Aug 4, 2019

Axios Capital

It's August, and after a busy week in the markets, things are beginning to slow down. This past week saw a rate cut, a trade-war escalation and a jobs report; the coming week is sure to be quieter. If you take a day or two off, probably no one will notice.

In this week's 1,865 words (a 7-minute read): Citigroup, monopolies, and r-g. But first, of course, Powell.

1 big thing: Jay Powell's constraints

Illustration: Sarah Grillo/Axios

Jay Powell did his best impression this week of a Fed chair making his own data-driven decisions about where he should set short-term interest rates. The reality, however, is that the markets and the president are giving him very little choice.

Driving the news: Powell cut interest rates on Wednesday — the first time the Fed has done so in over a decade. In doing so, he effectively fulfilled a prophecy that the fixed-income markets (and even the stock market) had been making for all of 2019. They saw the rate cut coming long before the Fed was willing to admit it, and they were right all along.

Donald Trump has been just as adamant about the necessity of a rate cut — a big one — and this week he worked out how to get what he wants. After the rate cut a few days ago, the market priced in a 64% chance of another cut in September. Less than 24 hours later, thanks to Trump, that probability had risen to north of 95%.

  • What we're seeing: The most important new word in the official Fed statement was "global." The Fed is no longer just reacting to domestic conditions; it's looking at an economic slowdown around the world, including China. Trump's announcement of new tariffs ensured that global trade will continue to disappoint and the Fed will continue to cut rates.

What they're saying:

"The president and his trade negotiators believe they have downside protection against the possibility that trade policies will cause any lasting damage to the economy or the stock market. After all, the Fed has very publicly shown that it views it as appropriate to cut interest rates to combat any slowdown related to trade wars."
Neil Irwin, The New York Times

The catch: Fed rate cuts are better at protecting the markets than they are at protecting the economy. In any case, as economist Nouriel Roubini notes, the Fed doesn't have nearly enough ammunition to protect against a fully fledged trade war.

The bottom line: Now that the Fed is being treated as a marionette by both the markets and the president, its much-vaunted independence is becoming increasingly insubstantial. The less control that Powell has over the Fed's actions, the less power he has.

Bonus: 2 days in the markets
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Data: FactSet; Chart: Harry Stevens/Axios

This is a 2-day chart of what happened to bond yields and stock prices on Wednesday and Thursday. It shows 3 things pretty clearly:

  1. Jay Powell's historic rate cut, at 2pm on Wednesday, elicited only the tiniest market reaction. As Powell told Axios' Courtenay Brown roughly an hour later, the Fed did a very good job of preparing the market for the cut, which meant that everybody pretty much knew it was coming.
  2. Powell's post-meeting press conference went much less smoothly. After the Fed chair characterized the cut as a "midcycle adjustment" — with the implication that he still considered the Fed to be in a tightening cycle — stocks fell sharply, only recovering when he later walked those comments back.
  3. Trump's Thursday tweet announcing an escalation in the trade war with China was a bigger deal — both for bonds and for stocks — than anything the Fed did. Bond yields fell more in one day than in any session since 2009. The 10-year yield ended the day at 1.89%, lower than any point since Trump was elected in 2016.

Inverted yield curve alert: As recently as July 23, less than 2 weeks ago, the 10-year bond yield was higher than the interest rate on 3-month Treasury bills. Now, the curve is deeply inverted again. The 10-year bond closed at a yield of 1.86% on Friday, with the 3-month note at 2.06%.

  • International bond markets were similarly spooked by the Sino-American trade war. The German yield curve now has negative yields all the way out to 30 years, while the Swiss curve is negative to 50 years.
2. Shameless monopolies

Illustration: Aïda Amer/Axios

Given all the antitrust scrutiny being aimed at the tech giants, it can be surprising to see other monopolies operating — and even growing via acquisition — with few if any regulatory consequences.

Monopoly 1: EssilorLuxottica is a $50 billion eyewear giant that incorporates everything from lens manufacturers to dozens of brands such as Oakley, Ray-Ban, Varilux, LensCrafters and Pearle Vision. If your frames are from Chanel or Prada or Versace, they are EssilorLuxottica products.

  • The latest giant to be swept up into the EssilorLuxottica monopoly: GrandVision, a chain with more than 7,200 stores globally.
  • European antitrust regulators might force some divestments in France and Belgium, but either way, this deal will only serve to consolidate EssilorLuxottica's global monopoly.
  • Curiously, this $7.9 billion deal is being done while EssilorLuxottica is still searching for a new CEO.
"If the deal goes through, it would strengthen EssilorLuxottica’s ability to charge markups of as much as 1,000% for frames and lenses -- market power that comes from controlling all aspects of production, owning the country’s largest chain of glasses stores and operating a major insurance plan."
David Lazarus, LA Times

Monopoly 2: Surescripts manages about 80% of all prescriptions in America. It's owned by industry giants CVS and Express Scripts, and if your prescription is filled electronically, it's almost certainly filled by Surescripts. In the words of Amazon, Surescripts is "the sole clearinghouse for medication history in the United States."

  • Driving the news: CVS and Express Scripts are facing competition from PillPack, which is owned by Amazon. Now Surescripts won't give PillPack the information it needs to find out what medicines its customers have been prescribed.
  • The FTC is taking legal action against Surescripts, accusing it of forcing pharmacies to use its services. But that doesn't seem to be helping Amazon, whose PillPack product is a masterpiece of design that — by sending your pills in presorted packets that tell you when to ingest them — significantly increases the probability that patients will take all their pills as prescribed.

The bottom line: The world is full of anticompetitive monopolies, many of which operate in plain sight.

Go deeper: The monopolization of patient drug data

3. r >> g
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Adapted from Jordà et al., 2019, "The Rate of Return on Everything, 1870–2015"; Chart: Andrew Witherspoon/Axios

For the ultimate case of Smart Brevity, look to Thomas Piketty, who managed to distill the 816 pages of his global bestseller "Capital in the Twenty-First Century" down to the single formula r>g.

  • How it works: The speed at which wealth grows over time, r, is normally larger than the speed at which the economy as a whole is growing, or g. The result is that, absent wars or redistribution, the normal and natural state of affairs is for the rich to get richer and for inequality to increase.

What they did: A stunningly ambitious study in the Quarterly Journal of Economics has calculated r and g for the world as a whole, all the way from 1870 to 2015. The authors included in their calculations not only the rate of return on securities, but also, crucially, the rate of return on real estate. That's important because it's the largest component of household wealth.

What they found:

"In fact, r>>g for more countries, more years, and more dramatically than Piketty himself reported."
Alan Taylor, one of the study's authors

By the numbers: Before World War II (but excluding WWI), r was about 5 percentage points higher than g. Today, it's about 3–4 percentage points higher.

The bottom line: Left to its own devices, the global economy will create ever-higher levels of inequality. At least unless or until there's a cataclysmic war.

4. Beware Citi's would-be saviors
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Data: FactSet; Chart: Axios Visuals

Citi has been unwieldy, impossible to manage, and too big to fail for well over 30 years. Post-crisis, however, it has effected an impressive transformation. Its earnings, unjuiced by the excess leverage of the early 2000s, have largely regained their pre-crisis levels — an impressive enough achievement even before you realize that the bank has shrunk considerably over the past decade.

  • Citigroup has 204,000 employees today, down from 374,000 in 2007, and operates in fewer than half of the countries it did pre-crisis. A bank that once wanted to dominate the planet, Citi is now trying to make a virtue out of the fact that it has many fewer branches than its rivals.

The bottom line: Given Citi's status as an accident-prone and highly regulated central part of America's financial plumbing, the bank's first job is to be safe and boring. Citi's profitability is high enough that it should comfortably be able to weather a downturn, but not quite so high as to be a warning signal that the bank is taking on too much risk.

  • To see how well CEO Michael Corbat has done his job, just compare Citi with Deutsche Bank. The two have a lot in common, but Deutsche is a basket case, while Citi gets stronger every quarter.

The bank's shareholders are restive, however. The FT's Robert Armstrong came out with a 2,000-word "big read" this week devoted to the proposition that Citi is underperforming and needs a "strategic shift."

  • What they're saying: "Slow-and-steady improvement is not enough," writes Armstrong, channeling a growing consensus. "Mr Corbat and Citi’s board need to be bolder."

Be worried: The last time we saw headlines like this was in 2007, when Fortune described Citi's artificially inflated prior-year earnings as "less than stellar" at $21.5 billion, and when CEO Chuck Prince desperately told the FT that "when the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance."

My thought bubble: Citigroup's profits are already huge, at roughly $2 billion per month. Shareholders want the bank to try to boost them further. The rest of us, not so much.

5. The week ahead: A huge loss for Uber

Illustration: Rebecca Zisser/Axios

62 S&P 500 companies report earnings this week, writes Courtenay. Viacom and CBS report separately on Thursday; they might shed some light on their seemingly inevitable merger.

  • Other reports of note: SoftBank and Lyft on Wednesday, plus Uber on Thursday. Uber could lose as much as $5 billion this quarter, due to IPO-related expenses.

2nd quarter GDP in the U.K. is out on Friday. The economy probably expanded at a 1.4% annualized pace — slower than the 1.8% growth rate in the prior quarter.

  • Japan's growth figures for Q2 are also out that day. Per Reuters, growth is expected to come in at 0.6% year-over-year, down from 2.2% in Q1.
6. Building of the week: Fagus Factory

Photo by Julian Stratenschulte/picture alliance via Getty Images

The Fagus Factory, in Alfeld, just outside Hanover, was built by Walter Gropius in 1911. It counts as an early Bauhaus masterpiece from before the Bauhaus was even founded; indeed, it's one of the earliest modern buildings.

  • The factory was built for Fagus, a manufacturer of shoe lasts. The company still produces the foot-shaped forms that cobblers use (now out of plastic rather than wood), and it continues to occupy the building to this day.
  • The glass curtain wall was revolutionary, especially the fact that the corners of the building are fully glazed. (Normally, the corners of a building are exterior columns.) Gropius moved the load-bearing columns inside the building.
  • Architecture tours, increasingly popular in this centenary year of the Bauhaus, take place on Sundays at 1pm.

Elsewhere: Philly Phanatic in court over whether he's an "artistic sculpture." Facebook wants to add its name to Instagram and WhatsApp. Element Capital raises its fees to 2-and-40. Beyond Meat, which went public in May at $25 per share, is selling more stock at $160. Lunch with Dick Thaler, Tim Harford, and an untouched bowl of almonds.