Regime Change: The End of the Economy as we have Known it

 “There are decades where nothing happens: and there are weeks where decades happen.”

                       Attributed to V. I. Lenin

In the short span of twelve weeks, Donald Trump has undone the Bretton Woods monetary order established in 1944, the GATT free trade order of 1947, and the NATO collective security order of 1949. (See: https://shulmaven.blogspot.com/2018/02/my-amazon-review-of-benn-steils-marshal.html) As a result the world is now facing a simultaneous geopolitical and economic crisis and it is no surprise,  that stocks and especially treasury bonds and the dollar have sold off. (See: https://shulmaven.blogspot.com/2025/04/a-broken-stock-market-and-broken-trust.html) Simply put, the old world order is gone, an there is nothing, as of yet, to replace it. The transition will be painful.

Those who expect that the Trump tariffs are negotiating tactic will be sorely disappointed. Trump needs the revenue to finance his tax cuts, and the Democrats only differ with Trump as to the way his policy has been conducted. They still hope to reclaim their union support by being pro-tariff and they too need the revenue to finance an ever-larger welfare state. The era of free trade, as we have known it, is over.

Three years ago, I wrote that the United States was about to enter a new 13-year economic cycle. I noted:

“My guess is that we are at the very beginning of new thirteen-year cycle with unknown consequences. I would speculate that the next thirteen years will bring with it a much higher rate of inflation than we have been used to, a multi-year bond bear market and a partial deglobalization of the economy caused by local politics, supply chain issues and geopolitical tensions. To me the big question is whether this cycle will bring with it a stagflation or a high cap-ex/high inflation economy with a cap-ex boom coming from the in-shoring production and energy transition. As they say, time will tell.” ( See: https://shulmaven.blogspot.com/2022/05/the-useconomy-is-entering-new-thirteen.html)  

Although it has taken a bit longer to play out, we are now in the midst of it and perhaps something much more. We are likely entering an eighty-year super cycle in what Neil Howe has called a “fourth turning” which will involve economics, politics, values, and the way we relate to each other in society. (See: https://shulmaven.blogspot.com/2023/09/my-review-of-neil-howes-fourth-turning.html)  This is far bigger than my 13-year cycle in that it encompasses six 13-year cycles that began in, not coincidentally 1945.

If this is close to correct, then we are now entering unchartered waters. The stock market and economic histories that we have been used to over the past 80 years may no longer be relevant in understanding the future. Instead of ever rising share prices we may now be in an era where stocks go sideways for an extended period of time. I would note that between 1924-1949 the Dow Jones Industrial Average traded in a range of between 100-200 with the significant upside exception of 1928-30 and the significant downside exception of 1931-1933. For example, in 1927 the high in the Dow was 201 and which was nearly identical to that recorded in 1949 and the 1929 high was not exceeded until 1954. The equivalent going forward would be for the S&P 500 to trade in a broad 3500-6500 trading range over the next several years.

The recent action of the bond, currency and stock market is indicative of a sea change in the markets. Instead of rallying in a time of turmoil both the treasury bonds and the U.S. Dollar have sold off. Indeed, the dollar has declined 9% since the end of February. Simply put foreigners are losing trust in the U.S. Dollar and with 18% of U.S. stocks held by foreigners the selling is only now beginning. I would say the same thing for foreign holdings of U.S. real estate.

Over the weekend the Trump Administration announced that it would reduce the Chinese tariff of 145% to 20% on smart phones, computers, and other electronic products. That action has lifted the Sword of Damocles hanging over Apple. This suggests a major relief rally for Apple and the stock market as a whole, but what multiple can you put on company and the stock market as whole whose share prices are subject to the whim of one very unstable man? I would sell the rally.  

My Amazon Review of Walter Isaacson's "Elon Musk"

 

                                             Rocket Man

 

Every aerospace executive and board member should read Walter Isaacson’s biography of Elon Musk. Starting from scratch Musk has built America’s leading rocket and space communications company by ignoring the hidebound bureaucratic rules of the major aerospace companies delivering rockets at one tenth the cost of his bloated competitors. Musk’s rules are:

1.      Doubt every requirement.

2.     Question every cost?

3.     Act with a sense of urgency.

4.     Learn by failing.

5.     Improvise.

 

The other secret that Musk applied to Tesla as well as SpaceX is that he integrated design, engineering, and manufacturing so that each of those entities can learn from the others. Thus, engineers and designers are able to make improvements in manufacturing as issues arise. Steve Jobs at Apple integrated design and engineering, but outsourced manufacturing to China.

 

Rising from an unhappy childhood in South Africa, Musk became a Silicon Valley entrepreneur to become part of the famed “PayPal Mafia.” He used his PayPal success to fund Tesla and SpaceX and the rest is history.

 

Musk’s genius has the ability to inspire loyalty, at least for a time, of a host brilliant people who built his empire. However, empathy is not his middle name, and, in many ways, he seems to be a very cruel person. He is one of those people who professes to love humanity, but really doesn’t like people as individuals.

 

Isaacson discusses Musk’s chaotic personal life. Three marriages, 11 children two of whom by sperm donation. Isaacson doesn’t explain why so many of Musk’s children were conceived by in vitro fertilization.

 

Then, of course there is Twitter, now called X after his favorite letter. His adventure at Twitter seems to be one giant ego trip where he promised to free that social media site from it “wokeness.” To say the staff of Twitter was woke, would be an understatement. He wanted to encourage free expression, yet under his rule Twitter has become a cesspool of hate.

I had my own run in with twitter. Despite all of Musk’s talk of a new openness I was banned for using the term “circular firing squad” to characterize Hunter Biden bringing his father into his legal thicket. Something is really wrong with X and from press accounts is seems to be getting worse by the day.

 

Despite being hagiographic at times, Isaacson brings to life one of our leading entrepreneurs who is bringing us into new electric and space ages.

For the full Amazon URL see: Rocket Man (amazon.com)

The Defanging of the Stock Market

 

April has brought with it the defanging of the stock market where the hitherto invulnerable FAANG stocks crashed and burned bringing with it a full-fledged bear market in the NASDAQ Composite Index. FAANG stands for Facebook (now Meta Platforms) Apple, Amazon, Netflix, and Google (now Alphabet). From their respective 52-week highs Meta is down 48%, Apple is down 13%, Amazon is down 33%, Netflix is down an astounding 73% and Alphabet is down 23%. Taken as a whole the NASDAQ Composite is down 23%. The weakness in these five stocks which at one time accounted for nearly a quarter of the market value of the S&P 500 brought that benchmark index down 14%.

 

Market behavior of this type is reminiscent of the 1973-74 and the 2000-02 bear markets. In the 1970s the so-called Nifty-50 group of one-decision growth stocks which were trading at 50-60X earnings experienced declines in excess of 50 -80% during the course of the bear market. In the collapse of the 2000 dot.com bubble such stalwarts as Cisco, Microsoft, Intel, and Oracle (a group of stocks that I then characterized as “The Four Horseman of the NASDAQ”) which traded at multiples in the 80-100X range lost about three quarters of their market value. Indeed, just as today, the stock market was bracing for a tightening of monetary policy. Needless to say, the history is not encouraging.

 

There are, however, two distinct differences between then and now. First, from 1972-74 the 10-year Treasury traded in a 6-8% range and in 2000-02 it traded in a 5-6% range far higher than the current 2.9% yield. Second, with the exception of Netflix valuations are nowhere near as demanding with Alphabet trading less than 20X earnings, Apple at around 25X, Meta at a below market 14X earnings. As a result, even if Treasury yields rise to 4%, my sense is that the worst of the declines in FAANG and the market as whole are behind us.

 

To be sure, we could soon be looking into the teeth of a recession triggered by a very aggressive Fed and continued high inflation which would haircut earnings estimates across the entire market. We are sure to have a recession at some point, but I do not believe it is soon. Simply put the end of the pandemic is fueling a consumer boom and capex remains strong fueled technology and energy related spending of all types. Thus, it will take more than 250 basis points of tightening to break this economy. Of course, if we are in a rerun of “That 70’s Show,” all bets are off. (Shulmaven: Roaring 20's or That 70's Show)

 

As I wrote in February(https://shulmaven.blogspot.com/2022/02/the-unravelling.html), my sense is that we are in a structural bear market in bonds and in for a very volatile stock market. Whether or not the lows are in or not, I do not know, but the world will not look as bad in December as market participants feared last week. Net, net although 2022 will be a down year for stocks, the market will end the year higher than where it is now.

My Amazon Review of Bruce Greenwald's et.al. "Value Investing: From Graham to Buffett and Beyond" 2nd. Ed.

 

In Search of Value

 

As a value investor, I have the highest respect for Bruce Greenwald and his colleagues. Unfortunately, in recent years value investing has failed to live up to its billing. Indeed, over the past two decades Warren Buffett’s Berkshire Hathaway has performed roughly inline with the S&P 500. (I am a shareholder.) My history with value investing goes back to reading Graham & Dodd in 1964 while attending Baruch College. Further I own the classic 1940 edition of that book and Greenwald’s first edition of this book. Nevertheless, I did find my way to owning Microsoft, Apple, and Alphabet.

 

Nevertheless, Greenwald’s new book is worth a careful read. He is very wise in dismissing modern portfolio theory’s Beta as a measure of risk. Why? The beta measure of risk is independent of stock price. He is also very cautious about using discounted cash flow over long periods of time because the results are extremely sensitive to small changes in the discount and growth rates.

 

Greenwald plows over old ground in his discussion using net reproducible assets and earning power as a method for determining value. He then goes one step further by introducing franchise value into his valuation paradigm. Simply put franchise value is created by the ability of a firm to earn significantly higher returns over its cost of capital over a sustained period. Those returns arise from the existence of a protective “moat” around its businesses. Greenwald also recognizes that over time a firm’s franchise value can decline, and he thus introduces a decay factor to account for this factor.

 

The question arises is why hasn’t value investing been successful in recent years. There are at least two explanations. First is that the economy has shifted from tangible asset based to intangible asset based. That means GAAP accounting does not put on the balance sheet such intangibles as trademarks, patents organizational efficiency and research and development platforms. Greenwald adjusts for these factors, but there is higher error term surrounding the valuation of intangibles than tangibles. Second the Fed’s zero interest rate policy coupled with quantitative easing has likely distorted many of the historical metrics defining value.

 

The book was written before Berkshire Hathaway made its $735 million investment in Snowflake, a cloud computing software company. At Berkshire’s price, the company was valued at $34 billion and had trailing twelve months revenue of just under $500 million. Whatever one can say it is hard to make a valuation case for this company. Nevertheless, the stock more than doubled after Berkshire’s IPO purchase.

 

Greenwald has a very long discussion about Intel, the semiconductor giant, which at times in its history represented true value. He blames Intel’s recent problems on value destroying acquisitions. That is true in part, but Intel’s real problems run deeper. Its franchise value has deteriorated as it vaunted R&D operation failed to keep up with advances made by Applied Micro Devices, Nvidia and Apple. Moreover, its edge in manufacturing disappeared as Samsung and Taiwan Semiconductor surpassed it in the production of the latest generation of chips. In other words, Intel’s “moat” was paved over by competition despite its spending 19% and 22% of revenue on R&D and capital spending in 2019, respectively.

 

An added attraction of the book is that it includes vignettes from star value investors as Warren Buffett, Mario Gabelli, and Seth Klarman, among others. I read the book in the Kindle version; given the number of tables, it would have been an easier read in the hardback version.

 

Lastly, I recently started a position in a stock that currently trades at 10 times earnings and is trading at or below in my estimate, the reproduction costs of its assets. So, hope springs eternal and I will close with the opening quote that Graham & Dodd used in their classic text “Security Analysis: Principles and Technique,” from Horace’s Ars Poetica, “Many shall be restored that now are fallen and many Shall fall that now are in honor.”

For the full Amazon URL see: In Search of Value (amazon.com)

 

Quoted in an AP story, "Apple commits $2.5b to combat California Housing Crisis," Nov. 4

"It's a recognition that the San Francisco Bay Area is in a major housing crisis," said David Shulman, a senior economist with the Anderson Forecast at the University of California, Los Angeles.



https://www.ajc.com/business/apple-commits-combat-california-housing-crisis/6umms4WnEQiZk2tChPLFfO/

Via Atlanta Journal Constitution