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Good morning. Glad to have won the 2021 Best Newsletter Award from the Unhidden Society for Advanced Business Editing and Writing. Many thanks to the Sabeu judges for seeing the past of all Typo.
It’s been a week since the Fed threatened everyone; We look at some of the recent recession discussions below. Also, can Uncle Warren, by investing in HP, repeat the mistakes he made with IBM 10 years ago?
Email me: robert.armstrong
Speaking of recession
Bill Dudley, who was president of the New York Fed, wrote in Bloomberg on Wednesday:
It is difficult to know how much the US Federal Reserve will have to do to bring inflation under control. But one thing is for sure: to be effective, stock and bond investors have to pay more losses so far. . .
As [Fed chair Jay Powell] Put it in his March press conference: “Policy works through financial conditions. That’s how it gets to the real economy. “
She is right. . . The US economy does not respond directly to short-term interest rate levels. Most home borrowers are not affected because they have long-term, fixed-rate mortgages. And. . . Many U.S. families hold a significant amount of their assets in equity.
It’s a bit of a buzzkill, but it reveals an important fact. Tightening monetary policy destroys jobs, reduces investment and makes people poorer, stopping inflation. This does not mean that it is sometimes the best option. This is definitely the best option right now. But it’s not an expensive process, and it can’t be. Dudley is good for his simplicity.
Although he could still be simple. What sends stocks, in particular, for meaningful correction is not monetary policy alone. Lately, every Wall Street broker has been publishing charts and tables showing that stocks performed well in the first year or two of the Fed tightening cycle. What makes stocks right is the recession. Or more precisely, meaningful correction and recession are interrelated. Doodley says the Fed will be forced to push the economy into recession to stop inflation (and indeed, in other forums, he has made it clear).
Doodle is not the only donor in the Panditocracy this week. Also on Wednesday, Deutsche Bank became the first major bank to predict a recession Its chief economist, David Fokarts-Landau, and head of economic research, Peter Hooper, wrote that Ukraine’s war has pushed up inflation, which would force the Fed to raise policy rates more aggressively – 3.5 percent or more, better than market expectations for next year. Negative US growth in the second half will be the cause.
I’m not sure I’m at Doodley / Deutsche Camp. But very high inflation, bad consumer sentiment, and high stock and home prices definitely look like a volatile combination.
The two most common arguments against the impending recession are that consumers and corporate balance sheets flush with cash, and when the unemployment rate is at a historically low of 3.6 percent and falling, it is strange to predict a recession. I think the first argument raises the question: the recession is nothing more than a time when consumers and businesses hold on instead of spending their cash.
I found the second argument quite appealing, until John Wayne, an adviser to CIBC, pointed out to me that unemployment is a backward indicator, and that the wolves in the recession are at the very bottom. Here are the charts from the Fed, shaded by the recession:
I have a strong pessimistic bias that has made me wrong before. But just because you are paranoid doesn’t mean the economy can’t get you.
Berkshire bought HP
Berkshire Hathaway, as we mentioned recently, is taking a moment. Warren Buffett’s insurance / energy / railway / equity mutual fund mega-conglomerate thing has been a light but long-lasting underperformer for many years. But in 2022, as energy and insurance sectors outperformed, Berkshire has beaten the market well. It celebrated by buying $ 4.2 billion worth of shares in one of the world’s leading printer cartridge companies.
HP also sells personal computers. But the printing department is responsible for more than half of the company’s operating profit, and within that department, 60 percent of the revenue comes from ink cartridges. I have an HP printer. It works great, but when the ink runs out, which is often the case with how little I print, it costs my fortune. It’s annoying, but you have to appreciate the business model, which is the Gillette Mac3, only more expensive. Yes, cartridges cost a lot more; Yes, I will continue to purchase them; And yes, the pre-tax margin in HP’s printing division is likely to be at 18 percent or more favorable.
Which brings us to IBM. Buffett bought a $ 10 billion-ish stake in Big Blue in 2011, when its stock was about $ 170. By the time Berkshire completely exited its position in early 2018, the stock was around $ 140. This bad investment was annoying / bright just like HP’s core business.
Buffett visited CNBC when he first bought IBM and said, “It’s an organization that helps IT departments do their job better. . . Changing auditors for a large company, changing law firms is a big deal ”and IBM’s consulting business with the company’s IT department has the same enduring relationship. “In many places there is a general assumption that if you were with IBM you would be with them.”
There is another way to talk about Buffett: once you take IBM into your company, it is almost impossible to get rid of it.
Another similarity: Buffett went on to praise the way IBM has set its profits. The following brief advice comes from Berkshire’s 2011 annual report:
Today, IBM owns 1.16bn shares, of which we own about 63.9mn or 5.5 percent. Naturally, what the company’s revenue will be in the next five years is very important to us. The company will probably spend $ 50 billion or more to repurchase shares in those years. Our quiz for the day: What should a long-term shareholder like Berkshire rejoice in that time?
I will not keep you in suspense. We should keep IBM’s stock price declining for five years. . .
The reasoning is simple: if you are going to be a net buyer of stocks in the future either directly with your own money or indirectly (through the ownership of a company that repurchases shares), you are at a loss when the stock rises. You benefit when stocks are confused. Emotions, however, often complicate matters: most people, including future net buyers, feel comfortable looking at stock prices in advance. . .
Ultimately, the success of our IBM investment will be determined primarily by its future earnings. But an important secondary factor would be how many shares a company can buy in this activity.
In that last paragraph, Buffett died. The success of the IBM investment was largely determined by its future earnings. They stink. Between 2011 and 2018, IBM’s net income increased from $ 15.9bn to $ 8.7bn. IBM’s business has not been seen as sticky. And it’s fair to say how much it had to do with the decision to give preference to buybacks over investment in this business.
And what does HP do with its profits? Well, in the last two fiscal years, it has bought back নিজস্ব 9.3 billion of its own shares, more than one-fifth of its current market cap. Buffett follows IBM’s argument that if it continues, Berkshire will be HP’s sole shareholder by 2027, and soon if its share price rises.
As a quality person, I see the appeal of IBM. Berkshire bought the company at about eight cheap forward price / earnings ratios, and it grew revenue by 12 percent last year. This is a rare combination. But parallel to IBM – the so-called sticky last generation technology, buyback instead of investment – is volatile.
A good read
Black Lives Matter has bought a very expensive house. Great reporting from Shawn Campbell.
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