Mar 6, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

D.C. readers: You're invited to Mind the Skills Gap tomorrow at 8am. Join Axios' Kim Hart for a look into the role policy, business and education leaders play in offsetting the skills gap. 

  • The lineup: Kevin Hassett, chairman of the White House Council of Economic Advisers; Rob Falzon, vice chair of Prudential Financial; and Randi Weingarten, president of the American Federation of Teachers. RSVP

Situational awareness:

  • FDA Commissioner Scott Gottlieb said he plans to step down next month. (Axios)
  • Trade data released at 8:30am ET today is expected to show the U.S. trade deficit has jumped to $100 billion since Trump took office. (Bloomberg)
  • The OECD cut its global growth forecasts again in its new semi-annual report, citing "policy uncertainty, ongoing trade tensions, and a further erosion of business and consumer confidence." (Reuters)
  • Ex-Nissan Motor chairman Carlos Ghosn was released on a $9 million bail after being held for over 100 days in a Tokyo jail. (CNBC)
1 big thing: We can have wage growth, and profits too

Illustration: Rebecca Zisser/Axios

Companies again are complaining about rising wages and the potential impact on corporate profits, but history has shown that higher pay doesn't squeeze S&P 500 companies' profit margins, Axios' Courtenay Brown writes.

What it means: Profit margins have rebounded from recession lows, and are at the highest level in at least a half-century. But wages haven't kept pace.

  • Wages have been surprisingly sluggish throughout the 9-year recovery and finally started growing above 3% toward the end of last year. But they still haven't reached their pre-crisis levels and aren't anywhere close to catching up to soaring profits.

What they're saying: Shake Shack blamed lower profit margins this quarter on "significant headwinds around labor costs."

  • CFO Tara Comonte told analysts last week the company was facing "significant headwinds around labor costs" due in part to "double-digit minimum wage increases" in cities where their restaurants are located.
  • Back in November, executives at Dollar Tree said they expected "pressure" from states increasing minimum wage.
  • Chipotle's CFO Jack Hartung told analysts last month the company's "biggest challenge" was going to be labor inflation.

Executives outside of services-oriented industries are talking about the rising wage impact, too.

  • Steve Filton, CFO at hospital management company Universal Health Services, told investors last week that "rising wage rates" (along with a tight labor market) contributed to the company's inability to produce the operating leverage necessary for higher revenue.

There are 2 factors at play:

  • The tight labor market is pushing wages slightly higher.
  • Government-mandated minimum wage hikes are also forcing companies to pay up even more.

This year, 19 states had minimum wage hikes, effective Jan. 1, impacting 5.2 million workers across the country, according to the Economic Policy Institute.

Bottom line: Companies have levers to pull to offset any costs from wage hikes — and they are pulling them.

  • At Honeywell, for example, CFO Greg Lewis said the industrial was able to offset its margin pressure from labor inflation thanks to higher pricing and stronger productivity.
  • "When the economy is strong and sales are growing, companies can look for ways to up productivity and pass on the pressure in terms of pricing," Binky Chadha, chief U.S. equity and global strategist at Deutsche Bank, tells Axios.
Bonus: The profit-wage disconnect
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Data: Compustat & Haver via Deutsche Bank (h/t Business Insider Prime); Shows S&P 500's last 12 months net income margins; Chart: Axios Visuals.

Labor's share of domestic income has "barely recovered in this expansion from lows last seen when the U.S. was pulling out of the Great Depression," the Wall Street Journal points out. Meantime, business profits have skyrocketed from 12% of GDP in the 1980s to more than 20% now.

2. The market doesn't care about your reputation
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Data: The Axios Harris Poll 100; Chart: Axios Visuals

It turns out a company's reputation — good or bad — doesn't make much difference in the stock market.

The big picture: Results from the Axios Harris Poll 100, a new partnership between Axios and Harris Poll, found little difference between the performance of shares for the 10 companies that had gotten the biggest ranking improvements and those with the biggest ranking declines.

  • In fact, the basket of 10 public companies that saw the largest ratings declines marginally outperformed the basket of 10 public companies with the largest ratings improvements in 2018 (-4.9% vs -5.6%).

What they're saying: "Shareholders care about reputation, only in regards to return," Brian Battle, director of trading at Performance Trust Capital Partners, tells Axios.

Harris Poll CEO John Gerzema agrees, but says that in 20 years of the poll he's seen these things catch up with companies.

"In any given year we don't expect to see financial performance and reputation move in lockstep because shareholder value is often not correlated with the public interest. So many companies — even sectors like FAANG — can take reputational hits and still grow, at least in the short term. But over time, they risk losing market value by not being aligned with changing societal tastes."

Methodology: The Axios Harris Poll 100 survey was conducted November through January in a nationally representative sample. One group, 6,118 U.S. adults, was asked to identify the two companies they believe have the best and worst reputations. Then, the 100 “most visible companies” were ranked by a second group of 18,228 adults across key dimensions of corporate reputation attributes.

Go deeper: America's least favorite company is the U.S. government

3. What Venezuela owes
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Data: Institute of International Finance; Chart: Axios Visuals

Venezuela has ratcheted up its debt over the past few years, even as the country has been officially cut off from international credit markets and is facing U.S. sanctions.

What's happening: A new debt estimate from the Institute of International Finance finds the country has been issuing a steadily growing pile of debt through state-owned oil company PDVSA and private debt deals with the likes of China and Russia. But the central government also has managed to run up significant debt.

  • Venezuela's debt stock rose from around $62 billion in 2007 to nearly $156 billion last year, IIF's economists estimate.

Details: IIF economists tracked debt to exports and found that Venezuela's external debt is about 738% of its exports. That's more than 4 times the average for comparable emerging and frontier markets. It's also more than 200% higher than the level of debt to exports IIF estimated Venezuela carried just 2 years ago.

  • The next closest country is Tajikistan, which issued its first ever bond in 2017 for $500 million.

Because Venezuela hasn't kept reliable economic data for years and has barred bodies like the IMF and World Bank from conducting their own research, it's not even possible to determine Venezuela's debt to GDP ratio.

On the bright side: Nomura's head of Latin America fixed income strategy, Siobhan Morden, tells Axios she expects that Venezuela will be in much better position to pay off investors once a new government is in place.

  • "When bonds are repaid in 10 years or so the ability to repay should be much higher if you assume that they can recover oil production."
4. Opportunity zones: To do good or do well?
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Data: Develop LLC. Notes: City names refer to the larger metropolitan statistical areas defined by U.S. Census; "Large U.S. metros" refers to MSAs with at least 1 million people as of 2018; Values for each may not add up to 100 due to rounding. Chart: Harry Stevens/Axios

A new policy designed to attract investment to low income communities may not benefit rural areas and the most impoverished communities, Axios' Stef Kight reports.

Between the lines: The majority of what are being called "opportunity zones" — economically distressed census tracts nominated by governors to receive special corporate tax breaks — lie within large metro areas. While most have low median income projections, quite a few are in relatively prosperous areas of major cities like Washington, D.C. and San Francisco, according to data collected by Develop LLC.

Dion's thought bubble: The opportunity zones could be boon for low-income communities, but they may really be a once-in-a-lifetime opportunity for the wealthy.

Investors can use money from large capital gains like the sale of a business or a major stock position that they would have had to pay taxes on and instead invest in projects, which are typically real estate, in the approved zones.

If they remain invested for 5 years, investors can exclude 10% of the gain from taxation. If they hold for 7 years, 15% is excluded. And if they remain invested for at least 10 years, any gains from their investment would be tax-free, CNBC notes.

  • "You're basically earning a return on the taxes that you owe [in 2019] for 7 years and then you pay less in taxes than you would have to start with," Michael Crook, head of Americas investment strategy at UBS, told Axios in January. "So you can see why people would want to do this."

By the numbers: Only 3% of opportunity zones have a projected median household income of $75,000 or more, but certain well-known metro areas have a much larger concentration of these communities.

  • There also are equally competitive small communities inside struggling metro areas, such as St. Louis, Detroit or Cleveland, Steve Glickman, founder & CEO of Develop LLC, told Axios.

What to watch: Investors looking to take advantage of the new tax policy are faced with deciding whether to invest in communities where there is the most need or invest in impoverished pockets of areas that are already doing relatively well.

5. Goldman Sachs would like me to tell you about their new dress code
A screenshot of an email from Goldman's media relations team.

DJ D Sol is mix-mix-mixing things up at Goldman, y'all 🎧🙌👏🔥🔥🔥

Go deeper: Goldman Sachs goes casual for millennials

Dion Rabouin