James Agee and Walker Evans were being facetious, of course, in the title of their shattering depiction of the poor in 1930s Appalachia. How do we as a narrative-driven society understand the actual living conditions of actual people in our actual world? We don’t. We don’t see them at all. There are no Missionaries to tell the tale of a tenant farmer. But there are hundreds just aching to tell the stories of Famous Men.
Back in the day of Agee and Evans, the stories of Famous Men were almost always puff pieces, heroic narratives of Titans of Industry and Politics. Today, though, these stories are more often than not cautionary tales, steeped as we are in the other-observing Sheep Logic of the modern age, where it’s all schadenfreude all the time.
I thought of this when I was reading various year-end articles about the Famous Men whose stories dominate our financial press, men like Elon Musk and David Einhorn and the like. There are lots of others to choose from, and they’re almost all cautionary tales of Masters of the Universe getting their comeuppance. These are very popular stories. You may think that you’re above a comeuppance story, but you’d be wrong. You’re both biologically hardwired and socially trained to LOVE these stories.
To be clear, though, I’m not writing this note as an exercise in civic-mindedness or to call attention to the plight of some modern day tenant farmers.
No, I’m writing this note to help you make money in 2019.
When you focus on the behaviors of Famous Men, you cannot see clearly the behaviors of the mass of people who actually determine real-world market and economic outcomes.
We’ll leave Einhorn’s cohort of professional money managers for another day, as it’s an evergreen Epsilon Theory topic. Today I want to talk about the behaviors of Elon Musk’s cohort, corporate CEOs and senior management. And I’ve got a very simple observation about those mass behaviors.
The effectiveness of corporate management in surviving the Great Recession and thriving in the decade since is nothing short of astonishing.
In every sector, from tech to financials to healthcare to retail to energy to whatever, management teams have proven to be remarkably competent at implementing process technologies and calculating a strategic path that minimizes the maximum regret of business failure.
I’m not making this observation as a rah-rah booster. On the contrary, my forte as an investor is short-selling. Nine years ago, I was shocked by how FEW management teams failed. Today, I am shocked by how FEW management teams have blown out their balance sheets or their inventories. I am shocked by how FEW management teams have put their companies in a position of existential risk at the tail end of unprecedented monetary policy stimulus and excess.
Are there exceptions to this rule? Sure. And you’re aware of them all, because the cautionary tales sell like hotcakes. But this IS the rule.
Did management get a lifeline from the Fed and its extraordinary monetary policy actions? Yes. And you’ve heard about this ad nauseam from me and others. But what’s truly extraordinary is how few companies failed before these policies kicked in, how careful companies have been in the years since these policies kicked in, and how prepared companies are now that these policies are rolling back.
I think it’s the biggest and most important economic story that no one has written, invisible because it’s diffused across thousands of management teams and has none of the story elements that make for a compelling narrative arc.
We are living in a Golden Age of corporate management competence, driven by the adoption of process technologies and minimax regret strategies.
That’s not going to stop in 2019.
Here are two implications for your investment strategy:
1) Minimax regret strategy is NOT an earnings maximization strategy. It is a survival maximization strategy. Put another way … the Golden Age of management competence is not a Golden Age of EPS growth, and I have no idea if consensus 2019 earnings estimates for the S&P 500 or your particular sector of interest are too high or too low. In fact, that’s the point, because competent corporate management doesn’t know, either, so they’re not going to lead the company on the assumption of a particular state of the world that always beats and raises. On the other hand, though, that’s why the Golden Age of management competence IS a Golden Age of low default rates. It’s also why my spidey-sense is not tingling about some imminent systemic crack-up even if financial asset prices and earnings estimates continue to take it on the chin.
2) Super-low interest rates do not spur corporate risk-taking. On the contrary, ZIRP diminishes investment in real-world growth opportunities like building a new factory or developing a new product in favor of market-world growth opportunities like stock buy-backs and dividends. This was the fatal flaw in central banks’ decade-long effort to spur productivity growth and “good” inflation by cutting interest rates to zero and beyond. It’s not just pushing on a string … it’s providing infinite liquidity for a competent management team to satisfy its earnings growth goals in a risk-free manner! But by the same token, as the cost of money increases, competent management teams will need to take MORE risk in the real-world, and THAT is what generates wage inflation and productivity growth and all the rest. Just as cutting interest rates to zero failed to spur inflation, so will raising interest rates from zero fail to contain inflation. Sorry, Mr. Friedman, but inflation is not a monetary phenomenon in anything but a tautological sense. Inflation is always and everywhere a risk-taking phenomenon.
For more on minimax regret strategies and their role in markets, see:
For more on inflation risks, productivity, and the fatal flaw in the past decade of monetary policy, see:
- Things Fall Apart, Part 3 – Markets
- The Narrative Giveth and the Narrative Taketh Away
- Gradually and Then Suddenly
So much good stuff here…learning by the day!
Rambling thoughts: Inflation is a tax…taking on more risk is a tax…bullshit is a tax. What these management teams do or don’t do is simply a process of being conditioned by their environment. Nature does not care about your morality or lack there/of. Quant’s talk a lot about process…I equate process with zero tolerance…I have zero tolerance for zero tolerance. You better know when/how to break your process and evolve before time elapses on you and your Team. When a Team is on the “X”, the longer they stay on the “X” the higher their risk increases toward a negative condition which can/will turn quickly into a crisis. Adapt or Die!
The ET piece that finally made me see this note’s point clearly was, oddly, not one of the ones Ben mentions here, but one from July 2015 titled “Catch - 22.” Since, I can’t paraphrase it half as well as Ben wrote it, I’ll just quote (which sounds so much more sophisticated than “copy and paste”) it here:
“Here’s the Fed’s Catch-22. If the Fed can use extraordinary monetary policy measures to force market risk-taking (the avowed intention of both Zero Interest Rate Policy and Large Scale Asset Purchases) AND the real economy engages in productive risk-taking (small business loan demand, wage increases, business investment for growth, etc.), THEN we have a self-sustaining and robust economic recovery underway. But the Fed’s extraordinary efforts to force market risk-taking and inflate financial assets discourage productive risk-taking in the real economy, both because the Fed’s easy money is used by corporations for non-productive uses (stock buy-backs, anyone?) and because no one is willing to invest ahead of global growth when no one believes that the leading indicator of that growth – the stock market – means what it used to mean.”
It was like a light went on in my head (true, the brightest bulb up there is 60 watts, but it went on anyway) when I read that line. Now I will need some time to think about this line as I “get it,” but don’t “own it” yet:
“Sorry, Mr. Friedman, but inflation is not a monetary phenomenon in anything but a tautological sense. Inflation is always and everywhere a risk-taking phenomenon.”
Nice to see ET firing out of the gate in 2019 as strongly as it was running in 2018. Thank you Ben and Rusty for, not just writing thought-provoking pieces (which you guys do with incredibly frequency), but for building and sharing a new perspective and approach to trading, investing, markets and humans, in general. Because of you guys, I’m becoming better in all four of those areas.
Could it be that companies have not innovated, because they have outsourced that to the Technology/Start Up world? At least in the technology world (which is really all I know), the giants (FAAMG and Oracle, Cisco, CA etc.) have watched the startup landscape and acquired companies that look promising and done pretty well at it.
There are several large company that tried monitoring and acquiring innovation and have only succeed in imploding (IBM, GE, Verizon etc.)
Also, there are smaller companies that acquired startups that have done amazingly well (NY Times with Wirecutter, Conde Nast with Reddit)
Additionally, there are startups that don’t challenge FAAMG and have grown on their own.
But this is all in the technology space, where there has been a good amount of innovation and the pace seems to only be picking up.
Wow! That’s quite a narrative: an efflorescence of c-suite sagacity transmutes the bitter medicine of monetary miserliness into an intoxicating elixir of productivity plus rising wages and prices. If originality and audacity are the keys to winning the day, this story is hard to beat. But there’s another narrative from another Hunt (Lacy, not Ben) that’s all about the data. Here’s an excerpt from what this Dr. Hunt wrote back in October: “Recently, San Francisco Fed economists conducted a study on various spreads in the treasury market. Using monthly data from January 1972 through July 2018, they looked at each spread and predicted whether the economy would be in recession 12 months in the future. The study found that the ten year-three month (10y3m) spread was the “most reliable predictor” in signaling a recession. . . . if this yield spread is still positive but falls below +40 bps, there is a more than reasonable possibility of a decline in economic activity.” (full text here: http://www.hoisingtonmgt.com/pdf/HIM2018Q3NP.pdf) As I write this, the spread languishes at 20 bps.
So there you have it: Hunt vs. Hunt. You pays yer money, and you takes yer choice.
Ben, your stuff is confusing. Here is how I understand it. CB’s goal is here to help capital, print money at bad times to prevent bad business from goin under and this creates many Zombie businesses which hires a lot of labor and labor becomes expensive and start to hurt capital. Then CB will tighten to kill the Zombies and get some folks to lose their jobs so that capital have more negotiation power over labor, kill wage inflation. Okay, now, you are saying the past 10 years have been Golden Age for managements who are so smart to use minmax regret strategies and the are so robust now that even when valuations takes it on the chin, these companies will NOT die, and rising rate will force them to take real world investment risks and inflation will NOT be contained. So money printing has created Zombies that are soooooo minmax-regret that they will NOT die? Even when FED is trying to help capital kill labors by raising rates, the capital have to use more labor to take risk and cause wage inflation?
What’s also puzzling is that Elon Musk, AKA a raccoon, is NOT one of those share buy back minmax-regret CEO. He is one of those real world risk taking while everybody else is minmax-regret processing. Some how you use his name as an example of the golden age minmax-regret CEO. I thought Tesla is more like a Zombie company run by a raccoon and FED should kill it to release the labor for other golden age management companies.
Having been in various finance positions in corporations the last 12 years - some other things are key - not going public (if not already) - just cheaper and easier to operate; hiring less young, inexperienced people and wasting efforts and money on training task-rabbits vs. investing in technology or 3rd party services or hiring more experienced older operators who can change things quickly and easily harmonize to the industry best practices. For public companies and even some private make sure any large outlays are part of non-recurring items like M&A, restructuring, efficiency programs, divestment, etc. - so maximizing shifting funds to places that can be removed in the Adjusted EBITDA calculation. Lastly, I believe it is just drastically cheaper to maximize the share price rather then grow revenue - and share repurchases or debt service do not show up in Operating Income and EBITDA anyway so even if they don’t work, it’s not that visible.
Yet another diatribe from Ben arguing to sell vol.
Continue the discussion at the Epsilon Theory Forum