspiracy theory shift from “that crack-smoking socialist Kenyan Muslim” to “that racist, theocratic, fascist.”

If America experiences a “Lehman moment” over the next few years, it’ll be political, not economic or financial.

[csen]

New Themes When Demographic-Driven Labor Shortages Become Consensus

Over the past few years Guillermo, Matt and I have been insufferable members of the corner of finance twitter talking up reduced labor slack, wage growth, reversals in long-term inequality trends, and higher inflation.

Between the October jobs report, the excellent WSJ demographics series, and 2016 Wall Street forecasts, these views are increasingly catching on. We believe these are long-term trends, so it’s not time to declare victory and move on, but I don’t find it particularly interesting to tweet about well-understood long-term trends, so I’ve begun the process of thinking about what other emerging under-recognized trends and themes could be. If too many people are agreeing with you it’s a sign that maybe your ideas have gotten a little stale.

Here are some of the things I’m thinking about:

End of the tech startup era, beginning of the hegemonic tech platform era. There’s a belief that we’re in an amazing era of disruption where a few people can do a weekend hackathon, get funding, and bring an incumbent to its knees. What if that’s over and instead we’re living in a world where Apple, Google, Facebook, Amazon, and Netflix become the new age versions of AT&T, IBM, Wal-Mart, and the cable companies? The last useful app I added to my phone was Uber. There are cycles for everything and it’s not clear why this era of tech startups/unicorns will last forever.

Tech hegemons spending more and more of their money on content creation rather than innovation. This is Adam Carstens’s idea -- now that the number of tech platforms that matters has been established, they’ll spend more and more money incentivizing content creators and consumers to use it at the expense of others.

Knock-on effects of higher defense spending. Defense spending has been falling for around 5 years now, but with the rise of ISIS and changes in the political mood post-Paris, it seems probable that whether Hillary or a Republican is elected, defense spending is going up in 2017. What sorts of unexpected side effects will that have on employment, wage growth, inflation, where the growth happens, crowding out, politics, etc?

A comeback for conservative values in mainstream culture. This will be the point easiest to misunderstand so let me say that I don’t mean we’ll fall in love with Rush Limbaugh or Trumpism or anything. Values migrate from art to culture to politics/activism. Brokeback Mountain released in 2005 can be an Oscar nominee. Brokeback Mountain in 2011 becomes too overtly political. Just about every liberal (and conservative for that matter) cultural issue has been politicized at this point, so it’s becoming harder and harder to produce them in a mainstream content way (comedians complain about this). But culture never ends and is never finished. Maybe we’ll see more portrayals of nostalgia (inherently conservative), or depictions of marriage, family, fidelity, wholesomeness, self-determination and struggle in a positive light. An interesting way to do this would be to reboot mid-20th century concepts with a female/non-white lead, a way to make inherently “conservative white nostalgia” stories seem modern and progressive.

A constant reevaluation of where the areas of abundance and shortage are in the economy and society. When Baby Boomers were starting families labor and road infrastructure was abundant while housing, capital, and commodities were scarce. So the economy and politics were understandably directed towards the production of housing and capital at the expense of workers and infrastructure. With Millennials now in their “late 1970′s/early 1980′s moment,” tech/communications, capital, increasingly energy/commodities are abundant while housing, labor, infrastructure, and political will are scarce. The economy and political system are constantly looking for ways to use areas of abundance to solve problems of shortages, and somehow these factors will all interact to create solutions.

The potential for an unprecedented GOP majority in 2017. There’s no question that the GOP presidential field looks shaky, with the public’s obsession on every cringe moment by Trump. But the fact remains that outside of the presidency and large city mayorships the Republican Party has unprecedented control over American politics. And the Democratic bench after two Obama terms is weak, and likely won’t improve until after a presidential loss and/or the retirement of its current generation of gray leaders. If Republicans win a close presidential election in 2016 they’ll have full control over the federal government and a large number of states as well. There’s at least a 40-45% chance of this outcome yet surprisingly little thought about what it would mean.

[csen]

The 2009-2015 Economic Cycle is Ending

I remain bullish on the US economy for all of the reasons long-time readers know -- strong demographic demand coming as Millennials transition to their prime household-forming years, pent up needs for infrastructure spending, bargaining power shifting from companies and the rich to the higher-spending working class, and low levels of household leverage.

But in a sense, the economic cycle of 2009-2015 is drawing to a close. By that I mean the drivers of the past 6 years are unlikely to drive economic growth over the next 3-5 years.

And what has driven the past 6 years? I’d identify 5 main factors: fixed investment in commodities/energy, auto sales, multi-family residential construction, tech job growth, and corporate borrowing. Let’s go through them one by one.

Commodities/Energy Investment:

Anyone not living under a rock knows about this. Emerging markets and commodities have busted, and oil’s back around $40/barrel. Commodities busts last longer than the booms, and it’s unlikely we’ll be talking about a commodities bull market again for a decade or more.

Auto sales:

This has been one of the brightest spots in the US and global economy this year. We’re looking at the best year for auto sales in 15 years or so. But we’ve come a long way from the lows of 2009, with auto sales having roughly doubled since then. And some have concerns about the growth of subprime auto lending. Maybe auto sales grow from a SAAR of 18 million to 20-21 million, but they’re unlikely to drive much economic growth from here.

Multi-family residential construction:

While single family construction has been a big laggard in this cycle, the same can’t be said for multi-family construction. Maybe it’s Millennials, maybe it’s lack of mortgage availability, maybe it’s changes in lifestyle preferences -- multi-family has boomed. Multi-family building permits as a % of total building permits are around 40-year highs. While the overall level of building permits is likely to rise because of demographics and limited existing supply, increasingly the driver will be single-family, and it’s possible that multi-family is in the process of peaking as Calculated Risk’s Bill McBride and others have speculated.

Tech job growth:

It’s hard to know how to best represent this so I went with employment levels in the San Francisco and San Jose metro areas combined, the epicenter of this tech cycle. Employment here now exceeds the peak of the last cycle. However, with skyrocketing housing costs, limited ability to build, and the possibility of a unicorn downturn over the next couple years, we’re surely closer to the end here than the beginning. And as the last cycle showed, it’s possible that we could have a new economic cycle where tech employment doesn’t reach the highs of the prior cycle.

Corporate borrowing:

It’s debatable how much of an impact this has had on the real economy, but there’s no denying the impact corporate borrowing has had on asset markets, both from facilitating trillions of dollars of stock buybacks and allowing companies to lever up with cheap money. But with interest rate hikes on the horizon and credit spreads widening out all year it’s questionable whether this can continue indefinitely. The driver of one cycle is unlikely to be the driver of the next cycle, and this probably applies to corporate borrowing as well.

Again, the prospects for single family residential construction, wage growth, higher household leverage, and infrastructure spending are good, and it’ll be interesting to see how the economy hands off the growth baton from these old engines of growth to future ones.