Pleased to Meet You, Hope You Guess My Name


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It’s the one thing that Donald Trump and Rachel Maddow can agree on …


As deficits soar, Trump asks, ‘Who the hell cares about the budget?’  [MSNBC]

Donald Trump delivered remarks at a private dinner with wealthy donors Friday night at Mar-a-Lago, and as the Washington Post reported, the president shared some thoughts about the nation’s finances.

To those who criticized his spending and the growing national debt, Trump said: “Who the hell cares about the budget? We’re going to have a country.”

And though I’m generally loath to agree with Trump, his blunt rhetorical question — “Who the hell cares about the budget?” — may have some merit.

About a year ago at this time, White House Chief of Staff Mick Mulvaney — the far-right budget chief who got involved in politics because he was determined to help balance the federal budget — told a group of Republicans that “nobody cares” about the issue anymore. His boss echoed the sentiment on Friday night.

And perhaps that’s a good thing.

— Rachel Maddow, announcing the freezing over of hell

If you don’t see that every government in the developed world is about to embark on a massive deficit spending spree, with modern-day ziggurats constructed in every burg and hamlet … you’re just not paying attention.

You will be told that these are “investments” that will “pay for themselves” many times over.

This is a lie.

You will be told that the size of the federal deficit “doesn’t matter”, that it’s just “money that we owe to each other”.

This is a lie.

Pleased to meet you. Hope you guess my name.

This image has an empty alt attribute; its file name is Yakov_Guminer_-_Arithmetic_of_a_counter-plan_poster_1931.jpg

In the end the Party would announce that two and two made five, and you would have to believe it. It was inevitable that they should make that claim sooner or later: the logic of their position demanded it. Not merely the validity of experience, but the very existence of external reality, was tacitly denied by their philosophy. The heresy of heresies was common sense.

And what was terrifying was not that they would kill you for thinking otherwise, but that they might be right.

— George Orwell, 1984

You will be told over and over again that 2 + 2 = 5.

And what is terrifying is that you will begin to believe that they might be right.

You think you won’t. But you will.

And it is in that moment … that moment of doubt and pain … when this battle will be won or lost. It’s not a public battle. It’s not an electoral battle. It’s not a battle of ideas. It’s not a battle of wits.

It’s a personal battle of will … the will to maintain your autonomy of mind against the Adversary who would nudge and cajole and shake their finger at you until you welcome the saddle and desire the bit.

It’s the oldest battle. And it’s the only battle that matters.

It’s a battle that is infinitely easier to win when you know that you are not alone.

We call ourselves the Epsilon Theory Pack, because the Long Now is going to get a lot worse before it gets any better, and there is strength in numbers. You can watch from a distance if you like, but you are also welcome to join us.


The Church of the Long Now


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That’s Minneapolis Fed President Neel Kashkari on the left and JR “Bob” Dobbs, High Epopt of the Church of the SubGenius, on the right.

I know, I know … it’s me being mean to Neel again.

But I just couldn’t help myself when I saw this Twitter thread yesterday from my favorite stalking horse of Team Elite.

A little background here. The article that Neel is responding to is a spot-on Bloomberg Opinion piece by Elena Popina.

The Debate Over Whether to Call It QE Is Over, and the Fed Lost  [Bloomberg]

In the court of investor opinion, the verdict is in. The Federal Reserve is guilty of quantitative easing.

Never mind that Chairman Jerome Powell tells everyone his efforts to shore up funding markets are “in no sense” QE. Try as policy makers may, they’ve lost the ability to convince people that Treasury purchases aren’t at least partially why the Dow Jones Industrial Average is up almost 4,000 points since late August.

Sure, it’s all labels. If you want to call it QE, you can. Or not. If you want to ascribe the rally to Powell, that’s up to you. Certainly the Fed thinks it’s on solid ground. Rather than trying to drive down long-term interest rates to stimulate the economy, a la QE, it’s simply buying T-bills to keep the financial system’s plumbing in order.

And then here’s the money quote:

The problem for policy makers is that perceptions matter in shaping sentiment. If everyone believes central bank largess is pushing up prices, what happens in the market when it’s turned off?

So right.

Anyhoo … Neel’s inability or unwillingness to engage with the actual points and questions raised by this Bloomberg article is nothing new. I’ve had my own run-ins in this regard.

My Dinner With Neel

So I had a Twitter “debate” with Neel Kashkari. But it wasn’t a real conversation. It was me talking to a wall. Maybe one day I’ll get to have a genuine conversation with Neel or Jim or Jay or Lael or Richard or one of the gang. But I doubt it. We can’t have a real conversation with central bankers because they are both guards and prisoners of the island of policy and thought that they’ve created. … Continue reading



No, I’m just going to take Neel on his own merits today. I’m just going to take his actual words as an accurate representation of his actual beliefs and intentions.

Here’s what Neel tweeted yesterday …

By inverting the yield curve, the Fed created a cartoon of recession risk in the real economy. Not an actual cause of recession risk in the real economy, because that’s not how a yield curve works. I mean, the yield curve isn’t a thing. It’s a derivative of market data observations that market participants assign meaning to as a predictive signal of recession risk. The shape of a yield curve has zero actual impact on the real economy. To use ten dollar words, it is epiphenomenon not phenomenon. To use Epsilon Theory words, it’s a cartoon. It’s a market cartoon of real world recession risk named “Inverted Yield Curve!”.

That cartoon had absolutely no impact in the real world, of course. It can’t. It had a huge impact though, in the market world.

The Fed created FEAR in market world that a recession might be coming.

Then the Fed took that fear away.

In the immortal words of Neel Kashkari … Should we be surprised that the market is up?

At no point did the Fed’s actions, either in creating market fear or in taking away market fear, have any impact on the real economy.

It was entirely an exercise by the Fed to maintain control over market world.

It was entirely part and parcel of the effort to transform capital markets into a political utility.

What is The Long Now?

Exactly this.

The Long Now is the construction of artificial fear and the removal of artificial fear in order to maintain the social POWER of the constructors and removers of those fears.

They’re. Not. Even. Pretending. Anymore.


The Worm Turns

We published our macro narrative Monitors last week (attached here), and something really jumped out at me.

Media attention to an inflation narrative turned dramatically in December, and I will tell you that I see signs of it continuing to accelerate to the upside here in January, particularly in sell-side analysis and reports (which are typically NOT picked up in our Monitor analysis, which pulls from publicly available media).

Does this mean that real-world inflation is off and running? No idea. I mean … my personal opinion is that real-world inflation is much more prevalent and entrenched than we are led to believe by the mandarins, but that’s just my personal opinion. I do not have a professional opinion on real-world inflation. I DO have a professional opinion on narrative-world inflation, however, and that is YES, this a classic “Emerging Narrative” set-up. We are a couple of CNBC missionary statements away from everyone knowing that everyone knows that inflation is off and running. We are one “hot” employment report from everyone knowing that everyone knows that inflation is off and running.

And that’s going to be a very squirrely day for markets.

Why? Because it’s going to bring the politicization of the Fed into sharper focus than any amount of overnight and short-term repo financing will ever achieve.

The Fed is playing a weak hand. If we get an inflation narrative now, just as the “global recession is nigh” narrative kicks the bucket, then the chatter immediately becomes whether or not the Fed has to HIKE. Not “stand pat”. Hike.

There is zero market anticipation for this, which makes this a dinner bell for the trader types reading this note, and a warning bell for the buy-and-hold types. Political risk starts to get real after the Iowa caucuses in a few weeks. Put that together with an incipient inflation narrative and you’ve got the makings of a volatility party. Be careful out there.

Shot, Chaser


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Shot …

Internal Boeing Documents Show Cavalier Attitude to Safety  [Wall Street Journal]

“Would you put your family on a MAX simulator trained aircraft? I wouldn’t.”

“I still haven’t been forgiven by god for the covering up I did last year. Can’t do it one more time. Pearly gates will be closed.”

“This airplane is designed by clowns, who in turn are supervised by monkeys.”

“I don’t know how to fix these things … it’s systemic.”

“This is a joke. This airplane is ridiculous.”

“I’ll be shocked if the FAA passes this turd.”


Chaser.

Ousted Boeing CEO exits with $80 million – but no severance  [CNN Business]

“Ousted Boeing CEO Dennis Muilenburg left the company with stock options and other assets worth about $80 million, but did not receive severance as part of his departure from the embattled company, Boeing disclosed late Friday.”


Both of these articles appeared last Friday, and of course it got me thinking about my most disliked ET note ever:

When Was I Radicalized? (Boeing edition)

I wonder how much money Muilenburg and his management team and his board of directors have pocketed since he took over as CEO in 2015 and Chairman in 2016? I wonder if executive compensation practices have changed over that span since … you know … Boeing started buying back nine billion dollars of stock every year? … Continue reading



Yep, I got more angry emails on this ET note than anything I’ve ever written, telling me what a fine plane the 737 MAX was and how the government (or at least the Obama/Deep State holdover part of the government) was just out to get Boeing and how incredibly flawed my compensation analysis was on Muilenburg and Boeing executives.

OK, Boomer.

But even this article about the Muilenburg severance seemed off to me. I mean … it’s from a Boeing press release, also from late last Friday after everyone has gone home for the weekend. And since basic forensic accounting is a skill they don’t teach in journalism school anymore, not as it conflicts with a masters degree in advocacy studies, at least, I decided to dig in a little bit myself.

So I downloaded and compiled every SEC Form 4 filing that Dennis Muilenburg has ever made.

He’s EDGAR CIK# 0001471763 if you want to check my work, btw, and I’m just trying to answer a simple question …

How much money did Dennis Muilenburg suck out of Boeing over the last ten years?

Tell you what … I’m not even going to count his salary and annual cash bonuses. Nope, you’ve gotta work hard to destroy a corporate culture as big as Boeing’s, so let’s not begrudge the man whatever tens of millions of dollars he’s been paid in cash comp. Besides, cash comp is for suckers. Just ask Jamie Dimon.

So here we go. Ready?

Over the past ten years, and prior to this past Friday’s Boeing announcement, Dennis Muilenburg has acquired or been granted more than 430,000 shares of Boeing stock (all of this information is publicly available in the SEC Form 4s). Most of this stock was given to him gratis, but he had to pay to exercise some of this as options. The total price paid for these shares by Muilenburg was $12.4 million, at an average price of $28.65 per share.

Muilenburg has sold about 70% of these shares over the years. Here’s the Bloomberg insider transaction chart showing the activity, with the green flags showing net share acquisition (albeit at cheap or no cost to Muilenburg), yellow flags for no net share change, and red flags for net share disposal (with shares sold at full market price, natch.)

Over his tenure at Boeing, Dennis Muilenburg sold about 290,000 shares of stock for a total of $54.5 million, at an average price of $189 per share. His last major sales were in late February 2019, when he pocketed about $10 million in a top-tick of the all-time high Boeing stock price of $422. For those of you keeping score at home, the first 737 MAX crash was in October 2018.

That leaves about 143,000 shares still in Muilenburg’s hands as of his last Form 4 filing, which have a current market value of $47.3 million.

So over the past ten years, Dennis Muilenburg has $54.5 million in realized stock gains and $47.3 million in unrealized gains, at a cost basis to him of $12.4 million. That’s $89.5 million.

Once you buy a prize, it’s yours to keep!

And now we come to the Boeing announcement last Friday, which you can also read in all its gory detail on the SEC site.

First there’s $29.4 million in “long-term incentive awards”. LOL. Amazing how there’s never a “long-term clawback”.

Then there’s $28.5 million in pension and deferred compensation benefits. Then there are options that Dennis can exercise on 73,000 shares at an average strike price of $76 … that’s worth another $18.5 million at the current stock price. And finally, there’s $4.3 million in still more stock that Boeing has decided to give him.

All told, that comes to $80.7 million as Dennis Muilenburg is shown the door.

But don’t call it severance.

All told, that’s more than $170 million that Dennis Muilenburg has pocketed from Boeing in stock-based comp and “incentive awards” and don’t-call-it-severance payments, not even counting his salary and bonuses.

Oh, did I mention that Dennis is on the board at Caterpillar, too? They’ve only given him $2 million in stock, plus a couple hundred grand a year in cash comp.

One day we will recognize the defining Zeitgeist of the Obama/Trump years as an unparalleled transfer of wealth to the managerial class.

#BITFD.


Normalize This


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I feel like the Billy Crystal character in Analyze This all the time. There’s always some mob boss politician or central banker or CEO or asset manager pinching my cheek and telling me that it’s all gonna be okay, that I’ve just gotta understand how things are.

My god, I am so tired of having my cheek pinched.

I am so tired of being nudged in such an artless, heavy-handed way.

I am so tired of being told that 2 + 2 = 5.

Yesterday it was one of the asset managers pinching my cheek, a senior partner at Baillie Gifford, a firm that manages over $200 billion. Here’s his FT Opinion piece.


Japan’s GPIF is right — short selling is downright irresponsible  [Financial Times]

“Stock and bond markets, together with their investors, have a higher purpose than mere profit: their ultimate function is to provide capital to companies creating wealth for the benefit of wider society. This is best achieved through taking a long-term perspective and considered decisions.”

“What is the value created through stock lending? Those who defend the practice cite setting fair prices as an important outcome. But how valuable or helpful is this to the broader mission? Is such price discovery really helpful or necessary?”

“Baillie Gifford does not lend out stocks for our investment trusts or mutual funds, though many of our segregated clients do so, by their own choice. GPIF should be applauded for taking the long term and principled view of its responsibilities and hopefully more of our clients will follow its example.”


I mean, this is a sentence actually published by the FT in a non-ironic sense:

Is such price discovery really helpful or necessary?

As the kids would say on Twitter, let that sink in.

What is a Nudge?

It’s an article like this, pinching your cheek and telling you that of course it’s okay if market regulators decide to institutionalize GPIF’s “responsible” decision to stop lending out stock for short-sellers. After all,

Stock and bond markets, together with their investors, have a higher purpose than mere profit.

What do I mean when I say that capital markets have been transformed into a political utility?

This.

This is the water in which we now swim.

Or to use another vocabulary in vogue these days, it’s a method of normalizing an exceptionally non-normal world, where price discovery is something to apologize for, something distasteful and uncouth, like farting loudly in public.

from Hypernormalization, by Adam Curtis (2016)

This is a cover shot for a BBC documentary by Adam Curtis, called Hypernormalization. It is, in the words of The New Yorker, “painting a picture of a world increasingly dominated by the false reality put forth by corporations and politicians.” In Curtis’s own words, channeling Alexei Yurchak:

“No one could imagine any alternative. You were so much a part of the system that it was impossible to see beyond it. The fakeness was hypernormal.”

Yep, that’s the Zeitgeist. That’s Fiat World. That’s the Long Now.

But I see people waking up to this. I get hundreds of emails every week from people opening their eyes.

Change is coming. Not from above, but from below. Yes to tear down, but also to rebuild.

Tick-tock.


The Long Now


PDF Download (Paid Subscription Required): The Long Now


Every year, I try to put together a series of notes that captures where I think we are, from both a political and investment perspective. This year, that series is The Long Now. I’ve compiled the four notes in that series into a single PDF, attached here.

The kicker here is that I think both parties have embraced a profoundly destructive meaning to the fiscal powers of the State – to tax and to spend. When the tether between taxes and spending is severed – and make no mistake, both the Republicans and the Democrats have been working to this end for 20+ years – then taxes become a pure mechanism for the exercise of government power. They don’t exist to pay for government programs. They exist to satisfy the ruling regime’s conception of justice, equity and retribution for prior wrongs done by the other side. Again, this isn’t a partisan thing. This is a power thing. This is a Management thing.

Regardless of who wins the 2020 election, I believe we are going to be buffeted by punitive fiscal policies in the years to come … punitive on the tax side in the usual sense, where the rich and the old will be pitted against the non-rich and the non-old, back and forth … punitive on the spend side in the inflationary sense, where we will all feel the bite of a monster we haven’t seen in 40+ years.

You know, there was an article in the Wall Street Journal today, titled “China is Taking No Chances with Stagflation”. As if this were something that could be banished by fiat … as if soaring pork prices and declining growth would cease to exist if Chinese citizens were just TOLD that they didn’t exist.

As with every “outlook” or “analysis” article in the WSJ that talk about China, I took this as a crystal ball for what’s coming down the pike in the US in 6-12 months. Seriously. It’s uncanny how that works. (and the subject for another note another time)

So yes, that’s what I think is going to be the Big Story for the next several years … disappointing growth + alarming inflation + a government that tries harder and harder to TELL us that everything is wonderful. A United States that becomes more like China *politically* as well as economically. Smiley-face totalitarian flirtations on the political front, and old-fashioned stagflation on the economic front, all bearded by a stock market that has been transformed into a propped-up-at-all-costs political utility.

The thing is that – depending on where you stand in the pecking order – it won’t feel that BAD as the world is undone by inflation and the politics that comes with it. As the country song goes, “Funny how fallin’ feels like flyin’ … for a little while”. But this IS what undoes us.

We need to get together and talk about all this. Maybe I’m wrong about The Long Now. Maybe I’m exaggerating the issues here. Wouldn’t be the first time. But right or wrong I think we’d all be well served to connect in person and share our ideas and observations. Stay tuned for details on timing and location … probably early fall before the election. Let me know if you’d like to help.

The Long Now, Pt. 4 – Snip!


PDF Download of single chapter (paid subscription required): The Long Now, Pt. 4 – Snip!


PDF Download of entire series (paid subscription required): The Long Now


The Long Now is everything we pull into the present from our future selves and our children.

The Long Now is driven by the constant stimulus applied to our economy and the constant fear applied to our politics.

The Long Now is personal.

Tick-Tock

The Long Now is political.

Make – Protect – Teach

The Long Now is micro.

Wink

Today’s note is on the macro structure of the Long Now.

Today’s note is on the untethering of fundamental linkages between the economic policies that organize our social lives as investors and citizens.

SNIP!

Today’s note is on how we survive the Long Now. Because it won’t be easy.


That’s George Clooney in Gravity, right before he ends up like this.

The spacewalking astronaut, risking the abyss with only a slim tether to life, is a powerful trope. Gravity was an entire movie about that frisson of fear we get from these images, although for my money it doesn’t get better than Frank Poole’s murder by HAL in 2001: A Space Odyssey, with the looong shot of the body tumbling uncontrollably through space. Because it’s not just the aloneness and abandonment that sparks our hard-wired emotional response here, but the out-of-controllness of being truly untethered.

We’ve got happy-ending movies that use this trope (The Martian), Russian movies that use this trope (Spacewalker), and even haunted-house-in-space movies that use this trope (Event Horizon). So you’ll forgive me if I’m going to use this imagery, too, because it’s the best story-telling device I know to instill in you the fear and loathing I feel when I think through the consequences of the Long Now.

SNIP! is the Long Now’s destruction of the meaning of words that define our social connections.

Words like “war”.

This is a picture of the Predator drone firing a Hellfire missile. It’s probably going to kill someone that we want dead, and almost certainly going to kill some other people that we don’t mind being dead … collateral damage and all that. As they say on Succession, you can’t make a Tomlette without breaking a few Greggs. This is war, and we fire these missiles all over the world, on the daily, both in countries we have officially invaded, like Afghanistan, and in countries we haven’t, like Pakistan and Yemen.

But we have redefined war to NOT mean things like drone and cruise missile attacks, to NOT mean things like “observer” or “training” missions. We have redefined war to ONLY mean American troops being shot at.

So politicians can speak the words “End the war in Country XYZ!” without actually meaning it. Because what they mean is preventing any American troops from being shot at. But the actual war of drones and missiles and killing … that continues. And it will continue forever in the Long Now.

Words like “capitalism”.

This is a picture of the billionaire CEO of a government-supported too-big-to-fail megabank, telling his 60 Minutes interviewer that he has no control over his compensation, as that’s determined by the CEO’s board of directors. Interestingly enough, this is also a picture of the billionaire Chairman of that board.

And it’s not just the billionaire CEO bank manager. It’s his centimillionaire lieutenant bank managers. It’s the dozens of decamillionaire sub-lieutenant bank managers. All of them made generationally rich from stock-based compensation in a company where the government guarantees their success. None of them entrepreneurs. None of them risk-takers with their own skin in the game. All of them … lifer managers of a too-big-to-fail bank.

But, hey, the stock is up! They’ve done a good job! What’s the problem, Ben?

That’s exactly the problem. The problem is that we have redefined capitalism to mean “the stock is up”. We have redefined capitalism to NOT mean Smith’s invisible hand or Schumpeter’s creative destruction or productivity-enhancing and risk-taking investments in the real economy. We have redefined capitalism to ONLY mean financial asset price inflation in the here and now. By any means necessary. So that’s what we get. From the Fed, from the White House, from corporate management … that’s what we get in the Long Now … an endless series of policies and decisions in service to capitalism-as-financialization, where capital markets are maintained as a political utility.

George Orwell, who called the Long Now an “endless present, where the Party is always right”, understood how the most powerful weapon of a totalitarian society is to control its language, so that War IS Peace, Freedom IS Slavery, and Ignorance IS Strength.

Why? Because control over the meaning of words is control over how we THINK. When we no longer remember what words mean, when we are TOLD over and over again a NEW meaning … we start to doubt ourselves. We start to doubt our own autonomy of mind. And that’s when they win.

Iakov Guminer, Arithmetic of an alternative plan (1931)

In the end the Party would announce that two and two made five, and you would have to believe it. It was inevitable that they should make that claim sooner or later: the logic of their position demanded it. Not merely the validity of experience, but the very existence of external reality, was tacitly denied by their philosophy. The heresy of heresies was common sense.

And what was terrifying was not that they would kill you for thinking otherwise, but that they might be right.

— George Orwell, 1984

The Long Now is the Fiat World of reality by declaration, where we are TOLD that inflation does not exist, where we are TOLD that wealth inequality and meager productivity and negative savings rates just “happen”, where we are TOLD that we must vote for ridiculous candidates to be a good Republican or a good Democrat, where we are TOLD that we must buy ridiculous securities to be a good investor, and where we are TOLD that we must borrow ridiculous sums to be a good parent or a good citizen.

And the most terrifying thing is that you start to think they might be right.

Hey, maybe the whole Ukraine thing really is Trump “fighting corruption” and maybe the whole Saudi thing really is Trump “bringing the troops home”. Maybe the really important thing about Jeffrey Epstein is whether or not he committed suicide. Maybe we should really try some “democratic socialism” in 2020 … how bad could it be?

Self-doubt is a biologically terrifying condition for a social animal like humans, and that’s why you see more and more of us becoming rhinoceroses. That’s why you see more and more well-meaning citizens willingly give over their autonomy of mind to the MAGA Train or the Bernie Bros … some sort of social Answer with a capital A … so that the torture of self-doubt can end.

That’s why, in the end, Winston loved Big Brother.

And make no mistake, the Answer is always totalitarian. Not merely authoritarian, but totalitarian. It brooks no dissent, in ANY aspect of your life. The Answer is a general closed-form solution, something we are hard-wired to want, but something that is impossible to find in a social system. Yes, this is the Three-Body Problem.

Unfortunately, I believe that the totalitarian Long Now is going to get a lot worse before it gets any better. I believe that we are going to doubt ourselves in new and profound ways over the next decade. I believe that our common sense will become even more the heresy of heresies.

Why?

Because the Long Now has redefined the meaning of “taxes”.

Because the tether between taxation and spending – the most important macroeconomic policy relationship for our lives as both investors and citizens – has been severed.

Oh, I know that this snip-of-no-return doesn’t feel bad. Yet. In fact, it probably feels pretty darn good to you right now.

Funny how fallin’ feels like flyin’

For a little while

That’s from a song in the movie Crazy Heart, and that’s where we are right now. So yeah, you’re going to be told that 2 + 2 = 5, that it’s no big deal to cut the cord between taxes and spending, that in truth it’s good for you. And yeah, you’re going to start to think that they might be right.

The redefinition of taxation and the severing of the Tether of Meaning between taxes and spending isn’t something that I think WILL happen. This is something that I know HAS happened. We’ve had a steady fraying of this cord for about two decades now, ever since Al Gore’s idea of a Social Security “lockbox” (where those taxes could ONLY be used for Social Security spending and paying down the existing debt)  was met with derision rather than acclaim by both parties. Yes, both parties. By steady fraying I mean over both Republican and Democrat administrations. The political beneficiaries of the fraying are different when it’s Republicans doing the snipping or Democrats doing the snipping, but the INTENT – to eliminate the tether between taxation and spending – is the same whether you’re George Bush or Barack Obama. Or Donald Trump. Destroying the relationship between taxation and spending is not a partisan thing. It’s a power thing. It’s a Management thing.

I mean, there are still people who believe that the money they pay in Social Security taxes is their money, that they’ve purchased some sort of old age income insurance plan with their money, like an annuity where their money is invested somewhere to support that income down the road.

But that’s a lie.

In truth there is ZERO relationship between social security taxes and social security benefits today, other than sharing the words “social security”. In truth they are two entirely separate government programs, the former a regressive tax on workers that goes into the big pot of the annual budget and the latter a wealth transfer program to old people that comes out of that budget.

SNIP!

So for twenty years Republicans and Democrats have gone back and forth to steer taxation and spending to their political advantage, with divided government being the only thing to keep the tether intact. But divided government vanished with Donald Trump’s election, and as a result we got the 2017 Tax Cuts and (LOL) Jobs Act, which I think was the final cut.

What did the TCJA do? It lowered taxes by trillions without reducing spending by a dime.

The TCJA levered up the United States of America.

Management levered up our country and used the proceeds to provide a windfall gain for corporations and the rich. You know … “returning capital to job creators”. In exactly the same way that Management might lever up a company and use the proceeds for a big stock buyback. You know … “returning capital to shareholders”.

Both of these narratives – “returning capital to job creators” and “returning capital to shareholders” – had a truth to them, an important truth. I believed in the important truth of both of these narratives for most of my adult life! And yes, I’m using the past tense.

Because in the Long Now, the meaning of both narratives has been perverted beyond all recognition.

Both are now part and parcel of the Trickle-Down Lie, that the crumbs that fall off massa’s table are crumbs that you wouldn’t get otherwise, so let’s celebrate all those extra crumbs. Yay, crumbs!

And yes, there’s an Epsilon Theory note or three for that.

Pecking Order

The pecking order is a social system designed to preserve economic inequality: inequality of food for chickens, inequality of wealth for humans. We are trained and told by Team Elite that the pecking order is not a real and brutal thing in the human species, but this is a lie. It is an intentional lie, formed by two powerful Narratives: trickle-down monetary policy and massive student debt financing.

This Is Water

Time to add a fourth shift in the Zeitgeist: capitalist productivity, now 200+ years old, is becoming capitalist financialization. Wall Street gets something to sell, management gets stock-based comp, the Fed gets a (very) grateful Wall Street, and the White House gets re-election.

What do YOU get out of financialization? You get to hold up a card that says “Yay, capitalism!”.

Yeah, It’s Still Water

One day we will recognize the defining Zeitgeist of the Obama/Trump years as an unparalleled transfer of wealth to the managerial class.


But if we’re no longer even pretending that taxes are necessary to support spending …

If we agree that neither the Republicans nor the Democrats care about fiscal policy except as it advances their myopic political goals …

Then what are taxes FOR?


Yep, this is our George-Clooney-realizes-he-is-about-to-be-flung-into-outer-space moment.

In the Long Now, taxes are for … justice.

In the Long Now, taxes are for … equity.

In the Long Now, taxes are for … retribution.

And what do those words mean?

Whatever Management says they mean.

Donald Trump has a vision of how to use taxes for HIS conception of justice, equity and retribution, a vision that – well, how about that! – advances his political power.

The primary beneficiaries of the TCJA are large public companies, particularly the multinationals that dominate the S&P 500. For example, in each of the past two years, Amazon has availed itself of the deductions and deferrals and lower corporate rates created by the TCJA to be a “net-negative US Federal cash taxpayer”. In English, that means that in each of the past two years, the US Treasury has written checks of more than $100 million to Amazon out of YOUR tax dollars. I know you think I’m making this up, but check out Amazon’s 10-K. It’s all there.

And before you @ me, I am NOT saying that Amazon doesn’t pay taxes. What I am saying is that I really don’t care how much Amazon pays in taxes to freakin’ Ireland. What I am saying is that Amazon is cashing checks from the US government instead of writing checks. As the kids would say, let that sink in.

How does this advance Trump’s political power? Because the windfall tax benefits that the TCJA created for large public companies like Amazon and Apple and Microsoft translate directly into higher stock prices. Because in Trump’s own words, “the stock market is my report card”. Because Trump realizes that you can politically argue to death whether the real economy is doing better or worse, but you can’t argue with a new high for the Dow Jones.

What does it mean to transform capital markets into a political utility, and use the tax code to do it?

This.

Similarly, Bernie Sanders and Elizabeth Warren and No Malarkey Joe and Mayor Pete and all the rest have a vision of how to use taxes for THEIR conception of justice, equity and retribution, a vision that – well, how about that! – advances their political power.

None of the “wealth tax” proposals you hear from the Left are being proposed to pay for anything in a budgetary sense. They are explicitly proposed so that the rich pay their “fair share”. In fact, when candidates make the mistake of expressing their wealth tax idea in a fiscal sense – as Elizabeth Warren did when she linked it to “paying for” Medicare-for-all – the narrative immediately shifts from “fairness” to “making the numbers add up” (Spoiler Alert: they don’t and they never will), and these candidates immediately take a hit in the polls.

Bernie gets it. He doesn’t even pretend to make this about budgets. He realizes that the political popularity of the wealth tax has nothing to do with making the rich pay for a government program, and everything to do with making the rich pay for their sins. And yes, Bernie believes that great wealth is a sin. He believes that great wealth should not be allowed, not because it’s a source of unaccountable political power (my beef with great wealth), but because he believes it is fundamentally unfair. So do a lot of voters, maybe more than care about the Dow Jones.

SNIP!

Feeling out of control yet? Wait, there’s more!

If the meaning of spending is no longer constrained by taxation …

Then what is spending FOR?

In the Long Now, spending is ALSO for justice and equity and retribution … ALSO in whatever mode or measure fits the regime goals of whatever Management is in power at the time.

I think that whoever is elected in 2020, we will see a $2 trillion spending plan enacted in 2021.

If it’s a second term for Trump, it will be the 2021 Make America Great Again Act, and we will call them “Infrastructure Bonds”.

If it’s a first term for a Democrat, it will be the 2021 Take Back America Act or something like that (I suppose if it’s President Biden we can hope for the 2021 No Malarkey Act, although I’m rooting for the 2021 OK, Boomer Act), and we will call them “Green Bonds”.

In either case, I expect that the Fed will monetize at least half of the bond issuance. At least half.

In either case, I expect that the primary corporate beneficiaries of the spending will be exactly the same. Exactly the same.

And so here we are.

I believe there are no limits to the retributive and malicious use of taxation as a political weapon.

I believe there are no limits to the retributive and malicious use of spending as a political reward.

Sometimes those political weapons and rewards will be used by the rich and the old against the non-rich and the non-old, as we saw with the TCJA and Trump. Sometimes it will be the other way around, as we will see the day after a Democrat takes the White House, whenever that might be.

What’s to be done? Well, I suppose this is the point where I should tell you what I would do if I were given magic genie powers to change the world from the top down. And then you’d argue with me about my proposals and tell me what you would do if given magic genie powers.

How about we not do that? I don’t have magic genie powers. And neither do you.

It’s not that the severing of taxes from spending WILL happen. It’s not that the NEXT administration is going to make the cut. It’s ALREADY happened. It’s been happening for twenty years! This ship has sailed, and now there’s not a damn thing that you or I can do to turn it around. All we can do now is survive the voyage.

When I started this note, I said I wanted to instill an emotion of fear and loathing in you from the realization that the meaning of taxes had become untethered from the meaning of government spending. That phrase – fear and loathing – is of course a catchphrase for Hunter S. Thompson, who used it in the titles of his best-known works … Fear and Loathing in Las Vegas, Fear and Loathing on the Campaign Trail, etc. Thompson had lots of catchphrases, lots of mottos, lots of great quotes. My all-time favorite, though, is this:

When the going gets weird, the weird turn pro.

I love it because there are so many plausible interpretations, and it just sounds so cool to take a tired inspirational quote about what to do when the going gets tough, blah blah blah … and turn it on its ear. Or foot, or whatever body part you think Thompson would have approved. Here’s what it means to ME.

“The going gets weird” = an economic and political environment that no one alive has experienced.

I think that the smiley-face totalitarian genie (and yes, I wrote ‘totalitarian’, not ‘authoritarian’) is going to be let out of the bottle as the meaning of taxes becomes justice, equity and retribution.

I think that the not-so-smiley-face inflation genie is going to be let out of the bottle as the meaning of spending in the real economy becomes untethered from any concern of paying for it.

To paraphrase Richard Nixon paraphrasing Milton Friedman, we’re all MMTers now. “Modern Monetary Theory” is here, firmly ensconced in BOTH political parties in the Long Now.

We’re All MMTers Now

If Trump is reelected in 2020, I think he pushes forward a $2 TRILLION bond issuance that is fully or partially monetized by the Fed. They’ll be called Infrastructure Bonds. If a Democrat is elected in 2020, I think she or he pushes forward a $2 TRILLION bond issuance that is fully or partially monetized by the Fed. They’ll be called Green Bonds. We’re all MMT’ers now.

Modern Monetary Theory or: How I Learned to Stop Worrying and Love the National Debt

Modern Monetary Theory is neither modern nor a theory. It’s a post hoc rationalization of politically expedient policy that makes us feel better about all the bad stuff we’ve done with money and debt in service to Team Elite. And all the bad stuff we’re going to do in the future.

A recession isn’t weird. Deflation isn’t weird. Authoritarian isn’t weird. I don’t think ANY of those things is coming down the pike, and you don’t need my help (or anyone else’s) if any of them does.

But smiley-face totalitarian stagflation where capital markets have been transformed into a propped-up-at-all-costs political utility?

Now THAT’S weird. And that’s what I think IS coming down the pike. And we’re all going to need all the help we can get. Which gets us to the second half of Hunter S. Thompson’s quote.

“The weird turn pro” = an all-in engagement for those who see the societal transformation; a recognition that the fundamental rules of the social game have changed, and a willingness to confront the implications of that change in every aspect of your life without surrendering to an Answer.

How do we confront the Long Now?

Personal courage
Leaders who act as stewards of the future, not managers of the Now.

Professional courage
Investors who take more risk with what’s Real, and less with what’s not.

Social courage
Citizens who take back their vote, and who refuse to play the Fool.

You know, in one of my twitter fights with Angry-Billionaires-and-their-Renfields™, I was called “a bizarre combo of Zerohedge and self-help guru”. It was meant as an insult, of course, but for me … man, I wear it like a badge. Because I DO believe, in Zerohedge-esque fashion, that “the system” is designed by and for a Team Elite that, in the immortal words of The Outlaw Josey Wales, pisses down our backs and tells us it’s raining.  And I DO believe, in self-help guru-esque fashion, that the only effective resistance to the Nudging State and the Nudging Oligarchy is through a bottom-up grassroots social movement that is driven by one thing and one thing only: each individual’s courage and determination to maintain their autonomy of mind … the courage and determination to believe that 2 + 2 = 4.

The revolution will not be televised. The revolution will not be in the streets.

The revolution will be in our hearts.

It’s the hardest thing you’ll ever do, precisely because no one will be watching.

But you won’t be alone.

In 2020, we’re going to host an international conference to come together on this, an Epsilon Theory Forum. It’s intended to be the anti-Davos … a meet-up for those who still have a soul, who care about something bigger than the celebration and perpetuation of Team Elite. And I can promise you this … there won’t be a single billionaire on a panel at the ET Forum. But there will be plenty of real people … people with ideas and experiences that aren’t contingent on how many zeros they have after their name.

Clear eyes, full hearts, can’t lose.

Make / Protect / Teach.

As wise as serpents, and as harmless as doves.

We’ve got a lot of slogans. In 2020 you’ll have a chance to take action. You’ll have a chance to talk this through with like-minded truth-seekers, to figure out TOGETHER what a bottom-up grassroots social movement devoted to preserving each and every one of our autonomies of mind can do. It may be too late to prevent the SNIP! that severs the tether between taxation and spending, but it is high time to create new tethers, new personal bonds of association, loyalty and mutual support. Yep, it’s a Pack. And that’s how we survive the Long Now. Together.

Send me an email if you want to help. And spread the word.

Yours in service to the Pack,
Ben

ben.hunt@epsilontheory.com


PDF Download (paid subscription required): The Long Now, Pt. 4 – Snip!


PDF Download of entire series (paid subscription required): The Long Now


It’s Not So Much …


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For some reason, it’s not so much the fact that Harvey Weinstein is using a walker to make his appearances in court that makes me want to burn the world down.

It’s the popped collars.

It’s the bevy of 400-pound “assistants”.

What a freakin’ charade.


Harvey Weinstein, Ex-Associates, Accusers Reach Tentative $47 Million Settlement    [Wall Street Journal]

“Harvey Weinstein, his former associates, insurers and accusers have reached a nearly $47 million tentative settlement of almost all the civil cases pending against him, about $25 million of which will compensate women who have accused the Hollywood producer of sexual misconduct, according to people familiar with the matter.”


For some reason, it’s not so much the fact that only $25 million of the $47 million settlement is going to the actual victims of this serial rapist that makes me want to burn the world down.

It’s that the settlement will be paid for by insurance policies.

It’s that more money is going to creditors of the film studio ($7 million) than is going to the women who actually brought the civil suit ($6 million).

It’s that $12 million is going to pay the lawyers who defended Weinstein’s partners.

It’s that $1 million is going to Weinstein himself to defend him against accusers who didn’t join the settlement.

I think Harvey Weinstein will be acquitted in his criminal trial … or at worst he’ll plead out to a much lesser set of charges. And when that happens, he’s golden. He’ll still have all his money. He’ll still have his freedom. He’ll still have an audience willing to pay attention to what he says. Maybe he’ll move to France and hang out with his hero, Roman Polanski.

If you don’t see that there is one set of rules for the very rich and another set of rules for everyone else … if you don’t see that there is an unaccountable political power that accrues to the very rich in both big social ways and in small personal ways … well, you’re just not paying attention.

When I was boy, I would stand up every morning in school and pledge allegiance to a flag that promised liberty and justice for all. I bet you did, too.

More and more, I think we were played for fools.



New on ET Pro: the Debt and Credit Monitor

One of our original macro narrative Monitors attempted to analyze the US credit cycle, but we rarely got enough media articles in a given month to generate robust results, so we placed it on hiatus. Recently, however, we (and once again this is the royal we … it’s actually all Rusty) hit upon a clever way to recast our search queries so that we think we are now able to capture a decent narrative signal on debt and credit markets. Here’s the narrative map for Debt and Credit in November, first colored by cluster topics and then colored by sentiment (you can see the high resolution graphics in the Monitors document):

We’ve got three takeaways from these maps and the prior 12 months of narrative analysis with the new query formulation:

  1. After a mid-year bout of complacency in credit markets, the past few months have seen a rapid acceleration in cohesion (focused and connected narrative topics) mostly around a negative sentiment narrative of concern regarding leveraged loans, CLOs, and the liquidity of CCC loans.
  2. This is taking place as the proportion of articles we measure as Fiat News (highly opinionated/editorial articles) has risen consistently. Missionaries are increasingly promoting the idea of a ‘coming collapse’.
  3. At the same time, however, there is also an almost equally positive sentiment narrative building around technology-based lending solutions in consumer credit.

We’re going to do more with credit narratives in 2020, as we know that a lot of our Professional subscribers work in FI and credit markets. If you have questions regarding our Debt and Credit Monitor, please give us a shout!

That brings our total of ET Pro Monitors to six, covering:

  1. Inflation
  2. Central Banks
  3. Trade and Tariffs
  4. US Recession
  5. US Fiscal Policy
  6. Debt and Credit

Of the six, Trade and Tariffs remains the most dominant in terms of narrative attention. It’s also relatively coherent, as it remains dominated by US-China vocabulary. But I want to highlight two really striking (to me, at least) narrative phenomena happening here:

  1. As described in the last several emails I’ve written you (“Silly Season” and “The Sillier Season”), coherence continues to collapse across almost all macro narrative categories. What does this mean? It means this is a market waiting for a Big Narrative from a Big Missionary. Could be a positive narrative and it could be a negative narrative. But the will-they-or-won’t-they-sign-a-deal narrative regarding the US and China, what I’ve described at length as a game of Chicken where no odds are assignable, is no longer enough to move markets up or down with any sort of narrative half-life. I think that if nothing else, we’ll get a Big Narrative of some sort coming out of the Iowa caucuses in early February. Maybe that will be a market-positive narrative. Maybe that will be a market-negative narrative. Maybe we’ll get something else before then. But right now there is nothing to serve as a narrative engine – risk-on or risk-off – for this market. God help us, but fundamentals and stock-picking might actually matter for a while. I’d be long dispersion while this continues.
  2. The other really striking finding is in regards to the inflation narrative. Attention has collapsed, as has cohesion. This is the most complacent narrative structure around inflation that I’ve ever seen. If you’re looking for an asymmetric trade, where a little narrative shock could go a loooong way, this is where you need to spend some time.

And that leads to a final thought. It’s been a fantastic year of growth here at Epsilon Theory, and we truly couldn’t have achieved that without your support. We are more committed than ever to being an independent voice for original research and original thinking, and the Professional subscriber base is our most important resource for ensuring that. THANK YOU!

Happy holidays (and yours in service to the Pack),

Ben

Presented Without Comment


Former Purdue CEO Mark Timney (L) and former Uber CEO Travis Kalanick (R)

Every day we run the Narrative Machine on the past 24 hours of financial media to generate a list of the most linguistically-connected and narrative-central individual stories. We call this The Zeitgeist and we use it for inspiration or insight into short-form notes that we publish a couple of times a week to the website. To receive a free full-text email of The Zeitgeist whenever we publish to the website, please sign up here. You’ll get two or three of these emails every week, and your email will not be shared with anyone. Ever.

Below are two of the most narrative-central articles in financial media today. I’m going to leave this here, as the kids would say, without comment, because I’ve been railing on this topic for quite a bit lately (Yeah, It’s Still Water, When Was I Radicalized?, The Rake, OK Boomer).

But I’ll just say this:

Regardless of your personal views pro or con, if you don’t see that a powerful narrative backlash is forming against corporate management enrichment, you’re just not paying attention.


CEO Named in Opioid Lawsuits to Reap $68 Million for Year’s Work  [Bloomberg]

“Mark Timney faces the kind of allegations that can end careers. The former Purdue Pharma LP chief executive officer is accused of playing a key role in fueling the opioid crisis, according to scores of lawsuits by state attorneys general and others. They allege that he directed staff to mislead doctors about the addictiveness of painkillers, which devastated communities across the U.S.”

“Last December, about 18 months after leaving Purdue, Timney became CEO of Medicines Co., a Parsippany, New Jersey-based biotech firm with an experimental cholesterol-lowering treatment for cardiovascular disease. Last week, Swiss pharmaceutical giant Novartis AG agreed to buy it in a $9.7 billion deal that’s expected to be completed early next year. Timney’s stock options and small stake in Medicines are valued at $87.6 million at the offer price of $85 a share. After excluding the cost of exercising the options and the money he paid to acquire the shares, his take will total $68 million.“


Uber’s former CEO Travis Kalanick cashes in another $93 million in stock as he separates himself further from the rideshare giant [Business Insider]

“Former Uber CEO Travis Kalanick continued his ongoing share sell-off into December, cashing in more than $93 million after selling the company’s stock over a three-day period.”

“Kalanick’s combined sales now ring in at more than $1.8 billion since Uber’s post-IPO lockup period expired on November 6.”


The Sillier Season

Every day we run the Narrative Machine on the past 24 hours of financial media to generate a list of the most linguistically-connected and narrative-central individual stories. We call this the “Zeitgeist” and we use it for inspiration or insight into short-form notes that we publish a couple of times a week to the website. It’s usually pretty obvious why the articles rise to the top of our natural language processing (NLP) metrics, as they tend to be about specific companies or specific market events … topics where you see the headline and think “oh yeah, I understand why this article is appearing in financial media.”

Until recently, that is.

For example, Rusty wrote a brief note today (“Our Dumb World”) about one of the highest scoring financial media articles, “Amazon Removes Auschwitz Christmas Ornaments, Bottle Openers After Outrage”. This is as horrible as it gets, but we’ve been having lots of weird or off-narrative articles scoring high for narrative relevance recently. The same weird article never stays in the Top Ten from day to day, but it’s another weird flash-in-the-pan article day after day.

I think it’s related to the observation I sent you a few weeks ago (“Silly Season”) where I mentioned the low attention and coherence scores we were seeing across all of our macro narrative Monitors. It led me to ask a Big Question, one that I didn’t have an answer for:

At what point, if ever, do political narratives about Inflation and Fiscal Policy become market narratives about Inflation and Fiscal Policy?

We won’t have this month’s macro Monitor analysis completed for another few days, but I’ll tell you what it feels like to me. It feels like the lack of coherence around our “standard” macro narratives like Inflation or Central Banks or Recession has expanded into a lack of coherence around ANY market narrative, standard or not, macro or not. It’s like anything goes in financial media over the past few months, where not only is the ground unsteady beneath our feet in the real-world of market or company fundamentals, but it’s ALSO unsteady in narrative-world.

It feels like literally anything could happen in narrative-world. I honestly can’t imagine anything that would surprise me, or anything that would make for an investable move in markets, up OR down. It’s like the narrative-world heart is just quivering without a stable rhythm or beat of any sort.

We need a defibrillator.

Can you believe that the Iowa caucus isn’t until February? I think that’s going to be the defibrillator, the first real-world electoral result that begins to focus the political competition that’s going to dominate 2020 markets. That’s when I think political narratives start to become coherent market narratives.

Until then … the silly season is going to get even sillier.

The Rent Is Too Damn Low

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My favorite part of the Jimmy McMillan ouevre is the gloves.

And while I completely agree with McMillan that the rent is too damn high when it comes to urban apartments, I’m not talking about housing rents in this Zeitgeist note. I’m talking about the rental price of money. I’m talking about interest rates.

The problem with money is that the rent is too damn low.


Fed Repo Action Oversubscribed in Clamor for Year-End Funds   [Bloomberg]

“The Federal Reserve Bank of New York’s operation to inject cash into the financial system over the end of the year was oversubscribed on Monday, indicating a thirst for year-end funding.”

“Market participants submitted $49.05 billion in bids for the Fed’s 42-day term repo operation, which matures Jan. 6, 2020. That was more than the $25 billion on offer. This was the first of three term operations to provide funding past the year-end period. The others will be held in the coming weeks.”

“Even with the Fed’s commitment to continue providing liquidity to the financial system around year-end, the market is still showing concerns. This is due to banks’ year-end balance-sheet constraints related to capital surcharges and other regulatory requirements.


This $25 billion in term loans is in addition to the overnight repo facility, btw, which clocked in at something like $60 billion or thereabouts.

But, hey, it’s all good, people!

This is due to banks’ year-end balance-sheet constraints related to capital surcharges and other regulatory requirements.

WHY are the Fed repo operations a never-ending garbage fire? WHY is the Fed facing an apparently insatiable demand for cash and very short-term liquidity?

Because the banks are over-regulated, that’s why.

Jamie Dimon wants you to know that if only our Too Big To Fail banking institutions were “unleashed” from those awful post-GFC capital requirements, why then, by golly, JP Morgan and all the other primary dealers would be only too happy to step into the breach and provide more short-term liquidity from their reserves. They’d be doing that right now if not for those pesky capital requirements!

LOL.

Look, you can’t blame Jamie Dimon for taking advantage of the Fed’s impossible position in order to push for rolling back capital requirements and freeing up more cash to “return to shareholders”. You can’t blame Jamie Dimon for his Jamie Dimon-ness. It’s his nature.

After all, Jamie Dimon is the rake.

No, I can’t blame Jamie Dimon for trying the ole “awkshually, the problem is too much government regulation” line. But I can sure blame everyone else for parroting it.

It’s just another variation on the trickle-down economics song, that if only you’d use government policy to improve the heaping portion of profitability on a giant private enterprise’s plate, then enough crumbs will fall off that plate so that everyone eats a little better.

“Yay, crumbs!”

Yep, this is “capitalism” in the Long Now, where a government agency makes the money and sets the price of money and then sells it to a government-selected banking oligopoly that resells it for a profit. And then complains about their cut.

Money is a completely rent-controlled market. It’s Jimmy McMillan’s dream world, where the rents are never too damn high but are always so damn low.

And just like all rent-controlled markets, it’s the rich and the well-connected who make out like bandits.

But everyone who would throw an unholy temper tantrum at – gasp! – rent-controlled apartments is just fine with the manager of that banking oligopoly being a billionaire and his chief lieutenant managers being centimillionaires and a gazillion of his sub-lieutenant managers being decamillionaires.

Everyone is just fine with the manager of that government agency being a centimillionaire and his predecessors being decamillionaires.

Everyone is just fine with the current President being a billionaire and his predecessor doing everything in his power to become a billionaire and now two more billionaires deciding to run for President.

What’s the problem for the Fed and its repo operations?

The rent-controlled price of money is too damn low.

What’s the problem for American citizens and our democracy?

We sold our birthright for a mess of pottage, and we don’t even see that we were taken.


Sneak Preview

I was invited by the Financial Times to write a guest post on my recent windmill-tilting exercise of calling attention to how corporate management is using increasingly large stock buybacks to mask increasingly large stock-based comp packages issued to themselves. That post should appear in the Market Insights column online next Monday and on the back page of the paper next Tuesday (possibly this Friday), but I thought I would give you all a sneak preview today!

I think (hope) that it’s the sort of article that can create a bit of a stir on its own, so I’ve toned down some of my more incendiary language on stock buybacks that I might use on Twitter. At the bottom of the piece, I’ve also appended my notes to the FT editor so that you can see the math behind the “Lycroloft” example. MSFT 10-K available for download here.

If you’ve missed any of the notes I’ve written to date on the topic, here are the links:

Yeah, It’s Still Water (Texas Instruments)

When Was I Radicalized? (Boeing)

The Rake (JP Morgan)

OK, Boomer (FedEx … not directly on this topic, but of somewhat related interest)

As always, I’m keen to get your take on this. And if you happen to run through your favorite company’s 10-K and find something interesting to relate, I’m all ears! – Ben

******************************************

In poker, the rake is the cut that the casino dealer takes out of every pot. It’s usually a couple of dollars per hand … barely noticeable, certainly not to a donkey poker player like me.

But what if the dealer started taking 10% out of every pot? Would you notice then? How about 20%? How about 70%?

That’s what many large public companies are doing today, taking a rake of anywhere between 10% and 70% from the “pot” of stock buybacks – the hundreds of billions of dollars that these corporations make as a “return of shareholder capital” every year.

And no one is noticing.

This is the agency problem, a classic conundrum of economics, where shareholders’ agents – corporate management – find ways to enrich themselves at the expense of shareholders by gaming the system.

How does this latest incarnation of the agency problem work? Through massive stock issuance programs, masked and sterilized by even more massive stock buyback programs.

When a company issues new shares to employees with one hand (at a low price) and buys back those shares on the open market with the other hand (at a higher price), that price difference multiplied by the number of wash-traded shares equals value that never reaches shareholders at all, but is entirely captured by the recipients of the new shares. Please note that this value is lost to shareholders and captured by the employees whether or not their new shares are sold back to the company in the open market buyback operation. It’s an accounting identity. As the “Yay, stock buybacks!” crew likes to say, it’s just math.

For example, let’s say a company whose name rhymes with Lycroloft trumpets a big stock buyback program in their year-end earnings call, where they “returned capital to shareholders” in the prior 12 months by spending $16.8 billion to buy back 150 million shares of common stock on the open market. Sounds great, right? Very shareholder friendly!

But let’s also say that same company issued 116 million brand new shares to employees over those same 12 months as a result of employees exercising their stock options or vesting their previously restricted stock units (RSUs). The company receives some cash from their employees as these options are exercised and RSUs are vested (about $1.1 billion in this case), but obviously these new shares are being issued to employees at a dramatically lower average price than the average price of the same year’s open market buyback activity.

As a result, more than 60% of the total buyback “pot” that we donkey investors thought was coming to us as shareholders, close to $12 billion for this one company in this one year, is actually being raked by management to distribute among themselves.

Is this rake widely distributed among corporate employees? There’s no clean data on this, as – quelle surprise! – companies provide next to zero detail on the recipients of new stock issuance in their 10-Ks. What’s clear, however, from even a cursory review of the stock holdings of “insiders” at any big public company (Form 4 in SEC-speak), is that senior managers have done particularly well in this new regime of more stock issuance sterilized by more stock buybacks.

It’s not only CEO billionaires like Jamie Dimon, who owns more than 7 million shares of JP Morgan stock, or near billionaires like Tim Cook, who sold $114 million of freshly granted Apple stock just this August. It’s not only independent directors like Al Gore, who was issued 80,000 shares of Apple stock over the past two years, worth $21 million, after selling $38 million worth of stock in 2017. It’s the centimillionaire COOs and CFOs. It’s the legion of decamillionaire vice presidents and business line managers.

I think it’s a historic wealth transfer from shareholders to the managerial class. Not to founders or entrepreneurs or risk-takers. To managers.

What’s to be done? Here are three suggestions to start changing the incentives of rake-taking dealers.

  1. Separate the CEO and Chair positions of publicly traded companies. When the Chair of JP Morgan, Jamie Dimon, says in his 60 Minutes interview that the board independently sets the salary of the CEO of JP Morgan, also Jamie Dimon, we may be forgiven our incredulity. Let’s remove this obvious vehicle for the agency problem.
  2. No stock-based compensation for independent directors. Cash only. Let’s not give guardians of the shareholder hen-house any fox-like incentives.
  3. No exercise of stock-based compensation by ANY directors, independent or not, while they serve on the board. Again, hen-house. Again, fox-like incentives.

We’re never going to eliminate the agency problem, and the dealer deserves a proper rake. But we better start making this casino fairer to shareholders and less of a wealth transfer engine to the managerial 1%. Or someone is going to burn the casino down.

************************************

Notes to FT editor …

  1. On Microsoft …  see page 72 of 157 in the PDF (pg 44 of the original doc) for the FY 2019 open-market share repurchase of 150 million shares for $16.8 billion. Note that some sources like Bloomberg show total share repurchases for FY 19 were $19.5 billion, but that includes $2.7 billion that MSFT used to repurchase stock directly from management for tax withholding purposes, NOT open-market buyback operations. The note on the $2.7 billion (as well as more info on the open-market buyback) is on page 132 of 157 in the PDF.
  2. Also on Microsoft … see page 131 of 157 in the PDF (pg 85 of the original doc) for the FY 2019 new share issuance of 116 million shares. The $1.1 billion in funds received for that issuance is on page 85 of 157 in the PDF.
  3. The math on Microsoft is as follows … $16.8 billion spent on open-market buybacks divided by 150 million shares is an average price paid of $112.00 … $1.1 billion received on 116 million shares in an average price received of $9.48 … the difference in price per share paid and price per share received ($102.52), multiplied by the number of wash-traded shares (116 million), is the value received by employees ($11.9 billion). The total buyback “pot” is $19.5 billion ($16.8 b in open-market purchases + $2.7 b in direct-to-mgmt purchases), and $11.9 billion is 61% of that.

OK, Boomer


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How FedEx Cut Its Tax Bill to $0   [New York Times]

“The company, like much of corporate America, has not made good on its promised investment surge from President Trump’s 2017 tax cuts.”

“Nearly two years after the tax law passed, the windfall to corporations like FedEx is becoming clear. A New York Times analysis of data compiled by Capital IQ shows no statistically meaningful relationship between the size of the tax cut that companies and industries received and the investments they made. If anything, the companies that received the biggest tax cuts increased their capital investment by less, on average, than companies that got smaller cuts.”

“FedEx’s financial filings show that the law has so far saved it at least $1.6 billion. Its financial filings show it owed no taxes in the 2018 fiscal year overall. Company officials said FedEx paid $2 billion in total federal income taxes over the past 10 years.”


Fact check: TRUE.



Fact check: ALSO TRUE.


I think FedEx is one of the crown jewels of Western capitalism. This is a company that has invested (and continues to invest) billions of dollars in the US economy, creating (and continuing to create) tens of thousands of jobs.

I think FedEx can spend whatever tax cut windfalls they might receive in whatever way is best for their shareholders. There’s nothing unfair or wrong about that.

I think Fred Smith is one of the crown jewels of Western capitalism, too. His personal story is an inspiring one of risk-taking and patriotism.

I think Fred Smith, entrepreneur and risk-taker, can be as rich as he wants to be, and there’s nothing unfair or wrong about that, either.

But here’s the thing …

If I hear another lecture from Fred Smith and his fellow billionaires on trickle-down tax cuts and the “benefits to the United States economy, especially lower and middle class wage earners”, I’m going to lose it.

If I hear another lecture from Jay Powell and his fellow centimillionaires and decamillionaires at the Fed on trickle-down monetary policy and the “benefits to the United States economy, especially lower and middle class wage earners”, I’m going to lose it.

OK, boomer.


What’s the boomer world?

It’s a world where our current President is an on-the-make billionaire, and our most recent former President seems hell-bent on becoming one. A world where lawyers from Citadel write our securities regulations, and VPs from Boeing run our Defense Dept. A world where corporate managers can become billionaires – not by innovation or risk-taking – but by stock-based comp at scale. A world where asset managers can become billionaires – not by invention or outperformance – but by asset-gathering at scale.

It’s a world that has been systematically hollowed out for decades, through narrative capture of monetary policy, trade policy, antitrust law, mass media and the tax code.

“Yay, trickle-down economics!”

It’s a bipartisan thing. It’s a Zeitgeist thing.

And the 2017 Tax Cuts and (LOL) Jobs Act was just the latest smiley-face punch in the gut.

Worried about losing your freedom to a redistributive State? I think you’ve already lost it.

Just not in the direction you thought.


The Rake

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In a poker game, the rake is the cut that the casino dealer takes out of every pot. It’s usually a couple of dollars per hand … barely noticeable, certainly not noticeable to a casual poker player like me.

But what if the dealer started taking 18-25% out of every pot as his rake? Would you notice then?

That’s what JP Morgan management does with its “return of shareholder capital” through stock buybacks.


Cramer: Jamie Dimon, when questioned about $31 million pay, should have said he’s worth it   [CNBC]

“I would’ve said, ’Look I know you think that I may be overpaid but I do point out that others have shared in the wealth,” the “Mad Money” host says.


In 2018, JP Morgan bought back 181.5 million shares of stock for $20 billion. Also in 2018, JP Morgan issued 32 million new shares to management (18% of buyback). Those newly issued shares were worth $3.5 billion then, and are worth $4.2 billion today.

In 2017, JP Morgan bought back 166.6 million shares of stock for $15.4 billion. Also in 2017, JP Morgan issued 31 million new shares to management (18% of buyback). Those newly issued shares were worth $2.9 billion then, and are worth $4.03 billion today.

In 2016, JP Morgan bought back 140.4 million shares of stock for $9.1 billion. Also in 2016, JP Morgan issued 38 million new shares to management (27% of buyback). Those newly issued shares were worth $2.5 billion then, and are worth $4.94 billion today.

Were these newly issued shares spread evenly throughout the company, perhaps as part of an employee stock ownership program (ESOP)?

No. In each year, there were fewer than 1 million shares issued for the JP Morgan ESOP program, less than 3% of the dilutive issuance. Senior management received more than 97% of the newly issued shares.

Today, Jamie Dimon owns more than 7.8 million shares of JP Morgan, worth more than $1 billion. Some of these shares were purchased by Dimon on the open market. Most of them were not.

There are several JP Morgan senior executives listed on Form 4 who are centimillionaires from their stock holdings. More than a dozen are decamillionaires, most several times over.

One day we will recognize the defining Zeitgeist of the Obama/Trump years for what it is: an unparalleled transfer of wealth to the managerial class.

Not founders. Not entrepreneurs. Not visionaries.

Nope … managers.

Fee-takers.

Asset-gatherers.

Rent-seekers.

Rakes.

Here’s JP Morgan’s stock performance over these three years.

Not bad. Up 48% over the three years versus the S&P 500 up 23%. On a total return basis – which includes dividends (a true return of capital to investors IMO) reinvested in JPM – it looks even better … up 59% versus the S&P 500 up 30%.

Are Jamie Dimon and team good managers?

I think you’d have to say yes, although it’s also … difficult … to overlook the various felony charges and billions in civil settlements that have been assessed against JP Morgan during Dimon’s long tenure.

Did you know that Jamie Dimon and team are taking an 18-27% rake from the multi-billion dollar stock buybacks that JP Morgan announces every year?

I bet you didn’t. And no, it wasn’t always this way.

Are Jamie Dimon and team worth the 18-27% rake they take from the multi-billion dollar stock buybacks that JP Morgan announces every year?

I don’t think so. I think it’s obscene.

I think the way in which corporate management teams like JP Morgan’s have captured their compensation plans to enrich themselves at the expense of shareholders is a micro-version of the way in which Oligarchs have captured monetary policy and tax policy and trade policy and antitrust policy and securities policy to enrich themselves at the expense of citizens.

What is rent-seeking?

It’s setting the RULES – in big ways like tax policy and in small ways like compensation policy – to benefit the rule-setters over the people the rules are supposed to benefit.

And because it’s the RULES … well, you don’t even notice it.

Particularly if it’s masked by a compelling narrative like “Yay, Stock Buybacks!”.

What is rent-seeking?

It’s the rake.

I think these obscene rakes should be stopped and rolled back. Sadly, I think these obscene rakes are so ingrained in our economy and our politics that they are immune to incremental policy measures. Sadly, I think we have to take a flamethrower to these rakes to change any of this.

But that’s just me.

I understand and appreciate that you may feel differently about both the appropriate level of compensation for corporate management and – even if you agree with me about its obscenity – you may disagree with me about what actions should be taken to address this, and by whom. For example, Rusty and I disagree about a LOT of this on the policy/regulatory intervention side. Amazingly enough, we can disagree on this without accusing the other of lacking basic math skills. Yes, this is a subtweet.

Recognizing that well-meaning people can disagree on the urgency of the problem and how to redress it, I want to suggest three non-flamethrower policies that I think (hope) can get wide agreement. They all stem from this quote by Jamie Dimon in last Sunday’s 60 Minutes interview, when Leslie Stahl asked him if he thought his compensation was “appropriate”:

The Board sets my pay. I have nothing to do with it.

The Chairman of the JP Morgan board of directors is … Jamie Dimon.

And don’t @ me about independent directors and compensation sub-committees and all that. Just don’t. Don’t even start. Because you KNOW that’s bullshit. And so does Jamie Dimon.

So here are my three non-flamethrower policy proposals. These can all be legislated or regulated into existence tomorrow if there were political will to do so.

1) Require by law that the board Chair of publicly traded companies may not also be the CEO. [and if you really want to get serious about this, require that the board Chair be an independent director]

2) Require by law that board directors may only receive cash compensation for their services and are not eligible for any form of stock-based compensation.

3) Require by law that board directors may not exercise any form of previously granted stock-based compensation while they serve on the board.

Do these proposals go far enough? I don’t think so.

But they’re a start.


Silly Season

There’s something weird happening in narrative-world, and I’ve been trying to figure out what it means since we published our monthly Narrative Monitors update last week (attached to this email). I still can’t figure it out, but instead of continuing to wrestle in silence, I’m going to tell you what I find odd and ask what you think it means … if anything. It’s entirely possible that I’m just too much in my head on this.

First I’ll report on what we saw in the Monitors from October’s financial media.

Inflation – “Inflation narratives faded in both cohesion and attention in October. Any inflation narrative exists almost wholly within political worldas opposed to market world.”

Central Bank Omnipotence – “the level of attention on central bank narratives has faded rapidly: common knowledge has emerged that other investors are more focused on trade, IPO market/growth issues and election politics.”

Trade and Tariffs – “the attention on Trade War narratives has ticked down from our maximum level for the first time in months.”

US Recession – “US recession commentary drifted downward in both cohesion and attention in October.”

US Fiscal Policy – “there is no Fiscal Policy, Deficit or Austerity narrative, at least as it concerns markets.”

Individually, none of these Monitor reports is that odd. Taken together, though … well, that’s the weird part. Our measures of attention (drumbeating on an issue in financial media relative to all other issues) fell in October for ALL of these market-impacting macro narratives. Yes, Trade & Tariffs is still garnering a lot of attention, clearly the most of any of these standing issues. But even there we saw a noticeable decline in both the number of articles published in financial media on the topic and – much more importantly for our research – the centrality or “gravity” of those articles relative to other topics.

What took the place of these core macro factors? Well, we saw a ton of articles about politics … both impeachment and “how a Warren Presidency would destroy markets as we know them” articles. We also saw a lot of “OMG, WeWork” articles. I doubt that the spate of WeWork articles persists, although the Street really needs a good IPO to take the stench out … so we’ll probably get just that.

But I think we’re just getting started on the dominance of political narratives in financial media.

In fact, if you look at the Monitor narratives in terms of political-world rather than market-world, both Inflation and US Fiscal Policy are pretty darn robust in their attention scores. That is, “people are talking” about prices and taxes and spending as it impacts politics. People are not talking AT ALL about prices and taxes and spending as it impacts markets.

Or market prices.

Which leads me to the big question I have … and it’s the big question I don’t have an answer for:

At what point, if ever, do political narratives about Inflation and Fiscal Policy become market narratives about Inflation and Fiscal Policy?

Because right now they’re not, so we gravitate to new market high after new market high. And it is entirely conceivable to me that they never do – become market narratives, that is – and we continue to live in this, the best of all possible worlds. But I’m trying to figure out what might make that transition happen. Is it just time and getting closer to the election? Is it something else? That’s the weirdness that I’m wrestling with. As always, I’d love to hear your thoughts.

The Age of the High-Functioning Sociopath


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I’m old enough to remember when Donald Trump, the President-elect of the United States, and Masayoshi Son, CEO of Softbank, had an impromptu press conference in the Trump Tower lobby to trumpet the FIFTY THOUSAND JOBS and FIFTY BILLION DOLLAR INVESTMENT that Softbank would be bringing to the US.

As the articles covering this “incredible and historic” meeting pointed out, “Mr. Trump took credit for the investment, saying his November victory spurred SoftBank’s decision.”


When Billionaires Meet: $50 Billion Pledge From SoftBank to Trump   [Wall Street Journal]

Masayoshi Son, the brash billionaire who controls Sprint Corp., said Tuesday he would invest $50 billion in the U.S. and create 50,000 new jobs, following a 45-minute private meeting with President-elect Donald Trump.

The telecom mogul, who made his fortune in Japan with SoftBank GroupCorp., announced his investment plans in the lobby of Trump Tower, though he didn’t provide details. Mr. Trump took credit for the investment, saying his November victory spurred SoftBank’s decision.


The focal point of Son’s meeting with Trump was a three or four slide powerpoint deck that they both initialed. I have no idea what it means to say “$50bn + $7bn” and “50k + 50k new jobs”, but what the hell.

I thought about that Trump Tower deck when I saw the most recent Softbank and Vision Fund investor deck, presented in the aftermath of the WeWork IPO debacle and Softbank’s subsequent refinancing of the company.

That deck, apparently meant to “reassure” investors, was chock-full of slides like the ones I’m going to present without comment below. Honestly, when I first saw these slides on social media, I was certain that they were photoshopped. I was certain they were a put-on.

They’re not.

At some point, I expect this deck will be lost to the sands of time, so to preserve it for posterity I’ve saved a copy on our servers. You can download the Softbank Investor Deck here, if you like.

In the immortal words of transcendentalist poet Walt Whitman,

You just can’t make this shit up.

Haha, JK. Walt Whitman never said that.

But then again … maybe he did! How do you know for sure he didn’t? Maybe he muttered it to himself after a series of fishing mishaps out there on Walden Pond.

What’s that you say? … it was Thoreau who lived on Walden Pond, not Whitman? Are you sure about that, friend? Are you sure that Walt Whitman never visited Henry Thoreau and went fishing and lost a couple of hooks and said this?

Because lots of people are saying that it’s possible he did.

Because apparently I can say ANYTHING in an SEC-compliant investor presentation if I just put some 3-point font disclaimers at the bottom of a slide and say it’s possible.

Why should we play by the rules when raccoons like Donald Trump and Masayoshi Son not only break them with impunity and ludicrous intent, but are celebrated and made rich for breaking them?

Why should we care about anything when nothing matters?

Because you’re not a sociopath.

Because you care about your Pack.

Yes, this is the Age of the High-Functioning Sociopath. Yes, this is the Age of Sheep Logic. Yes, this the age where scale and mass distribution are ends in themselves, where the supercilious State knows what’s best for you and your family, where communication policy and fiat news shout down authenticity, where rapacious, know-nothing narcissism is celebrated as leadership even as civility, expertise, and service are mocked as cuckery.

Stipulated. What, did you think this was going to be easy?

These clowns don’t deserve us. And it will take decades of a persistent, bottom-up social movement that rejects and negs and ridicules them … ALL OF THEM … before we have the opportunity to reclaim our world.

The Age of the High-Functioning Sociopath will never change on a single point of failure like an election. Or a “suicide”. Or an impeachment. Or a busted IPO.

But a MILLION points of failure? A MILLION points of rejection and negging and ridicule?

Yeah, that can work.

So let’s get started.


When Was I Radicalized? (Boeing edition)


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Dick Fuld

That’s Dick “Gorilla” Fuld, former CEO of Lehman Brothers, who oversaw a criminal fraud conspiracy that went by the name of Repo 105.

Dick Fuld never saw a courtroom, much less a jail cell.

When was I radicalized?

When Dick Fuld walked away scot-free from Lehman with half a billion dollars in cash comp and stock sales during his tenure.

I thought of Dick Fuld today when I saw this picture and read this article.


Prosecutors Face Complex Path to Charging Boeing Over 737 MAX   [Wall Street Journal]

To bring a successful criminal case against Boeing itself, prosecutors would have to show that executives repeatedly concealed or ignored the 737 MAX’s engineering problems, experts said.

And there is a larger economic and political component: A corporate indictment and potentially huge sanctions must be balanced against the economic and national-security risks of incapacitating the country’s second-biggest defense contractor.


That’s Boeing CEO Dennis Muilenburg, about to testify before Congress about the 737 MAX.

The article is correct, of course. There’s no way that the Justice Dept. will ever bring a criminal case against Boeing, not one that hits top management or really shackles the company.

And I know that Boeing said today that Muilenburg won’t get a bonus or (more) stock grants until the 737 MAX is flying again, but this article got Radical Me thinking …

I wonder how much money Muilenburg and his management team and his board of directors have pocketed since he took over as CEO in 2015 and Chairman in 2016?

I wonder if executive compensation practices have changed over that span since … you know … Boeing started buying back nine billion dollars of stock every year?

Tell you what, I’ll make it easy and I won’t even count the cash compensation of Boeing management since 2016. I’ll just stick to the direct value of the sterilized stock options they exercised and the restricted stock units they were vested. And I won’t count any compensation of any sort here in 2019.

Over the 3-year period 2016 through 2018, Boeing employees received newly issued stock that’s worth $4.9 billion today. There was another $3.5 billion worth of stock issued to the Boeing pension plan, which was immediately sold into the open market.

As a result, $5.4 billion of the $25.2 billion in stock buybacks that you thought was a “return of capital” over that span was actually a USE OF CASH to either buy shares directly from management or mask the dilution of non-management shareholders.

In 2017 alone, the one good stock-performance year Boeing has had in a decade, $3.8 billion in buyback activity went to sterilize new stock issuance. That’s 29% of cashflow from operations for the year. The board totally reconfigured their stock compensation system to accomplish that. You know, the board that Muilenburg took over the year before.

And as they say on Wheel of Fortune, once you buy a prize, it’s yours to keep. There’s no clawback here. There’s no repercussion over the 737 MAX, either civil or criminal, for Muilenburg and crew. The only thing the 737 MAX debacle is going to make more difficult is for these same guys to pocket ANOTHER fortune.

And yes, some portion of this stock-based comp went to rank-and-file Boeing employees … I figure 5-10% is a good rule of thumb for most S&P 500 companies and their employee stock ownership programs (ESOPs). The balance went to employees as part of whatever employment agreement they might have, and the Boeing 10-Ks are silent on the distribution profile of that. But remember, I’m not even counting cash comp here. This is three years of stock comp for the management of an American icon of a company that had two so-so years and one really good year.

Is Muilenburg a billionaire from being a Boeing management lifer?

A guy who says his top management “insights” are:

“React quickly. Events can change everything. So must you.”

“Know your team. What really matters to them, on every scale?”

“Chart the course. What should the next 100 years look like?”

No, he’s not a billionaire. He’s just a centimillionaire CEO of a Too Big To Fail company.

LOL.

Yeah, It’s Still Water.

It’s the greatest transfer of wealth in 100 years. Not to founders. Not to visionaries. Not to inventors. Not to entrepreneurs. Nope … to managers.

This is the story of every S&P 500 company over the past five years.

Oh yeah, one more thing for the “Yay, Stock Buybacks!” crowd.

Over the past 20 years, Boeing has NOT bought back stock in two of those years. That was way back in 2002 and 2003, back when the top management and board jobs were just a twinkle in Dennis Muilenburg’s eyes.

Wanna guess what the total value of exercised stock options by Boeing management was in the years where they did NOT have stock buybacks to sterilize the issuance and so had straight shareholder dilution?

In 2002, with zero stock buybacks, the total value of exercised stock options was $31 million.

In 2003, with zero stock buybacks, the total value of exercised stock options was $19 million.

It was hundreds of millions in the years before that, when they had stock buybacks.

It was hundreds of millions in the years after that, when they had stock buybacks.

It is BILLIONS of dollars today, as Dennis Muilenburg cranks up the buyback machine to its current record levels.

I believe it is impossible to separate the modern management practice of self-enrichment through massive levels of stock-based comp from the modern management practice of investor placation through massive levels of stock buybacks … without regulating one or the other practice.

But I’m all ears for any ideas.


Yeah, It’s Still Water (follow-up)


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You know, I was a big fan of stock buybacks back when I was running a fund. And I’ve thought (and written) that so much of the anti-buyback fervor we’ve heard over the past year or so, particularly from political candidates, was mostly silly on the merits, even though it was pretty effective as a narrative. I think that’s why it’s been so shocking to me when a few hours work on Texas Instruments in response to a stray tweet turned into a research project that’s threatening to take over my life!

The difference in my views now is that I’m looking at stock buybacks from a micro perspective, not a macro or overall market perspective. And from that perspective, there is no doubt in my mind that stock buybacks have been totally hijacked by corporate management and boards over the past few years to sterilize exercised options and restricted stock units. As a result, this narrative of “returning capital to shareholders” is pretty much a sham, as anywhere from 10% (McDonalds) to 40% (Texas Instruments) to 60% (Microsoft) of the money spent on buybacks never reached shareholders at all, but simply carried out a wash trade where one corporate hand issued new stock on the cheap and the other corporate hand bought it back at a much higher price. Note that the full monetary value of this wash trade goes to the recipients of the newly issued stock whether or not they sell it then and there at the repurchase price. There is ZERO EPS leverage accomplished through these wash sales. There is ZERO benefit to non-management shareholders.

For example, over the past 3 fiscal years Microsoft bought back 419 million shares at an average price of $85 per share, but they also issued 254 million NEW shares to management at an average price of $11.50. So out of the $35 billion that Microsoft supposedly “returned to shareholders” with their buyback program, less than half of that actually went to the benefit of shareholders. More than $18 billion in value went directly to the Microsoft employees and directors who exercised these options and restricted stock units. In addition, Microsoft spent more than $6 billion over the past 3 fiscal years to buy back stock to satisfy the tax withholding requirements of management option grants. That’s more than 20% of Microsoft’s cash flow from operations over that span.

But at least, you say, Microsoft stock outperformed all of its benchmarks over the past 3 years. Fair enough. But that’s one hell of a vig that the casino withheld on your winning bet!

Last Friday we published a note –  “Yeah, It’s Still Water” – about a company that has decidedly NOT outperformed all of its benchmarks, but has comped management and directors with billions regardless. That company is Texas Instruments (note attached).

From 2014 – 2018, 40% of TXN’s stock buybacks went to sterilize the options and restricted stock grants given to senior management and the board, for a direct value transfer of $3.6 billion from shareholders. There’s an additional $2.6 billion in stock-based comp already issued but yet to be exercised. That’s above and beyond a billion or two in cash comp.

For what? Over the same five year period, 2014 – 2018, TXN stock performance matched the Philly Semiconductor Index ETF zig-for-zag. That’s an ETF with a 47 basis point all-in expense ratio, by the way.


 
One day we’ll get as angry at index-hugging corporate managers who get paid BILLIONS as we do at index-hugging fund managers who get paid a few basis points.
 
One day we’ll see the Zeitgeist of the Obama/Trump years for what it is: an unparalleled wealth transfer to the managerial class.
 
What is financialization? THIS.
 
It’s not illegal or incompetent.
 
But yeah, this is why our world is burning.

Do I like companies that return unproductive cash to shareholders? YES. So use a special dividend. That’s why they exist. There, fixed it for you.

And one last point. IMO, the most culpable parties in this entire charade are the independent directors of these public company boards. I think they’re bought off by options and RSUs of their own, and I think they’re almost always ex-management or current management of other companies, with all the incestuous baggage that brings.

Okay, I’m off the soapbox. For now. But I am going to keep working through these 10-Ks and compiling my list of the naughty and the nice. That second list is the null set so far.


Yeah, It’s Still Water


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Back in April, I wrote This Is Water.

There are these two young fish swimming along and they happen to meet an older fish swimming the other way, who nods at them and says “Morning, boys. How’s the water?” And the two young fish swim on for a bit, and then eventually one of them looks over at the other and goes “What the hell is water?”

David Foster Wallace (2005)

It’s a note about financialization … the zombiefication of our economy and the oligarchification of our society.

Financialization is profit margin growth without labor productivity growth.

Financialization is the zero-sum game aspect of capitalism, where profit margin growth is both pulled forward from future real growth and pulled away from current economic risk-taking.

Financialization is the smiley-face perversion of Smith’s invisible hand and Schumpeter’s creative destruction. It is a profoundly repressive political equilibrium that masks itself in the common knowledge of “Yay, capitalism!”.

What does Wall Street get out of financialization? A valuation story to sell.

What does management get out of financialization? Stock-based compensation.

What does the Fed get out of financialization? A (very) grateful Wall Street.

What does the White House get out of financialization? Re-election.

What do YOU get out of financialization?

You get to hold up a card that says “Yay, capitalism!”.


So anyway, there I was yesterday, minding my own business, and I saw a tweet about Texas Instruments (TXN) and how they were getting slammed after a difficult earnings call. Sometimes I can’t help myself, so I wrote this:

It’s a popular tweet. An excellent ratio, if you’re into that sort of inside-baseball social media stuff, but a couple of replies thought I was full of it. And there were the de rigueur “stock buybacks mean NOTHING” blog posts and tweets the following day.

So I decided to spend a day and dig into TXN a bit. Maybe I was wrong. Maybe there’s more to the story of Texas Instrument’s stellar stock performance over the past 10 years than mortgaging the future OVER and OVER and OVER again for the primary benefit of management shareholders and the secondary benefit of non-management shareholders.

Nah.

Texas Instruments is, in fact, a poster child for financialization.

There’s nothing illegal or incompetent or even unethical about it. It’s the smart play! Hats off to the TXN management team! I’d have done exactly the same thing in their shoes!

But yeah, this is, in fact, why the world is burning.

I’m going to focus on a 5-year stretch of TXN’s financials, 2014 through 2018. This is where the truly meteoric stock price appreciation took place over the past 10 years, even with the Q4 2018 market swoon, and comparing full year financials makes for a more apples-to-apples comparison.

But before I get into the numbers, let me tell you the story.

The Texas Instruments story is free cash flow and earnings growth that management “returns to shareholders”. EPS on a fully diluted weighted basis has more than doubled from 2014 through 2018, net income available to shareholders on a GAAP basis has doubled, and cash from operations has almost doubled.

The Texas Instruments story is NOT a Salesforce.com story. This is NOT a non-GAAP-this or pro forma-that story. There are real earnings and real operations and straightforward financial statements here.

What makes this a story of financialization is the WHY of the very real free cash flows and earnings growth. What makes this a story of financialization is the HOW of the allocation of those cash flows and earnings.

The WHY is pretty simple.

TXN management has cut their cost structure to the everlovin’ bone.

At the end of 2013, TXN cost of goods sold (COGS) was 48% of revenues. By the end of 2018, COGS was 35%. Gross margins went from 52% to 65%!

At the end of 2013, TXN sales, general and administrative costs (SG&A) was 15.2% of revenues. By the end of 2018, SG&A was 10.7%.

At the end of 2013, TXN research and development expenses (R&D) was 12.5% of revenues. By the end of 2018, R&D was 9.9%.

And while it’s not part of the fixed cost structure per se, Texas Instruments was a keen beneficiary of the Tax Cuts and Jobs Act of 2017, seeing their 2017 tax rate of 16% cut to 7% in 2018, reducing their tax bill by $1.2 billion.

Good thing they’re using that tax cut windfall to hire new workers and invest in new facilities!

Hahahahaha! I’m just joshing with you. Of course that’s not what the tax cut windfall went for.

But hang on … let me finish with the WHY of cash flow growth.

See, there was zero revenue growth at TXN from 2014 to 2015 ($13 billion flat in both years), and tiny growth from 2015 to 2016 (less than 3%). But there was healthy revenue growth from 2016 to 2017 (11% or so) and so-so growth from 2017 to 2018 (6% or so). And when you’re cutting costs like TXN was doing over a multiyear period, even mediocre top-line increases can lead to dramatic profit increases.

How dramatic? Cash from operations was $3.9 billion in 2014, but by 2018 was $7.2 billion. Nice!

Over this 5-year period, Texas Instruments generated $25.5 billion in cash from operations and $32.5 billion in earnings before interest, taxes, depreciation and amortization (EBITDA).

From a cash perspective, of course you’ve got to pay taxes out of all that (again, thank you for the extra $1.2 billion, GOP!), which comes to about $7 billion over the five years, but you can defer some of this to minimize the cash hit. And you’ve got to pay interest on the $5.1 billion in debt you’ve taken out, which comes to … oh yeah, basically nothing … thank you, Fed! And you’ve got to account for depreciation and amortization, which comes to $5.2 billion over the five years … but this is a non-cash expense, so it’s not going to dig into that cash hoard. And you’ve got some cash puts and takes from working capital and inventory and what not, but nothing dramatic. And you’ve got $1.3 billion in stock-based comp, but again that’s a non-cash expense … whew! And – oh, here’s an interesting cash windfall – TXN raised about $2.5 billion by selling stock over these five years. Wait, what? Selling stock, not buying stock? Selling stock to whom? Hold that thought …

Put it all together and I figure the company generated about $25 billion in truly free cash flow over this 5-year span (everyone calculates FCF a bit differently, so don’t @ me on this … I’m in the right ballpark). What are you going to spend this treasure chest on, Texas Instruments? HOW are you going to allocate this capital?

Well, surely you’re going to spend a healthy amount on capex, right? I mean, you took a $5.2 billion depreciation and amortization charge over this time span, and we all know that semiconductor manufacturers need to stay on that bleeding edge of technological innovation, right? Because we all know that technology and the productivity it brings are how we grow earnings, right?

Nope. Texas Instruments spent $3.3 billion on fixed assets from 2014 through 2018, one-third of that total in 2018. Some significant proportion of that was maintenance capex as opposed to growth capex. Significant like in approaching 100% (my guess). LOL. And don’t call me Shirley.

Well, if you didn’t spend your money on property, plant and equipment, then surely you spent a healthy sum in M&A, right?

Nope. $1.6 billion over five years. Tuck-in stuff. Again LOL. Again Shirley.

I guess you were paying down debt, then. Deleveraging up a storm, right?

Nope. Paid down debt by $500 million per year in 2014, 2015 and 2016, but got smart and increased debt by $500 million in 2017 and $1 billion in 2018. Wait, what? MOAR debt, on top of all that cash generation? Huh. Weird.

So it’s dividends, right? This is where all the cash went, yes?

Yes, now we’re getting there. $9.1 billion in dividends over five years. A healthy direct return of capital to shareholders. But it’s just a warm-up to the main event.

Texas Instruments spent $15.4 billion buying back its stock from 2014 through 2018.

Between stock buybacks and dividends, that’s $24.5 billion in cash “returned to shareholders”, essentially 100% of the free cash flow generated by the company over the past FIVE YEARS.

Now here’s the kicker.

What sort of share count reduction would you think that this $15.4 billion in buybacks gets you?

I mean, that IS the logic here, that we’re leveraging earnings growth through the share buybacks. I mean, this IS the judgment call that management is making on behalf of shareholders, that investing $15.4 billion in the company’s own stock is the best possible capital allocation that the company can make.

I would have guessed that surely $15.4 billion would retire anywhere from 20-25% of the outstanding shares over this time frame, with the stock price ranging from $40 to $100.

In truth, Texas Instruments retired only 10% of its outstanding diluted shares with its $15.4 billion investment, going from 1.1 billion shares to 990 million shares.

Remember all that stock and all those warrants sold to management with one hand while the other hand buys it back? Remember all that stock-based compensation?

Again LOL. Again Shirley.

But wait, there’s more.

We can measure the windfall compensation paid to TXN management here.

From 2014 through 2018, Texas Instruments bought back 228.6 million shares for $15.4 billion. That works out to an average purchase price of $67.37.

Over that same time span, Texas Instruments sold 90.8 million shares to management and board members as they exercised options and restricted stock grants, for a total of $2.5 billion. That works out to an average sale price of $27.51.

The difference in average purchase price and average sale price, multiplied by the number of shares so affected, is the direct monetary benefit for management. This is true whether or not management sells their new shares into the buyback or holds them. That amount works out to be $3.6 billion.

In other words, 40% of TXN’s stock buybacks over this five year period were used to sterilize stock issuance to senior management and the board of directors.

In other words, senior management and the board of directors received $3.6 BILLION in direct value from these stock buybacks.

But wait, there’s more …

As of December 31, 2018 there were still 40 million shares outstanding in the form of options and restricted stock grants to management and directors, at an average weighted exercise price of $55.

At today’s stock price, that means there is an additional $2.6 BILLION in stock-based compensation already awarded to TXN’s executives and directors.

Well golly, Ben, these surely must have been amazing managers and directors to warrant that sort of stock-based compensation in addition to their cash compensation!

Again LOL. Again … oh, you get the point.

That’s TXN stock performance in white and SOXX performance in gold over the 5-year period 2014 – 2018.

SOXX is an ETF that tracks the Philly Semiconductor Index. Texas Instruments is the fifth largest position in that ETF and that underlying index, with a 7.1% weight.

Oh yeah, one more thing … the expense ratio of the SOXX ETF is 47 basis points.

For the past five years, Texas Instruments has been nothing more than a tracking stock for a passive semiconductor index.

For this privilege, shareholders have rewarded management and directors with $6.2 BILLION in stock, plus a couple of BILLION in cash compensation.

I’d say LOL, but I’m not laughing anymore. Are you?

It’s never been a better time in the history of the world to be a senior manager of a publicly traded company.

Under the narrative cover of “returning capital to shareholders” and the common knowledge of “aligned interests” and the cash windfall of “job-creating tax cuts” and the equity valuations driven by “extraordinary monetary policy” … management teams like that at Texas Instruments have sucked the FUTURE of their company dry for the NOW of their personal enrichment.

What’s the real story of Texas Instruments?

It’s the real story of pretty much every public company over the past decade.

Public companies are managed today to mortgage the future OVER and OVER and OVER again, for the primary benefit of management shareholders and the secondary benefit of non-management shareholders.

And their main tool for this is the stock buyback.

It’s a crying shame, because here’s the thing … the total return on owning TXN is, in fact, 15% higher than the SOXX ETF over this five year span 2014 – 2018.

Not because of the stock buybacks.

Because of the dividend.

Do you want to run your company for cash generation? Do you want to return that cash to shareholders? GREAT!

Use a special dividend, not buybacks.

There, fixed it for you.

Do stock buybacks lift the stock market “artificially”? I guess. Kinda sorta. On the margins. Then again, markets happen on the margins.

IT’S THE WRONG QUESTION.

The right question is not whether or not stock buybacks prop up the overall market.

The right question is not the macro.

The right question is the micro.

The right question is whether or not stock buybacks are the best use of capital if you take a steward’s perspective rather than a manager’s perspective.

Which no one does today.

Not even the boards of these companies. Especially not the boards of these companies.


You know, everyone is all in a tizzy about Softbank paying Adam Neumann $1.7 billion just to go away.

My unpopular opinion: the Adam Neumann story is repeated in a non-infuriating and non-obvious way every day in every S&P 500 company. And it’s been going on for a DECADE.

Dimon, Iger, Cook, Nadella, Pichai, Fink … they’re not founders like Gates or Bezos. They’re not investors like Buffett or Dalio. They’re management. And now they’re billionaires. And all their captains and lesser brethren are centimillionaires. And all their lieutenants and subalterns are decamillionaires.

And everyone is perfectly fine with this. No one even notices that this is happening or that it’s different or that it’s a sea change in how we organize wealth in our society. It’s not good or bad or deserved or undeserved. It just IS. This is our Zeitgeist.

This Is Water

One day we will recognize the defining Zeitgeist of the Obama/Trump years for what it is: an unparalleled transfer of wealth to the managerial class.

It’s the triumph of the manager over the steward. The triumph of the manager over the entrepreneur. The triumph of the manager over the founder. The triumph of the manager over ALL.

Welcome to the Long Now.


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