Jan 20, 2019

Axios Capital

By Felix Salmon
Felix Salmon

Situational awareness: Sheryl Sandberg is still apologizing, this time at the DLD conference in Munich, aka the Davos pre-conference. Rihanna is going to have her own luxury brand. Are you ready for the super blood wolf moon?

1 big thing: Jack Bogle's misunderstood legacy

Illustration: Aïda Amer/Axios

The best speech ever given to an audience of bankers was delivered by Paul Volcker in December 2009. His famous zinger: "The most important financial innovation that I have seen in the past 20 years is the automatic teller machine."

Volker was right in substance, but he did miss one financial innovation that has been unambiguously positive for the world.

  • The low-cost index fund, as popularized by Jack Bogle (1929–2019), has given millions of investors billions of dollars in extra retirement income.

Bogle created a fund-management giant in Vanguard, which is owned by the investors in its funds and therefore has no need to maximize the profits it makes.

  • For anybody trying to work out where to invest their retirement savings, it's hard to do better — and very easy to do a lot worse — than just putting the whole amount into a Vanguard index fund.
  • Bogle's insight was that an individual investor will find it statistically impossible to beat the market over the long term, either by picking stocks or by picking fund managers. Index funds provide market returns at minimal cost, by excising stock-pickers entirely.

Millions of Americans have got the message and have moved their investments to index funds and other passive strategies. The biggest fund managers, including Vanguard and BlackRock (which owns iShares), are built on not picking stocks.

  • Vanguard and BlackRock are two of the largest shareholders in just about any big company you care to mention; they have no choice in the matter. Yet as large shareholders, they are constantly subject to campaigns urging them to divest from certain companies.
  • BlackRock, in contrast to Vanguard, is reluctant to admit that it has very little control over much of its asset base. BlackRock CEO Larry Fink enjoys the bully pulpit that comes with controlling trillions of dollars. (Bogle, by contrast, never tried to tell public-company CEOs how to run their companies.)

This week, BlackRock was embarrassed by a fake letter from Fink, designed to make him look like an ineffective blowhard. The point of the letter was to show what Fink could achieve if he really wanted to, including divesting from carbon-investing companies even in his "broad indexed funds."

  • There's a case for divestment, but a fund manager doing any such thing is by definition an activist.

The bottom line: Passive investment is good for millions, but active investment is still necessary. It holds managers accountable for their actions and provides crucial price discovery. Bogle was proud to be a passive investor. Fink, by contrast, seems to want to have it both ways.

2. When long-termism backfires

Illustration: Sarah Grillo/Axios

Larry Fink's real letter this year hammered home one point in particular. His clients "have decades-long horizons," he wrote, which means that he's looking for "long-term growth" and "a long-term approach" (a phase he used three times, including twice in the final paragraph). To that end, he said, he would like the companies he invests in to have "compensation that promotes long-termism."

  • Many of Fink's exhortations are vague and platitudinous, but that last one is clear: Companies should pay their employees not on the basis of how much money they made this quarter, or this year, but rather on a much longer time horizon.

The big picture: In general, high-paid employees are much more likely to find themselves in multiyear compensation schemes, which Fink presumably likes. But those schemes have their own downsides.

  • They're bad for optimal allocation of labor, since they make it incredibly hard for highly paid executives to move to another company. For instance:
    • Apple CEO Tim Cook made $137 million in 2018 alone, thanks almost entirely to a single stock grant in 2011. His opportunity cost of leaving Apple could be close to $1 billion — making it effectively impossible for anybody else to hire him.
    • Banco Santander hired UBS investment-banking chief Andrea Orcel to be its new CEO, but then had to un-hire him when they realized just how much it was going to cost them to compensate him for the deferred pay he was giving up in Switzerland.
  • Conversely, multiyear contracts make hiring mistakes ludicrously expensive. Consider:
    • Marissa Mayer hired Henrique De Castro from Google after she became the CEO of Yahoo. He only lasted 15 months, but that was long enough for him to earn well over $100 million, including $58 million in severance.
    • Megyn Kelly got paid the entirety of her $69 million contract at NBC, despite disappointing ratings that led to her being fired long before her contract was up.
    • Even Les Moonves, fired from CBS for cause, is fighting for $120 million in severance.

Be smart: When people like Larry Fink extol long-termism, they encourage companies to lock in executives with contracts that can be worth hundreds of millions of dollars. It's far from clear that shareholders are well-served by such deals.

3. An earnings reality check
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Data: FactSet; Chart: Naema Ahmed/Axios

Analysts were convinced that the last quarter of 2018 was going to be great for earnings — until, suddenly, at the end of the year, they weren't.

  • JPMorgan is a good example. It had a record year in 2018, earning $32.5 billion in total. That shattered the previous record by some $8 billion. And yet its quarterly fixed-income trading revenue was its worst since the financial crisis.
  • Apple's earnings warning at the beginning of January was particularly noteworthy, and wiped some $2.5 billion off expectations for its quarterly earnings.

The bottom line: The stock market's volatility at the end of 2018 was to a certain degree based in genuinely unexpected fourth-quarter weakness. And 2019 is getting off to a very rocky start. With expected earnings still at or near all-time highs, there's definitely a lot of room for them to be re-rated downwards.

Bonus: Earnings talk

DJ D-Sol's new single

DJ D-Sol released his first original track at the end of December, called "Feel Alive." Full of uptempo house beats, the single weirdly didn't set the tone for how the DJ introduced himself on his first earnings call as CEO of Goldman Sachs.

I'm going to start off this morning by reiterating that I'm fully committed to an active and ongoing dialogue with our shareholders and our broader stakeholders. I'm excited about our new call format... Our overarching priority is to execute our core mission, serving our diverse client franchise.
— DJ D-Sol, aka Goldman Sachs CEO David Solomon, introducing the bank's Q4 2018 earnings call

OK, maybe that's more "feel as though you want to stick a fork in your eyeball" than "feel alive," but maybe it's hard to feel too alive when the sticker price for avoiding criminal prosecution in Malaysia is $7.5 billion.

Netflix's quarterly shareholder letter was much more pointed. You thought Netflix's main competitor was HBO? Think again:

We earn consumer screen time, both mobile and television, away from a very broad set of competitors. We compete with (and lose to) ​Fortnite​ more than HBO.

Go deeper: Fortnite isn't a video game, it's a social network.

4. Japan's hard at work
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Data: Organization for Economic Cooperation and Development; Chart: Chris Canipe/Axios

This chart was inspired by the wonderful FRED blog, and it shows a lot more slack in the American labor market than the record-low unemployment rate would suggest.

  • If you're a working-age American, you're less likely to have a job now than you were pre-crisis. And you were significantly less likely to have a job pre-crisis than you were during the Clinton boom of the late 199os.
  • The equivalent numbers in Japan show that this isn't a story of demographic inevitability. More working-age Japanese have jobs today than at any point in the country's history. Today's employment rate in Japan is also significantly higher than the employment rate at any point in American history.

The bottom line: America hasn't run out of workers, not even close. Unemployment might be low, but employment could rise significantly from its current levels.

5. Aid works
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Data: United Nations Inter-agency Group for Child Mortality Estimation; Chart: Lazaro Gamio/Axios

As Axios' Eileen Drage O'Reilly reports, a child born today is half as likely to die before the age of 5, compared to if she was born in 2000. This isn't general global good fortune; rather, it's the result of targeted interventions, costing hundreds of billions of dollars, from GAVI, the Global Fund, the Global Polio Eradication Initiative and the Global Financing Facility.

  • Every year, more than 6 million children under the age of 5 survive who would have died had they been born in the 1990s. Those kids — especially the girls — are also being educated better than ever before.
  • Saving children's lives is the lowest-hanging fruit in the development world, and we're surprisingly good at it. That's not only fantastic for the children themselves and for their parents, it's also fantastic for their countries' economies.

Why it matters: These figures are worth remembering next time someone tells you that aid doesn't work and that we should all be investing in disruptive innovation and electric cars instead.

6. A striking chart
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Data: BLS; Chart: Andrew Witherspoon/Axios

New data from the BLS show that unionized workers still make substantially more money than their non-unionized counterparts.

  • The teachers strike in Los Angeles has cost $125 million so far, and all indications are that it's not going to end soon.
7. Brexit, in a single gif

Illustration: Sarah Grillo/Axios

Britain is broken, and there doesn't seem to be anybody who's able to fix it.

8. This week: Davos

Illustration: Rebecca Zisser/Axios

Thousands of business and government figures will be at the World Economic Forum in Davos, Switzerland, this week, writes Axios' Courtenay Brown. (Jack Bogle pointedly never attended.)

  • Some world leaders won’t be there, dealing instead with chaos in their own countries. Trump is entering the fifth week of a government shutdown, while Theresa May has to announce her Brexit Plan B. Emmanuel Macron will skip Davos too, after weeks of protests in France.
  • A notable Davos first-timer is Brazil’s Jair Bolsanaro. The controversial, far-right president is using the trip to push his trade and economic agenda in what’s expected to be a 10-minute speech on Wednesday.

For economy watchers, China has a full-scale data dump later tonight, including retail sales and GDP figures. Any further signs of a slowdown are likely to be bearish for global markets.

  • The Bank of Japan announces its policy decision on Wednesday, with the European Central Bank following on Thursday. Don't expect action from either.

The U.S. stock market will be closed tomorrow for Martin Luther King Jr. Day.

9. Building of the week: 270 Park Avenue
Photo by Max Touhey

Many thanks to Max Touhey for his gorgeous photo of Natalie de Blois' 270 Park, the former headquarters of Union Carbide and now home to JPMorgan Chase.

  • This clean and beautiful exemplar of Park Avenue modernism was the largest building ever designed by a woman when it was built in 1961 — a title it held for 50 years.
  • It was effectively rebuilt in 2011, with an architecturally sensitive retrofit bringing it up to LEED Platinum status.
  • JPMorgan has now filed permits to demolish the building, in the face of opposition from the Municipal Art Society, as well as architecture critics like Alexandra Lange and Justin Davidson. Its current headquarters building is set to become the tallest building ever to be voluntarily demolished.

Our thought bubble: Tearing down this landmark building, which is effectively only 8 years old, flies in the face of JPMorgan's stated sustainability policy. 270 Park is historically important on multiple levels. It does not deserve this fate.

Felix Salmon