Welcome back. I hope you enjoyed your long weekend. Here in New York we had icy rain and were cooped up in the house. And so, with some relief, back to business.
A brief exchange with Olivier Blanchard
Last week I wrote that I thought inflation expectations and the stock market had fought to something like a tie. The data continue to stoke fears of inflation (and therefore sooner-than-expected monetary policy tightening) sufficient to keep the market rangebound, but not enough to force it into a decline.
But as a market writer, I’m in something of an echo chamber: I read and talk to a lot of people who have a professional interest in saying that the market will be OK, despite inflation. I need someone to shake me from my complacency.
It was fortunate, therefore, that a friend introduced me to Olivier Blanchard, who is a fellow at the Peterson Institute for International Economics, a professor emeritus at MIT, and a former chief economist at the IMF. He wrote in February about his worry that, because the US stimulus proposals would put significantly more money into the economy than the pandemic took out of it, unpleasant levels of inflation threaten.
I asked him if the data that has come in since then had changed his view. He replied that things were playing out as expected, but that the central question had not yet been answered. He puts that question like this:
“Whether workers, who will have seen a decrease in their purchasing power, who are operating in what will increasingly be a tight labour market, and have an administration which is (rightly) labour and union friendly, will stay pat, or ask for and obtain wage increases.”
If the answer is no — as US president Joe Biden’s team thinks — inflation will fade quickly. As for Blanchard:
“My belief is that yes is more likely. And if so, prices will reflect the increase in wages, and inflation will have much more momentum than the administration and the Federal Reserve assume. Time will tell. But it has not yet.”
I pressed him. In the past, hasn’t it taken a long time for inflation expectations to rise significantly? His reply:
“While the discussion has focused on expectations, I think this is misleading. A worker who sees that his or her consumption basket is 5 per cent more expensive than last year will want to have a wage increase of 5 per cent to compensate, whatever his or her expectations of the future. Wouldn’t you?”
His message is clear: “Watch new wage contracts and wages like a hawk.”
Well, private hourly wages rose 0.7 per cent in April against the month before. That may not be much (all of 21 cents an hour, to $30.17). But, other than the wild spike when millions of low-wage workers fell out of the workforce in the spring of last year, a rise of that size had only happened once before since the Fed started tracking the data in its current form 15 years ago. And that was in December.
Is Amazon a bargain?
A couple of weeks ago in Barron’s, Bill Miller said that he thought Amazon stock would double in a few years and that, if he was building a portfolio from scratch, he would put 20 or 30 per cent of his net worth in it. I’ve quoted this interview before, in the context of bitcoin; as a portrait of the growth investor mindset, it’s remarkable.
In any case, Miller’s Amazon argument has stuck with me. The stock has had such an astonishing multiyear run and its valuation is so steep that it’s a bit hard for me to imagine the shares going on repeat rip (they have flatlined for almost a year now). It is equally hard to imagine the financial results the company would have to report to justify a price two or three times today’s.
I used to think the stock was overvalued, because I thought the growth rate would normalise. I said this repeatedly in print, and I was hilariously wrong! The growth rate accelerated! Now I think Amazon is an unstoppable monopoly that (as Miller also thinks) would only get more valuable if the antitrust cops broke it up. So it’s worth thinking about the price of the stock.
To do this, I use the World’s Dumbest Earnings Model™. Here it is:
Here’s what the WDEM assumes:
Amazon’s revenue growth rate is 29 per cent over the next five years, driving sales to almost $1.4tn. It’s the same growth rate as the last five years. This is a dumb model, in which things go in straight lines.
Its margins are stable. Could Amazon widen its margins, once it becomes a trillion dollar biz? Sure, but it won’t. Its whole model is based on using low margins and high investment as a competitive bludgeon.
Its tax rate goes up. Populism, plus everyone hates Bezos.
Its share count keeps creeping up. In a straight line.
The shares keep trading at their current multiple of 77 times trailing earnings. Why wouldn’t they, with revenues growing at nearly 30 per cent a year?
Under these conditions, the shares deliver a 25 per cent annual return through 2025. That’s just the sort of return Miller envisages. And if the growth rate averages just 20 per cent, and the multiple accordingly contracts to a mere 46 (twice the current market multiple) I will still make a return of 5 per cent a year, which is not so bad.
I think Amazon is going to continue to deliver absolutely epic growth, for the simple reason that I can’t think of anything that would stop it. But it is important to see just how much growth my Dumb Model and the Miller view envisage — that is, what five more years of Amazon growing at the rate of the last five years implies. If Amazon’s revenues in 2025 are $1.4tn, it will be generating significantly more than the current revenues of Walmart, Microsoft, Google and Apple combined. It will be a mega-corporation unlike any the world has ever seen.
One Good Read
One place where inflation is falling? IPO prices: “It’s just not the ‘everybody’s a winner’ market that it was in the first quarter.”