Tuesday, July 11, 2023

Tuesday Afternoon Links

  • According to Power Failure, almost every time GE made a major decision that destroyed shareholder value, the obsession with manipulating earnings was front and center in the thought process. GE lost a lot of money in insurance, but why was a manufacturing company in the insurance business in the first place? Well, insurance companies offer a lot of accounting leeway, in terms of the way reserves are taken and assets are sold for profit, and could act as “shock absorbers” that let Jack Welch report smooth earnings when other divisions stumbled. [MD&A]
  • Goodhart is one of my favorite economic thinkers because of “Goodhart’s Law,” which states when a measure becomes a target, it ceases to be a good measure. This is because people will take shortcuts to artificially boost the measure once they know it’s being tracked. One of my “laws” of business is that managers should have measures they track, but keep them secret, only using the measure to trigger deeper investigation into possible problems. [The Tom File]
  • One of Charles Goodhart's most prominent contributions to monetary economics is known as Goodhart's Law. Charles wrote this law in the footnotes of his paper Problems of monetary management: the UK experience for the Reserve Bank of Australia during his time at the Bank of England (1975). The law states that: "whenever a government seeks to rely on a previously observed statistical regularity for control purposes, that regularity will collapse." Although written initially as a witty comment about monetary targeting, the underlying thought behind this notion was taken very seriously and was linked to the Lucas Critique of evaluation and policy modelling. This law was generalized by anthropologist Marilyn Strathern beyond the world of statistics. The most commonly used version of Goodhart's Law comes from Strathern's paper: "When a measure becomes a target, it ceases to be a good measure." In reflection to the creation of Goodhart's Law, Charles wrote: "it does feel slightly odd to have one's public reputation largely based on a minor footnote." [Charles Goodhart
  • Andy Grove, in High Output Management, advocates the notion of pairing indicators. His first example, ironically, is inventory: if you want to start tracking inventory as a performance metric (lower being better), you should also start tracking the prevalence of inventory shortages, to make sure you aren’t damaging the business by holding too little inventory. Another general example he cites is pairing measures of output quantity with measures of output quality; if you track the number of widgets produced, you should also track the defect rate. [MD&A]
  • In modern times in the US, we have come to expect 2% annual inflation, so if you keep $10,000 in a checking account, you can expect to lose $200 of purchasing power each year. Sometimes, inflation comes in a bit hotter than expected. Inflation was about 7% in the US in each of the last two calendar years, meaning depositors lost 14% of the value of their investment during that period. Even excluding expected inflation of 2% per year, that’s a 10% surprise haircut. There are about $20 trillion of bank deposits in the US, so that means depositors collectively ate a $2 trillion surprise loss over the last two years. Given the circumstances, bank depositors as a group hardly seem like a fair target for our collective ire for requiring a bailout of less than $100 billion. [MD&A]
  • Passive investing, like hitting, is (more or less) a zero sum game. Davis was able to build a fortune by purchasing undervalued insurance stocks for ten cents on the dollar, but that was only possible because there were people willing to sell at those prices, investors who did not understand the true value of what they were parting with and who were effectively transferring their wealth to him. What Davis and Buffett have much in common, but what is most relevant to our puzzle is not their shared interest in insurance or their approach to investing or their use of leverage. It is when they began investing. Davis and Buffett began investing at a time when knowledge about security analysis was far less widely disseminated and most assets were not yet professionally managed, and thus the variation of returns was very high. They were both students of the father of the discipline, Benjamin Graham, a man who made his fortune by paying only two times earnings for a highly profitable, fast growing company that was on its way to being the industry leader for decades to come. Today, Tiger probably would have outbid him with an offer that was a thousand times larger. [MD&A]
  • Brooks makes the case, citing Brookings economist Jonathan Rothwell, that the top one percent of earners in America are disproportionately composed of members of professions that have convinced legislators to allow them to collude to restrict supply and pass laws that shield existing members from competition. In other words, legalized cartels. His chief example is the medical profession. In America, the number of medical school and residency slots is capped, and other medical professionals such as nurse practitioners are legally limited in what they can do. As a result, doctors and surgeons in the US get paid over double what doctors and surgeons get paid in Western Europe even relative to the average worker in their countries. He also points out that there are eight times as many software developers as there are dentists in America, but there are about as many dentists as there are software developers in the top one percent of earners, the result of restricted entry to the dental profession, as well as laws that limit the kind of work that dental hygienists can do. [MD&A]
  • Most Americans (66% of American households) are in the business of owning and leasing residential real estate. It just so happens that they usually rent to themselves rather than an outside tenant, but the economics are the same regardless. There is also a plethora of publicly available data about each house online. Why not analyze a business that almost everyone is interested in? To get into this business, American households routinely enter into a complex and highly leveraged trade where they put 500% of their wealth into a property and fund it by shorting the dollar in a massive way. This is no small industry either; according to the Fed, owner-occupied residential real estate alone is worth $31 trillion at current market value. [MD&A]
  • Historically, it has been hard for non-income producing assets to keep up with income producing assets over a long period of time. An ounce of gold was worth $20.67 back when the US was on the gold standard, before the 1930s; that same ounce of gold is worth $1,772 today, 86 times your original investment, a respectable return. If you took that same $20.67 and put it in the S&P 500 in 1926 (the earliest date for that index), and reinvested dividends, you would have $225,905 today, or 10,929 times your original investment. This is through the Depression, the wars, and everything else. [MD&A]
  • It took nearly eight years to sell the first 1mn battery-powered cars, trucks and vans in the US, a milestone hit in 2018. The 2mn mark took roughly 32 months, and the third million took approximately 15 months. The accelerating pace brought the 4 millionth sale after just 10 months. Tesla, General Motors and Rivian all reported strong US sales and deliveries for EVs during the second quarter, as did BYD in China. EV sales declined 2 per cent at Ford in the second quarter versus a year earlier, but they were still up 12 per cent in the first half of the year compared to 2022. [FT
  • Darko had told us how good the food would be here, as Ireland’s odd climate enables cows to eat green grass 365 days per year. It almost never freezes, and it’s never hot, sort of like a European Argentina. High-quality grass-fed beef seems rather cheap compared to the States, and I’m making the most of it. Our evening restaurant featured “beef dripping chips.” Distant memories of McDonald’s fries from my early childhood - before a zealot ruined them - are activated. No volatile, off smells, and a background taste of a good ribeye in every bite. They’ve taken so much from us with the seed oils. [The Tom File]

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