Christopher Matthews
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A brick and mortar juggernaut in the Amazon economy

bargainmoose.ca (Flickr)

The economic recovery is in its 7th year, and unemployment has sunk to levels rarely seen in a generation. Retail sales are picking up, too, growing at their fastest pace in seven months. But you won't see these trends reflected in the performance of most well-known retailers, as department stores like Macy's close stores, and household names like Sports Authority go bankrupt altogether.

This raises a question: Where exactly are consumers spending their money if not at the shopping mall? One answer is Amazon, but it's not alone in avoiding the retail apocalypse: LVMH, the French conglomerate and owner of brands Louis Vuitton and Sephora, had a 15% rise in first-half 2017 revenue, and that did not come by running fire sales — profit was up 23%. Investors have responded enthusiastically, sending up its share price by 20% this year, outperforming retail and and luxury sector indexes.

Why it matters: LVMH's success is a reason for traditional retailers to despair as much as hope. The secret behind LVMH's success is near total control of products from conception through manufacturing and sales, the opposite strategy of traditional mass-market retailers that largely act as middlemen and little more.

It's all about exclusivity: In world where consumers can buy nearly anything they want from anywhere in the world with a tap on a screen, the most desirable product a retailer can offer is one that not everyone can have. Enter Louis Vuitton, the 163-year-old luxury retailer that is LVMH's flagship brand, accounts for fully half its profits, and gooses customer demand by strategically restricting the supply of certain products. "Vuitton redefined the luxury business model a long time ago," says Oliver Chen, a senior analyst with Cowen. "They own their own factories, they source their own leather, and they own their own stores. When you have that, it's the ultimate leverage."

  • Vuitton has total control over distribution and pricing of its product, protecting its exclusivity and the company's profit margins.
  • This factor in its success was on display in Vuitton's recent partnership with the hyper-trendy lifestyle brand Supreme, where the pair agreed to sell limited editions of streetwear items like jackets, jerseys, and hats.

Make shopping fun: Next to Louis Vuitton, LVMH's most important brand is Sephora, the beauty retailer that has been gobbling up market share in the $22-billion cosmetic retail industry. Customers interviewed by Axios raved foremost about the in-store experience, with freely accessible samples of any product absent any interaction with a salesperson. If shoppers want help, these customers say, Sephora's staff is knowledgable and eager to find them the right look.

Go global: a perkier European economy and stable growth in China are two macroeconomic drivers of LVMH's stock price. According to Jelena Sokolova, a Morningstar analyst, Louis Vuitton's presence in key cities of the emerging world, like Rio and Shanghai, has set the firm up for its current success. LVMH is reaping the benefits as a cache brand in the world's second largest economy, which is still growing at more than twice the U.S. rate.

What goes up, must come down: Sokolova points out that Louis Vuitton's vertically integrated approach is risky. If customer tastes change, for instance, and the company is unable to charge premium prices, its high-priced leases for retail space in the world's most expensive markets could quickly become a millstone around its neck.

What about e-commerce? Cowen's Chen worries that Louis Vuitton isn't doing enough to cater to customers who want quick and convenient electronic shopping. LVMH's answer is Severes24, a multibrand luxury website that it hopes will marry its curatorial talents with the ease of online shopping. It launched in June, though the jury is still out on how the company's high-end customers will embrace it. Tristan d'Aboville, analyst with William O'Neill and Co. points out, however, that this is not LVMH's first on-line foray: it previously pushed products through a site called eLuxury, which it was forced to fold in 2009.

The bottom line: LVMH is demonstrating one formula for making a success of brick-and-mortar retail. That does not mean it can rest: Even high-flying luxury retailers like Louis Vuitton must constantly innovate as e-commerce matures and offers more products and more ways to buy them.

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How to invest in the singularity

Carolyn Kaster / AP

Peter Thiel has made some shrewd bets in his lifetime: a half-million dollar wager as Facebook's first outside investor, earning him roughly $1 billion when he cashed out in 2012; and more recently, his contrarian political bet on Donald Trump.

Need more evidence to recommend Thiel's foresight? Check out this video from the 2007 Singularity Summit (ignore the erroneous year in the video title), in which Thiel suggests how to bet on the singularity, the inflection point when machines achieve super-human intelligence.

Thiel's thesis is that the only real choice is a bet that the singularity wildly succeeds, and not that humanity is doomed (i.e., a Matrix-like conquest of man by machine). "If you are somebody who is predicting the end of the world, even if you are right, I think you will still not make a lot of money," Thiel quips in the video.

  • Thiel did this talk months before the financial crash pulled the U.S. into the Great Recession, and many years before the recovery led to today's lofty valuations for AI-intensive companies like Google and Facebook.
  • "If you have a singularity, there is presumably going to be one entity or one company or one tea that's going to take over the whole world and be worth more than everything else put together," Thiel says.
  • In a world where the singularity is nigh, the only way for investors to bet on it is to invest in the entity that triggers it or some proxy for that entity (like, say, the San Francisco real estate market).

Thiel's predictions: We should expect booms and busts of successively greater magnitude as investors go all in on whatever they see as the future source of unbounded technological growth.

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What Trump's Amazon tweet got wrong, and right

Patrick Semansky/AP

President Trump has taken another swipe at Amazon, tweeting that it is damaging "towns, cities and states throughout the U.S.," paying no taxes, and killing jobs.

  • His tweet: "Amazon is doing great damage to tax paying retailers. Towns, cities and states throughout the U.S. are being hurt - many jobs being lost!"
  • Why Trump is wrong: As of April, Amazon does collect taxes on goods sold from its own inventory for every state in the union that has a sales levy.
  • Why Trump is right: Amazon has been a buzzsaw through big swaths of traditional retail, including brick-and-mortar bookstores, department stores and apparel shops. Tens of thousands of jobs have been lost, along with sales taxes that fund local services. And Amazon doesn't collect sales taxes on goods sold by third-party affiliates, unless it is contracted to do so by those sellers. Amazon declined to comment, but has said previously that close to half the items sold on its site are from third-party affiliates.

A legal grey area: In the case of product sales across state lines, sales taxes are collected only if that business has a significant presence, like a factory or warehouse, in that state. Otherwise, the customer still technically owes that tax, but only very rarely is the state able to collect.

The economic impact: As e-commerce has grown, so has revenue generated by selling goods across state lines. For years, this enabled many retailers, including Amazon, to offer lower prices by not collecting sales taxes. According to Richard Cram of the Multistate Tax Commission, third-party sellers on Amazon are avoiding more than $1 billion annually in sales taxes across the country, giving those dealers an unfair advantage on brick-and-mortar competition, and robbing local governments of revenue.

Amazon itself, however, now pays sales taxes in all sales-tax states, and has publicly supported the Marketplace Fairness Act, which would allow states to require out-of-state retailers to collect sales taxes.

  • The latest iteration of the act would exempt companies with less than $1 million in annual revenue, so even if this legislation passes, a significant number of third-party sellers could avoid collecting sales duties.
Our thought bubble: If Trump were truly concerned about this sales-tax loophole, he could get behind the bipartisan bill, reintroduced in the Senate in April. More likely, however, he is only taking the opportunity to tweak Amazon and its founder, Jeff Bezos, who owns the Washington Post, which the president has accused of being unfair to him.
Featured

Study: Higher minimum wages bring automation and job losses

As of the start of the year, 19 U.S. states had raised minimum wages, dramatizing a long simmering debate: Do minimum wages kill jobs, and make the working class worse off in the end? Or do they simply make them a little richer, with little or no loss to overall employment?

In a new paper, economists Grace Lordan of the London School of Economics and David Neumark of UC Irvine parse 35 years of census data and come down on the worse-off side: For lower-skill jobs like bookkeepers and assembly-line workers, they say, higher minimum wages encourage employers to automate — according to their calculations, a $1 increase can cost tens of thousands of jobs nationally.

Unsurprisingly, the paper has triggered serious pushback. Read on to hear the debate.

What they studied: Lordan and Neumark relied on census data from 1980 to 2015 to define the impact of a minimum wage increase on what they call "automatable" jobs — lower-skilled employment involving more or less rote tasks.

  • Their forecast is probably conservative because they examined the impact of raising minimums to $7.77 an hour from the nationwide average over that period of $6.77.
  • That is only a little more than half the $15 an hour that minimum wage advocates are urging — and that has been enacted in places like Seattle. At the higher level, automation could be much greater.
  • Furthermore, the effects of minimum wage hikes have grown more pronounced as robots have improved, since it's more economical to use them.

The pushback: Axios exchanged emails with Michael Reich, economist and co-chair of the Center on Wage and Employment Dynamics at UC Berkeley. He challenged Lordan and Neumark, arguing that "the paper's findings conflict with the only two extant studies on the subject (here and here), which find no statistically significant net effects [of minimum wage hikes] on employment in automatable jobs.

  • Reich also quibbles with the paper's focus on workers with no college education whatsoever, even those with community-college degrees. "This group comprises a substantial proportion of workers in automatable jobs and there is no reason to exclude this group from the study," he said, arguing that it skewed the results.
  • He also criticizes the paper for not considering "whether offsetting job increases occurred in less automatable but nonetheless low-paid jobs."
  • Heidi Shierholz, an economist with the Economist Policy Institute, tells Axios that other research has shown just that — that automation causes a change in the type of jobs worked, but not overall employment levels.
Neumark responds: In a phone interview, he said he concentrated on workers with just a high school degree because they are the target of minimum wage laws. It's this very population that is most at risk of joblessness as a result of a higher minimum wage, he said.
And re-training may not help: Many lower-skilled workers won't be absorbed into a new economy involving automation technology jobs, he said. "If I'm 55 and displaced as a result of minimum wage laws, am I really going to be able to retrain to operate new machinery?" Newmark said.
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Sears was retail's cutting edge for a century, until it wasn't

Sam Jayne/Axios

The New York Times Business section takes a deep dive into Sears' recent woes under the leadership of hedge fund titan Eddie Lampert. He took control of the firm in 2005, after coordinating a merger between it and Kmart, and has since presided over the loss of $26 billion in market value and the elimination of 176,000 jobs.

The failures of Sears are numerous:

  • The company first faltered in the 1990s under pressure from new, hyper-efficient, big-box stores.
  • Lampert implemented an organizational structure in which different business lines like men's wear and home furnishings would compete with each other over performance. The set up has worked in asset management, but it led to crippling infighting among staff.
  • Sears overspent on buying back its stock to boost its share price, while pouring money into a failed loyalty program aimed at getting shoppers to spend more online. This led to underinvestment in its core business of brick-and-mortar sales.

America's most innovative retailer: Sears' decline is a stunning reversal for a company that was the juggernaut of its day. The first Sears catalog was launched in the late 19th century, and capitalized on new railroad infrastructure to ship everything from sewing machines to bicycles across the country.

The company continued to stay at the leading edge of retail, offering customers good prices and a reliable, no-questions-asked-returns policy on products that defined the successive generations, adding auto parts and gleaming appliances as consumers demanded them, and pioneering the issuance of credit cards to loyal shoppers.

But it was caught flat-footed by big box retailers like Walmart, which used new information technology to perfect inventory management and give itself leverage in negotiations with suppliers. Sears and its department-store brethren couldn't beat the big-box stores on price, and no longer set the pace on products themselves. The rise of Amazon has been another defining blow, cutting into department-store profits.

The bottom line: Sears isn't the only incumbent retailer to lose out to nimble competitors that focus on the future (in this case e-commerce) absent any worry about underinvestment in the main operation that provides cash flow (Sears' physical stores). As bankruptcy rumors swirl around Sears, the health of rivals JCPenney and Macy's are not much better.

But those chains haven't had to deal with the sort of financial engineering that Lambert applied to Sears, when he spun off its valuable real estate into a separate company that he owned, burdening the retailer with rent payments on top of its many other obligations.

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The housing market has recovered; construction workers haven't

Rebecca Zisser / Axios

It's one of the great mysteries of the U.S. real-estate recovery: home prices nationally are just a touch below pre-crisis levels, and at all-time highs in many populous markets, as buyers scramble to grab what they can during a 30-year low for housing inventory. Yet homebuilders are moving at a snail's pace to meet this heated demand — they are breaking ground on just 849,000 new single-family homes per year, well below the 2007 rate of 1,036,000.

This is having a spillover effect in jobs: Just 767,000 people are employed in residential-construction in the U.S., 20% below the figure a decade ago.

A level deeper: During past recoveries, the housing industry has jumpstarted the rest of the economy. If we were following historical trends, the number of homes under construction per month would be 30% greater — along with the jobs that go with them. "New construction is a solid source of middle-class jobs historically," says Ralph McLaughlin, chief economist for Trulia, a real estate data firm. But this time, construction is lagging the rest of the labor market. "We're massively under-building in this country," he told Axios.

A shortage of qualified labor? In interviews with Axios, homebuilders complained foremost about a shortage of skilled workers — that's why they are not building enough homes to meet demand. In surveys by the National Association of Homebuilders, 78% of construction firms say labor shortages are their number-one concern, up from just 13% in 2011. "It's difficult to find good reliable labor with the right skills," said Donnie Evans of Dallas-based Altura Homes.

  • Labor advocates take issue, however, noting that, when adjusted for inflation, the average hourly wage for a construction worker is unchanged from 2006. If they really want more workers, why don't home builders raise wages to attract back the folks who left the industry after the housing crisis?
  • Homebuilders say they can't afford higher wages because home prices would surge beyond the reach of the typical buyer. Evans, for instance, says he's already raised his average home price by 50% — from roughly $160,000 four or five years ago to $240,000 today.
  • But Trulia's McLaughlin says that in such cases, it's typically the sellers of land who eat the cost of higher wages, not the final customer.

How about regulation? McLaughlin said government fees and construction standards can be onerous and make building uneconomical even when land can be bought on the cheap. Homebuilders must also contribute to the cost of infrastructure related to new development; such costs account for roughly 25% of a new home, and rose nearly 30% between 2011 and 2016, according to the NAHB.

Financing is tight for homebuilders, the majority of whom borrow to fund their projects. Residential construction loans outstanding are at 40% of their 2007 levels, and year-over-year lending growth has been slowing, says the Federal Deposit Insurance Corporation. Housing economist Lawrence Yun of the National Association of Realtors suggests that Dodd-Frank regulations on community banks are holding back development lending, in addition to a stubborn wariness by bankers to dive back into real estate lending.

The bottom line: There's no one factor holding back the homebuilding industry from building desperately needed homes and hiring more workers. The culprit instead is a combination of a banking sector that is less willing to finance the industry, a shortage of construction workers, and a paucity of buildable land in many metropolitan areas absent changes in zoning regulations. Builders also are resisting wage increases after years in which they enjoyed plentiful labor, and no pressure to push up pay.

What can be done: Some of these headwinds will just take time to dissipate, but state and local governments can reexamine regulations and land-use laws, and the federal government should expand its affordable housing tax credit, which encourages builders to construct homes that middle and working-class homebuyers can afford. Finally, builders should face the law of supply and demand, and raise their workers' pay.

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Occupational licenses may reduce income inequality

The Wall Street Journal highlights a study by Clemson University economists Peter Blair and Bobby Chung which purports to show that occupational licenses, which legally permit workers to do certain jobs like barbering or pest control, reduce income inequality between men and women and between whites and African Americans.

According to the report, occupations that require licensing see a decline in wage inequality between men and women between 36% and 40%, and a decrease between black men and white men of 43%.

Why it matters: Occupational licensing has been criticised by both Democrats and Republicans as unnecessary barriers erected by vested interests to keep new entrants out of the market, which reduce employment and raise prices. But Blair and Chung argue that they also enable workers who are discriminated against an opportunity to signal their competence to prospective employers.

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Retailers take another stock-market beating

Retail stocks posted their worst day since March during trading Thursday, as the SPDR S&P Retail ETF fell roughly 3% on disappointing earnings by retailers like Macy's and Kohls.

Data: Money.net; Chart: Axios Visuals

The worst performer in the S&P 500 on Thursday was Macy's, which was down more than 10% after reporting earnings that showed yet another quarter in which same-store sales declined. Urban Outfitters and Kohls were also among the S&P 500's top losers, shedding roughly 6% each of their market values on Thursday.

Why it matters: This is the continuation of a long and painful decline for America's top retailers. It's the fourth quarter in a row that both Macy's and Kohls have traded down after earnings, suggesting that their performances have been even worse than an already pessimistic investor class expects.

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Computer-powered hedge funds lag the bull market

Even as experts worry over the havoc AI could bring to financial markets, quantitative hedge fund strategies actually aren't outsmarting more human-reliant competitors in recent quarters, according to Bloomberg.

Quant fund managers — who feed huge caches of data to sophisticated, proprietary algorithms to find inefficiencies in the market they can exploit for profit — are struggling to keep pace with the broader market, and some funds, like the once-promising R&F Capital, are shuttering their doors altogether.

Why quants are struggling: Noted quant fund investor Neal Berger wrote in a letter to clients this summer that it comes down to two factors:

  • Increased competition: more investors are using algorithms to fight over the same inefficiencies in the market.
  • Low volatility: quantitative funds are most successful in an environment where there is large disagreements in the market over the prices of assets. Today there is little disagreement, and the best way to earn outsized returns is placed highly leveraged bets that the market will remain calm. That's working for some investors, but is far too risky for others.

So what explains low volatility? Market watchers have been scratching their heads for an explanation for low volatility even as traders have processed important unexpected events like Brexit and the election of Donald Trump. But one answer is the increasing popularity of index funds that allow individual investors to buy into a broad diversified set of stocks or other assets that reallocate automatically. Instead of individual investors duking it out with competing stock picks, many are choosing just to buy a small but broad slice of the market, and letting it ride.

What's next: Quants won't take their disappointing returns lying down. Major investors like Paul Tudor Jones are putting money behind investment strategies powered by artificial intelligence that aim to use ever larger data sets and more sophisticated algorithms to weed out profitable inefficiencies in the market.

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E-commerce isn't killing Las Vegas retail shops

Isaac Brekken/AP

There will be more store closings in America this year than in 2008, but Las Vegas Strip retailers are actually expanding square footage, the Las Vegas Sun reports.

Purveyors of the strip attract customers with sensory experiences, and profit from impulse buys once shoppers are in the store. It's no surprise that Las Vegas is attracting record crowds, but its traditional retailers are also leveraging that success despite an overall shift toward e-commerce.

Why it matters: Las Vegas is uniquely positioned to attract shoppers looking for something to do, so it's not clear that this model is replicable in every case. That said, mall owners across the country are investing in their properties at the highest rate since 2008 on the logic that they can breathe life into their businesses by making the shopping mall a destination in its own right.