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The Hutch Report

Welcome to the Jungle

By | Law, Music, Politics

Music is a powerful force in life. Not only is it a dominant art form, a form of entertainment that goes back to the beginnings of human history, it has also been used as a form of communication. The reason it is so effective as a communication tool is because it drives emotions and it is emotions that play a large part in our decision making process. 

Wherever you encounter a form of sales or commercialism of a product you are bound to find some kind of catchy music attached. There is a long history of branding campaigns that have become successful mainly because of the emotion and message communicated through the music. 

We make decisions everyday but some decisions have a greater impact than others. One of the most powerful decisions you make as a citizen is your power to vote. For this reason music has been an integral part of political campaigns and elections for years. The problem is that quite often the politicians prefer to choose music that conveys their message by just using popular music that has already created an impact in order to play it safe. The music is more often than not used without the consent or knowledge of the copyright holder. When they do this they ironically disregard copyright law (a law they are supposed to be upholding).

The true artist creates for the sake of creation. The work is the focal point. This is why whenever you find a piece of music or artistic expression used for any other purpose other than that for what it was conceived, a work of art, the artist becomes incensed. The artist knows that there is a danger that the use of their work for commercial purposes can forever change the association of that music with the listening public. 

Rihanna recently sent a cease-and-desist letter to Donald Trump, with the Anti singer deploying legal action after her “Don’t Stop the Music” was played at the president’s rally Sunday in Chattanooga, Tennessee. Trump is also experiencing a backlash from the likes of Axel Rose for his use of Sweet Child o’ Mine. Over the weekend, the controversial Guns N’ Roses frontman complained on Twitter that Trump had used the hit against the band’s wishes. He explained that a legal loophole allowed the president, whose administration he referred to as “s***bags,” to do it.

This is not isolated to the midterm elections or the Trump campaigns. The unlawful use of the popular song goes back much further. 

When Independent billionaire Ross Perot ran in 1992 in a three way race against Bill Clinton and George H. Bush. He was one of the most unconventional presidential candidates in American political history, so his choice of campaign song was Patsy Cline’s 1961 love song “Crazy.” It attracted attention because his critics dismissed him as such.

During his successful 2000 presidential campaign, George W. Bush picked Tom Petty’s 1989 hit “I Won’t Back Down,” to be played during his events.  Petty threatened to sue the campaign for its unauthorised use of the tune, and Bush stopped playing it.

When Sarah Palin ran as John McCain’s 2008 Republican presidential running mate she chose to play Heart’s 1970s hit “Barracuda” at campaign events. The band objected to the use of the song and got the campaign to stop playing it.  Ann and Nancy Wilson didn’t want the song to be associated with the views of Sarah Palin. During the same campaign, Jackson Browne won a suit against John McCain when the Republican presidential candidate played “Running on Empty” in an ad bashing Barack Obama on gas conservation.

Ex-Talking Head frontman David Byrne successfully sued Florida Republican Charlie Crist for using “Road to Nowhere” in a video to attack opponent Marco Rubio during a 2010 U.S. Senate campaign.

Of course, the opposite effect can happen. Mick Fleetwood, from the group Fleetwood Mac, recently said Bill Clinton’s campaign never requested permission for what became his iconic 1992 campaign anthem, “Don’t Stop,” but the band generally voted Democratic and didn’t object to the exposure. 

Legally speaking, copyright laws allow political candidates to use just about any song they want, as long as they’re played at a stadium, arena or other venue that already has a public-performance license through a songwriters’ association such as ASCAP or BMI. However, the law contains plenty of gray area and the artist does have the ability to protect their “right of publicity.” 

The Hutch Report

“Extremely Dangerous to Our Democracy”

By | Education, Health, Politics, Psychology

Another day, another day of mud slinging. The media is after Trump and Trump is after the media. Trump cries fake news on one hand, yet on the other he produces fake news. It doesn’t take much digging to discover the number of false or misleading statements he has made. The Washinton Post did a count of these statements throughout his first 100 days. However, this is not an attack on Trump, it is simply the process of making the sitting President accountable for his words and actions and has been done throughout the years with all administrations. When the voting public catches the President with his pants down (in reference to Nixon, not Clinton!) he is called to answer, which Nixon was and forced to resign. 

One of the problems we face today regarding the news is the facility of its distribution, especially in this era of social media. It is simple to write, simple to publish, simple to distribute and very cheap to do. This has pulled everybody who is anybody with an opinion into the news game. We looked into propaganda side of this during the Russia accusations.

At one time, the American population would get home from work to watch the Six O’Clock newscast. You would get your news for the day, which was a mix of mainly local news with a portion for national and international stories. That was it and that was enough. If you wanted something lighter or deeper and more informed there was a selection of magazines and newspapers. 

The big change came with news all day, all the time. What were once headlines with an overview to give the public a general idea have become stories with a team to analyze every word and every angle. CNN was the first but should not be considered the only one. All of these all day news networks are bombarding the public with the same headlines all day long. They put together round tables to beat the crap out of a story. They parse every word in hopes of making some discovery that may drive their ratings a little higher. The constant barrage of news and information also has additional detriments to our well being, as we posted here. 

To make matters worse, what used to be independent local news stations were eventually bought up one by one by conglomerates. For example, The Sinclair Broadcast Group is the largest owner of television stations in the United States, currently owning or operating a total of 193 outlets across the country in nearly 80 markets, ranging from markets as large as Washington, D.C. to as small as Steubenville, Ohio. The stations are affiliates of various television networks, including ABC, CBS, NBC and Fox as well as numerous specialty channels. Many stations are owned outright by the company, while others are owned by legally distinct companies but operated by Sinclair through a local marketing agreement. The Fox Broadcasting Company operates an American television network made up of 17 owned-and-operated stations and over 185 affiliates. Sinclair’s aggregate televised reach covers about 40 percent of the U.S.

Unfortunately, with this kind of power and control some members of the media use their platforms to push their own personal bias and agenda to control exactly what people think. How do we know? The nightly newscasts of all these affiliates are scripted. They are all told what to read each and every day, regardless of where they are located. 

A video compilation was published earlier this year on YouTube  that presents this idea perfectly. It shows dozens of news anchors at local affiliate stations owned by the Sinclair Broadcast Group reciting word-for-word the exact same message on “fake” news. The video shows CBS, ABC, NBC, and Fox affiliates sharing the message.

This is, as the anchors in the video clearly outline, ”Extremely dangerous to our democracy.” However, that it is up to each individual to decide. 

The Hutch Report

A Day of Carnage in the Trading Rooms

By | Business, Economics, Finance, Money, Politics

Thirty one years ago today, on Oct. 19,1987, the Dow Jones Industrial Average plunged 22.6%, its largest one-day percentage-point drop ever.

You may have noticed that the financial media has started to highlight the point drops as opposed to the percentages. To say the Dow lost 500 points makes better news than saying it lost 2%. In percentage terms though this years recent plunges pale in comparison to what “could” happen as we have seen in history.

Here are five of the worst stock market crashes in U.S. history, based on daily percentage losses (source: ajc.com):

Oct. 19, 1987

Percentage change: -22.61 percent

About: Known as “Black Monday,” this devastating crash began in Hong Kong, spread to Europe and then hit the U.S. hard.

Oct. 28, 1929

Percentage change: -12.82 percent

About the crash: The Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 started on Oct. 24 and signaled the beginning of the 12-year Great Depression. Black Monday, the fourth and worst day of the crash, saw a drop of 12.82 percent.

Dec. 18, 1899

Percentage change: -11.99 percent

About the crash: During the Panic of 1896, the U.S. experienced an acute economic depression caused by a drop in silver reserves and deflation.

Oct. 29, 1929

Percentage change: -11.73

About the crash:  Black Tuesday was the fifth day of the the Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 that started on Oct. 24 and signaled the beginning of the 12-year Great Depression.

Nov. 6, 1929

Percentage change: -9.92

About the crash: Just a week after the height of the 1929 Stock Market Crash, investors saw another dip.

As many often refer to these numbers when speaking about this event the real point of interest should be in what they were saying back then, which not many financial media tend to refer to. Ironically they were saying many of the things they say today.

We looked back at a Nightly News Broadcast of that time in order to gain a better understanding of the mindset of the time. You would be advised to watch the broadcast because in the words of Philosopher George Santayana, “Those who cannot remember the past are condemned to repeat it.” (See The Nightly News Broadcast October 19, 1987 at the bottom of the post)

The 1987 crash lost much more than the crash of 1929, and although (as they said at the time), “Conditions today are much better than they were then,” “today’s precipitate decline struck fear in hearts and pocket books of even Wall Street veterans.”

All the same actors showed up as they do today with the same speech tracks. New York Stock Exchange Chairman at the time, John Phalen, tried to be reassuring. “We are extremely fortunate today that the country is in a very strong position.”

The word of the Economists was that they were worried that the market plunge at the time could impact the psychology of even those that didn’t own stocks. They worried the consumer would stop borrowing and spending which could grind the economy to a halt. Compare those worries of the time to today. They are the same. The big difference is that today consumers are already heavily indebted. They are carrying mortgage debts, auto loan debts, student loan debts and credit card debts that are far higher than they were in 1987.

The broadcast pointed out that, “A week ago most economists were saying that the stock market decline was merely a correction.” This is also familiar territory. Of course it is always a correction until it isn’t, however making that judgement before the fact is just a guess. On October 19, 1987, that guess turned out to be very wrong. They went on to say that, “Today’s plunge was so huge, so shocking, that no economist, no Wall Street analyst was willing to predict where it would end.” Irony so thick you could cut it with a knife.

By the end of the day, everyone was looking to Washington for some action that may help stop the carnage. At the time President Ronald Reagan ignored the plunge and continued to “brag” about the Reagan recovery. This doesn’t sound to different to anything we would expect today. Although we can probably assume that no matter what kind of serious drop that the stock market may go through in the future, Trump will be quick to blame the Federal Reserve (however that will not stop him from taking credit it for it if it keeps moving up).

All in all, it is a fascinating 9 minutes to watch. We shouldn’t expect to hear anything different today than we did 31 years ago and that means we should have a pretty good idea of what to expect in the future.

The Hutch Report

Understanding the Face of China

By | Business, Economics, Politics

The current Trump trade war with China and the fact that The Shanghai Composite Index is off roughly 24% for the year has placed a lot of the recent news focus on China. However, understanding the Chinese takes much deeper digging into the Chinese mindset as opposed to just looking at current economic numbers. The Trump administration strategy towards China may produce some short term benefits in terms of public support but the Chinese are working on a much longer timeline with which to accomplish their goals.

The best way to understand China is to be there and speak with those with whom we have business relationships, which is exactly how we gained the following insights.

In order to get to where China is today, they required expertise that they didn’t originally have. According to Professor Paul Gillis, a former head of PwC in China turned academic at Peking University’s Guanghua School of Management, and now the pre-eminent foreign analyst in China’s accounting industry, the then big eight western accounting firms clearly saw the opportunity developing in China back in the 1980s. 

“They began building up representative offices to advise foreign firms entering China, at first often working out of hotels. By 1992, they had won the right to audit, working with Chinese partners, and were helping to develop China’s accounting standards. They pulled in all manner of outside experts to help them understand the country.”

The domination of Chinese accounting by four foreign multinationals soon became a source of annoyance in the official halls of Beijing. Paul Gillis wrote that by 2006, Ding Pingzhun, director-general of the government-aligned Chinese Institute of CPAs (CICPA), spoke of the Big Four as firms that “lord themselves arrogantly across China”. 

These firms indirectly and or directly have under their tutorship approximately 60% of the Corporate sector in China. Because of this China knows that the US is intimately familiar with China’s business internal operations (shadow banking and corruption) and thinks they may be using this knowledge to form policy to secretly undermine them and weaken them.

For this reason, China believes that the US has been planning this attack using tariffs since 2000 from the Republican administrations. The expected George W. Bush to implement tariffs during his Presidential administration, however, the attack on New York on 9/11 most likely derailed the initial opportunity. The 2008 crash most likely took away the second opportunity for Bush to apply any meaningful tariffs against China. By the time Trump came along and implimented this strategy the Chinese were not surprised as they had been expecting such a move for some time. 

The Chinese understand the recent US moves to reduce corporate taxes in order to repatriate money offshore and induce these companies to return their manufacturing bases back to the US. The Chinese also realise that an agreement between North Korea and South Korea (with the US brokering) could create a much cheaper labor base. The threat is that this could take away a lot of labour intensive industries from China.

They believe that the tariff program was put in place to try and weaken or slowdown China’s growth in manufacturing and thus their world influence. It is not a secret that China has been going after markets in the Middle East, Africa and Central America spreading their influence in order to breakaway from any stranglehold that the US may currently have on them. In addition, to facilitate this in the future China has taken on the massive development of the One Belt, One Road initiative which if successful will change the face of international trade. 

China is playing on a much longer timeline so they are prepared for some pain and suffering. In China, Xi has now solidified his position for life. China knows that the US changes party power every 4 years and is betting that the democrats get back in and reverse the Trump plan.

In order to deal with the Chinese one has to understand some important character traits. 

Of all the idiosyncrasies of Chinese culture, the concept of “Face” is perhaps most difficult for Westerns to fully grasp. And because “saving face” is such a strong motivating force in China, it’s also one of the most important concepts in understanding the Chinese Mind. It goes back centuries and appears in many Chinese sayings and proverbs. 

“Men can’t live without face, trees can’t live without bark.”

(ren hou lian, shu hou pi)

“A family’s ugliness (misfortune) should never be publicly aired”

(jai chou bu ke wai yang)

A traditional insult is to say that someone “has no face”.

(mei you mianzi)

Similarly, one of the worst things is to “lose face”.

(diu lian)

The management of “Face” goes much deeper than just impression management (or “protecting and enhancing your ego”) in the Western sense. Although nobody, regardless of culture, wants to look bad or have their ego bruised, the Chinese concept goes beyond the narrow Western concept of face (and is perhaps closer to the Arab concept of “honour”).

While an American businessperson might be respected back home for his frankness and being a “straight-shooter,” he would likely be viewed in China as uncultured, overbearing, and rude.  President Trump’s remarks against the Chinese on the world stage do not, by any means, go unnoticed by the Chinese public.

The Hutch ReportDuring Hu Jintao’s 2006 visit to the US, there were a large number of missteps on behalf of the Bush administration that were believed to be an intentional campaign to make China lose face on the international stage. If this was truly the case, the Chinese have not forgotten. 

The Hutch ReportThe current trade war should be looked at as an economic battle that could drag on for some time and not as a short term tactic on behalf of the Trump administration. They have opened up Pandora’s box. According to a recent article in the Washington Post, the tough tone on behalf of the US effectively ties Xi’s hands. 

“James Zimmerman, former chairman of the American Chamber of Commerce in China stated, 

“Getting the Chinese to the bargaining table should be all about face-saving — not a chest-thumping exercise, Xi has no choice but to stand firm and stand tall.”

Trump’s bravado approach to try to win concessions from Beijing has provoked a public fury that could ultimately derail his efforts. Although the Trump administration believes that a trade war can be won and that they are in a position to win against China, it should be perfectly clear that today’s China is a much stronger adversary on the economic, military and cyber front, than they ever were. If their back is against the wall it will only be a matter of time before “Xi hits the fan.”

The Hutch Report

The Deadly Market Sin – Complacency

By | Finance, Money, Uncategorized

What may go wrong if you are right?

The debate around the stock market’s performance continues to rage on. On one side the argument is that the market gains are justified because of explosive company earnings, Trump’s tax cuts or that the US markets are the only game in town. The competing view is that nothing has been fixed since 2007 and this is just all makeup on a pig. Low interest rates and company buybacks are fueling the drive for better returns. It is believed that it is all a slow motion train wreck ready to collapse. 

The purpose of this piece is not to add anything new to the debate but to highlight some issues that could arise in the event of the return of extreme volatility. Bear and Bull calls that appear initially correct could suddenly violently flip in a second as any number of unforseen events suddenly appear out of nowhere. Understanding historically how some of these events have been brought on may help dampen any future surprises.

The collapse of the Internet bubble, perhaps one of the largest financial fiascoes in U.S. history, came after a three-year period, starting in January 1997, when investors would buy almost anything even vaguely associated with the Internet, regardless of valuation. Investors ignored huge current company losses and were willing to pay 100 times expected earnings in fiscal 2002. They were provoked by bullish reports from sell-side securities analysts and market forecasts from IT research firms, such as IDC, Gartner and Forrester Research.

There are many of us who were around during the dot com bubble of 1999 to 2001 and lived the collapse of so many high flying overvalued stocks with huge cash burns and no profitability. The claim at the time was that it was a “new world.” Profitability did not matter. Eye balls mattered. As long as you had large traffic flows to your site you could worrry about profitability later.

All this activity did influence the economy and everything was firing on all cylinders. This held true for a while as long as investors kept throwing money at these wild west startups. The day the financing dried up, so did the company’s prospects of continuing as a going concern. The darlings of the day including pets.com, webvan.com, eToys.com, GeoCities, TheGlobe.com, go.com or flooz.com all but disappeared. This meant that these and thousands of companies like them ran out of cash and fired all their employees.  

Even if you are paying attention and think you understand the valuations you may be mistaken. The problem today is that companies and accountants are coming up with all kinds of clever ways to mask the true financial state of a company. This means that more and more professional and individual investors are not looking deeply enough into the details, as it takes more and more effort. Besides, it is not in reason to have to become an accounting forensic scientist just to figure out a company’s profitability. 

Jim Grant’s excellent “Current Yield Podcast” highlights the current environment of financial reporting in his show “Read the Footnotes,” and “Loan Sharks,” where for example they discuss how WeWork came up with different adjusted EBITA to suit their purpose. Fundamental analysis is usually how financial analysts make their judgements on a stock. If the company beats the analysts estimates it could rise considerably. If that analysis is flawed then the stocks are moving on false premises. Eventually stocks will always revert to their fundamental values, which indeed they did in 2001 to 2003.

What does this have to do with today’s market? A new report by the Wall Street Journal highlighted that a record number of IPOs, or 83% of US listed IPOs over the first three quarters of 2018, were companies that lost money in the 12 month prior to their going public. However, there are still many more that appear to have impressive balance sheets until their true financial state is exposed. Lurking within the financial statements and communications of public companies is a troubling trend. Alternative metrics, once used sparingly, have become increasingly ubiquitous and more detached from reality.

In 2011, Groupon Inc. announced plans for a highly anticipated initial public offering. But enthusiasm for the offering waned when the U.S. Securities and Exchange Commission (SEC) issued a comment letter questioning Groupon’s use of a profit metric it called “adjusted consolidated segment operating income.” It was believed that no company had ever used that metric before; it was intended to measure operating profit without including marketing expenses, stock-based compensation, and acquisition-related costs. Management argued that a $420 million loss from operations reported on its 2010 income statement should really be considered a $60 million gain.

The financial crisis of 2007-2008 that led to a decline in stocks was different. It began in 2007 with a crisis in the subprime mortgage market in the United States, fuelled by the Fed, and developed into a full-blown international banking crisis with the collapse of the investment bank Lehman Brothers on September 15, 2008. Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial impact globally.

When this crisis hit and volatiliy exploded so did trading volumes. We remember trading on a few different plaftorms during this period only to see them seize up from the volumes daily. You could be correct on a trade but find yourself not able to get out. 

Then this showed up:

SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets

Commission Also Takes Steps to Increase Market Transparency and Liquidity

FOR IMMEDIATE RELEASE

2008-211

Washington, D.C., Sept. 19, 2008 — The Securities and Exchange Commission, acting in concert with the U.K. Financial Services Authority, took temporary emergency action to prohibit short selling in financial companies to protect the integrity and quality of the securities market and strengthen investor confidence. The U.K. FSA took similar action yesterday.

They changed the rules of the game. A large number of traders were caught holding short positions in financial stocks having to scramble to get out of them. A massive short squeeze erupted. 

Just when investors and traders had positioned themselves for larger gains on the short side, the Fed stepped in with extraordinary monetary policy adjustments which included never before seen bailouts. Investors that never fully understood the old adage “don’t fight the Fed” paid dearly. 

Readers may be aware of some of these facts but it is essential to highlight that even though you may be correct in your trading or investment decisions and thesis, you are working with a dynamic system that has the leverage to change the rules to its advantage. Many of these adjustements could put the trader and investor at an extreme disadvange. We advise you to listen to the RealVision interview with Marc Cohodes as his experience with Goldman Sachs during this time illustrates this perfectly. 

In 1971 the New York Stock exchange incorporated as a non-profit. The change to for profit status was organizational and the result of a transaction first approved in April 2005 by the New York Stock Exchange governing board. In March 2006 the New York Stock Exchange, a non-profit corporation, merged with Archipelago Holdings, Inc. into a new organization NYSE Group, Inc. as a publicly traded and for-profit company.  In April 2007 the company in a stock swap transaction combined with Euronext, the European stock exchange, becoming NYSE Euronext.

Interestingly enough, we began to see the advent of high frequency trading. One of the ways exchanges such as the NYSE make money are by allowing big-deal firms to install their computers closer to the actual exchange, so their electronic trade requests will arrive milliseconds earlier than competitors. High frequency and algorithmic trading now accounts for a very large percentage of total exchange trading volume.

The May 6, 2010, Flash Crash, also known as the Crash of 2:45, the 2010 Flash Crash or simply the Flash Crash, was a United States trillion-dollar stock market crash, which started at 2:32 p.m. EDT and lasted for approximately 36 minutes. 

The Chief Economist of the Commodity Futures Trading Commission and several academic economists published a working paper containing a review and empirical analysis of trade data from the Flash Crash. They concluded the following:

“Based on our analysis, we believe that High Frequency Traders exhibit trading patterns inconsistent with the traditional definition of market making. Specifically, High Frequency Traders aggressively trade in the direction of price changes. This activity comprises a large percentage of total trading volume, but does not result in a significant accumulation of inventory. As a result, whether under normal market conditions or during periods of high volatility, High Frequency Traders are not willing to accumulate large positions or absorb large losses. Moreover, their contribution to higher trading volumes may be mistaken for liquidity by Fundamental Traders. Finally, when rebalancing their positions, High Frequency Traders may compete for liquidity and amplify price volatility.”

Traders and investors that still believe that we have free markets may get a rude awakening. Aside from the famous flash crash, we are still not able to forecast how these algorithm trading bots will react in the case of a market event or Black Swan. 

So as an investor or trader you may be holding a short position or long position and be correct in your analysis only to find the profitable company you have been invested in has just declared bankruptcy, or have your trading platform seizes up under the massive volume hitting the markets due to a shock to the market, rendering you helpless, have your brokers suddenly adjust all margins putting you at a severe disadvantage, have the Fed step in with a nuclear option not yet known, have the SEC ban short selling or suddently watch in horror as prices tank as most of the market’s liquidity disappears because a number of large program trading algorithms have been turned off. Complacency in these markets in any form can be deadly. 

The Hutch Report

Could we see the end of Google?

By | Business, Technology

According to futurist George Gilder the era of Google could be coming to an end. In his recent book “Life after Google”, Gilder explains why Silicon Valley is suffering a nervous breakdown and what to expect as the post-Google age dawns.

Is it worthwhile paying attention to what somebody like George Gilder says? Putting aside the fact that nobody can accurately predict the future on a consistent basis (as has been shown by Gilder’s track record), it is possible to make informed statements about the future based on sound logic. Here Gilder does base his assumptions on more than conjecture. 

So where does Gilder come up with such an outlook regarding Google? As Peter Thiel pointed out, “Google’s algorithms assume the world’s future is nothing more than the next moment in a random process. George Gilder shows how deep this assumption goes, what motivates people to make it, and why it’s wrong: the future depends on human action.”

The argument is based on an analysis of big data. Right now, big data looks like it holds all the answers for any questions a person or company might have. William Terdoslavich wrote in InformationWeek, “At the heart of big data is the search for “insight — some correlation or finding that eludes the seeker until he or she adds another terabyte or 10 of data, just in case it is lurking there. At a certain point, the law of diminishing returns has to kick in. Adding another 100TB becomes redundant.”

Nassim Taleb pointed this out by the following analogy, “We humans do not predict when it’s safe to cross a road by adding more different data-points, like e.g. the color of the eyes of by-passing car-drivers, to our decision-making process, but by filtering the data and only assess what’s relevant to get across safely.”

In 1972, Gordon Bell formulated what is now known as Bell’s law of computer classes. It describes how types of computing systems (referred to as computer classes) form, evolve and may eventually die out. New classes of computers create new applications resulting in new markets and new industries. Gilder believes that Google can’t continue on the present path as we now need an entirely knew infrastructure. 

Kurt Godel, the brilliant Austrian mathematitian exposed the limitations of mathematics (the incompleteness theorems). He proved that there can be no human construct, no human system of thought that does not rely on some reality outside of itself. It shows that human intelligence could not be recreated by a traditional computer. 

Google was built on ads. All these arguments can be seen as presenting a case where Google’s system of aggregating huge amounts of data to create adverts will inevitably break down. There is also the concern that Google and Silicon Valley in general have put security on the back burner. The fear is that Google has been avoiding the challenge of security across the internet by giving away most of its products for free, and financing itself with an ingenious advertising strategy. This has become more apparent with the recent massive data breach at Google+.

But is it really possible for a company such as Google, which is so engrained in everybody’s daily life, to cease to exist? A good way to understand the present and future is to look at the past in order to gain some insight.

Comparing the 1955 Fortune 500 companies (here)  to the 2017 Fortune 500 (here), there are only 60 companies that appear in both lists. In other words, fewer than 12% of the Fortune 500 companies included in 1955 were still on the list 62 years later in 2017, and 88% of the companies from 1955 have either gone bankrupt, merged with (or were acquired by) another firm, or they still exist but have fallen from the top Fortune 500 companies (ranked by total revenues). Many of the companies on the list in 1955 are unrecognizable, forgotten companies today (e.g., Armstrong Rubber, Cone Mills, Hines Lumber, Pacific Vegetable Oil, and Riegel Textile). One recent name that was driven into extinction by its own technology was Kodak. They came up with the first digital camera but did not capitalize on it. 

It’s reasonable to assume that when the Fortune 500 list is released 60 years from now in 2077 (although it could happen much sooner), almost all of today’s Fortune 500 companies will no longer exist as currently configured, having been replaced by new companies in new, emerging industries.

In any case there was a time when Google didn’t exist and the world was inundated with search engines. Nobody was really crying out for somebody to build a new one. To imagine Google being replaced by another technology wave is by no means difficult. It is probably just a question of how fast it happens. 

The Hutch Report

The Ghostly Budget

By | Economics, Finance, Money, Politics

It appears that the dark halls of the US Military Complex could teach Trump, Cohen and Manafort  a few things about shadow budgets and hiding money.

Anybody reading this may have come across a story that grazed a few pages a year ago. However, surprisingly it didn’t seem to make more noise among the public than it did at the time. The story involved some unsupported adjustments, or spending by the US army that amounted to roughly $21 trillion. That number is not a typo. If true, it would mean that the US army had spent an unauthorized amount that would equal the current sum of the national debt. Even though the story may not have created a very large public disturbance, it did put a few people in the Pentagon into action. We wanted to find out where the trail was leading. 

For those not familiar with the case, it all started when Dr. Mark Skidmore, a PH.D. in economics and Professor and Morris Chair in State and Local Government Finance and Policy at the Michigan State University, was listening to an interview with Catherine Austin Fitts, former assistant secretary of Housing and Urban Development. In the interview as Skidmore explained “Fitts refered to a report that had come out in 2016 by the Office of the Inspector General (responsible for providing some accountability and tracking of financial activity of the Federal Government).” The report indicated that in fiscal 2015, the US army (with a budget of roughly $122 billion) had adjustments of $6.5 trillion. Because of Dr. Skidmore’s experience and knowledge base, he had some serious doubts about the quoted figure and assumed they must have meant $6.5 billion. He looked at the report himself and to his surprise found that it was not an error. 

This prompted Dr. Skidmore to suggest to Fitts to investigate the issue further.  So during the summer, two MSU graduate students searched government websites, especially the website of the Office of Inspector General (OIG), looking for similar documents dating to 1998. What they found was far beyond what they expected to find. They found documents indicating a total $21 trillion in undocumented adjustments over the 1998-2015 period, of which $11 trillion were directly linked to the US Army.

Dr. Skidmore’s work was able to show that there was something very broken within the budget process. By October 5, 2017 they suddenly discovered that the link to the original OIG report “Army General Fund Adjustments Not Adequately Documented or Supported” of July 26, 2016 had been disabled. Within several days, the links to other OIG documents that had been identified in their search were also disabled. However, Dr. Skidmore and his team had the foresight to copy the July 2016 report and all other relevant OIG-reports in advance and re-post them (The original government documents and a report describing the issue can be found here).

On December 7, 2017, Pentagon officials announced that the Defence Department was beginning the first agency wide financial audit in its history, 

By June 2018, Dr. Skidmore wrote the following update:

“In late May 2018, a graduate student at Michigan State University found on the OIG website the most recent report for the DoD, which summarizes unsupported adjustments for fiscal year 2017. However, this document differs from all previous reports in that all the numbers relating to the unsupported adjustments were redacted. That is, all the relevant information was blacked out.”

So is this situation just over exaggerated with hyperbole and blacked out documents for more dramatic effect? Governmental departments are extraordinarily inefficient organizations. It often requires a number of documents to be signed off before one can order some additional pencils. 

Could such an inefficient department have the smarts and tools to be able to disguise such a massive amount of money from the taxpayers eyes? Well here are some other incidents which shows they never stop short of giving it their best try. 

December 5, 2016, The Washington Post reported that the Pentagon had buried an internal study that exposed $125 billion in administrative waste in its business operations amid fears Congress would use the findings as an excuse to slash the defence budget.

February 5, 2018, a leading accounting firm said in an internal audit obtained by POLITICO, that one of the Pentagon’s largest agencies couldn’t account for hundreds of millions of dollars’ worth of spending, (curiously just as President Donald Trump was proposing a boost in the military budget.)

On August 13, 2018, President Donald Trump signed a military budget boosting the Pentagon’s spending by $82 billion in the next year—a spending increase that dwarfs the entire military budgets of most other nations on Earth. (Russia, for example, will spend an estimated $61 billion on its military this year). With the increased spending included in this year’s National Defense Authorization Act (NDAA), the Pentagon will get to spend more than $700 billion next year. The budget hike was a priority for Trump and was approved by Congress as part of a March spending deal that saw spending on both defense and domestic programs hiked by about $165 billion—smashing through Obama-era spending caps.

On September 17, 2018, it was reported that the Pentagon had massively overestimated, for the second fiscal year in a row, how much its new retirement system would cost.

All that is required is a quick search of the Pentagon and their funding requirements to discover that this is a game that has gone on for a long time. There seems to be a budget for some and a black budget for others in the government.  In the end, it is the taxpayers that are flipping the bill for all the spending. In a Dec. 8 Forbes column that he co-authored with Laurence Kotlikoff, Skidmore said the “gargantuan nature” of the undocumented federal spending “should be a great concern to all taxpayers.”

The fact that these previous reports along with the revelations of Dr. Skidmore and Catherine Austin Fitts have not caused people to become enraged is surprising. This just seems to show that the general public view towards the current levels of greed and corruption are still complacent.  Although the US dollar as a reserve currency may allow the government to get away with many of their spending habits and shadow budget operations for the moment, the day it’s removed will cause some serious repercussions. 

We can already see many signs of the international community getting frustrated with strong arm tactics by the US and adjusting appropriately in order not to be held hostage anymore by the US dollar reserve status.

Reuters recently reported, 

“The U.S. dollar’s share of currency reserves reported to the International Monetary Fund fell in first quarter of 2018 to a fresh four-year low, while euro, yuan and sterling’s shares of reserves increased.” 

It is no longer a matter of if, but when.

The Payments War: Who will the winner be?

By | Economics, Finance, Money, Technology

When mentioning Payments War, some people think of Shopping Wars and fist fights at Walmart on Black Friday. This article is not about that. The Payments Wars are actually multiple wars. A war on cash. A war for your shopping behavior and data. A war for your wallet. These wars are raging both online in the digital world as well as offline in the analog world and the two worlds are converging as combatants vie for cashless digital transactions for offline payments. Why should you care? Every time you buy something, whether you like it or not, it is over you and your data for which the battle is being fought. Your payment behavior and your payment data is what they are after. How will you pay and which platforms will be used? Will that be cash, credit card, debit, PayPal/Venmo, Square, Bitcoin and other cryptocurrencies, Apple Pay, Samsung Pay, Amazon one-click payments, Visa, Mastercard, Discover, Amex or even a credit line offered at the time of checkout?

The Hutch Report

Many may not realize this war going on right before their eyes each and every day as they buy their coffee, their lunch, their gas, groceries, electronics and anything else. And it has been going on for a long time. The winner wants to be the master of how consumers pay for things. As hinted above, the reasons are several-fold. One is, that at scale, there is money to be made processing payments and slicing a few cents or more off of each transaction which amounts to massive amounts at scale. To put this in some context here were the quarterly revenue volumes reported by a few of the combatants in the summer of 2018

A 2017 report by Statista estimates that total payments revenues, which were 1.6 trillion US dollars in 2016 will reach 2.2 trillion US dollars by 2021. That is what the processors are earning on payments. The overall payments volume, what PayPal calls TPV or Total Payment Volume, is a much higher amount.

These massive volumes of payments occur each day online, in stores around the world, at market places, peer to peer, travel and transportation, domestic services, credit payments, business to business payments, cross border and international payments… in other words, there is a lot. We were unable to find exact figures for the total value and number of transactions comprising annual payment volumes including cash and non-cash world-wide, but you can easily see that this number is easily in the trillions. Effectively it would probably be very close to the sum of the GDP (gross domestic product) of all countries – in other words the Gross World Product which is currently near $80 Trillion dollars a year.

 

 

 

Alibaba, the world’s largest (454M buyers) online market place processed $547 Billion of payments in China alone in 2017. So while $547B is large, it is a small fraction, less than 1% of world GDP … or total world payment volume.

 

 

 

 

 

 

 

 

 

Secondly and some may argue even more valuable than the processing fees, generating revenues for payments companies such as the ones mentioned above, is the data that can be collected on consumer and merchant behavior.  The Hutch Report recently chronicled how data is quickly becoming the new biological nerve gas. The credit card associations assign a merchant category code to each merchant and this code corresponds to the type of business or service the company offers. But this is just the tip of the iceberg, data is collected for each transaction on the amount, the location, the date and time, the type of transaction (purchase, refund, withdrawal, deposit, etc), the type of account, card number, identity of the card acceptor (eg. merchant), information on the terminal used for payment, and much more. Apple already has over 450 million credit cards on file related to iTunes, the iOS Appstore, and Apple TV. In addition to knowing what media you consume, with Apple Pay, they will know even more about you. In addition to advertisers and the merchants themselves, payments data is also super interesting to investors and market speculators. Investors and speculators will go to great lengths to collect data in order to build an edge for themselves. There are now even companies such as RSMetrics that produce and sell aerial imagery of retail outlet parking lots and production facilities. Payment data is much more granular and refined. In addition, the Government also loves digital data, particularly digital cash because then they can completely monitor it, control it, and even charge negative interest rates quite easily if they so choose.

Given the size of the battlefield, a fragmented regulatory landscape and the existence of a plethora of consumer segments, consumers and consumption types … these wars for how you pay and how your payments data is collected will continue to rage for some time.

The Hutch Report

Anchors Away! Is the US retail boat sinking?

By | Business, Economics

If you put one or more buildings together and form a complex of shops representing merchandisers, add to that interconnected walkways enabling visitors to walk from unit to unit, you get what is known as the great American shopping mall. 

1,500 malls were built in the US between 1956 and 2005, and their rate of growth often outpaced that of the population. They replaced main street and became the epicentre of communities, the foundation of retail economies, and the place for teenagers everywhere to see and be seen.

At the heart of these malls has been the main stays of American retail, the department stores. They have been come to be known as the “anchors.” Every mall has them and it is these stores that make up a large portion of the retail space being dominated by one brand. Without them, there is a very large hole to fill. 

Malls became so popular over the years that everybody wanted in until the point where the market became saturated. “We are over retailed,” according to Ronald Friedman, a partner at Marcum LLP, which researches consumer trends. There is an estimated 26 square foot of retail for every person in the US, compared with about 2.5 square foot per capita in Europe. Howard Davidowitz, famed retail analyst says, “the US has 5 times more retail space per capita than that of Japan, Canada, UK or France.”   

Like anything else, the good times were bound to come to a halt. By the mid-2000s, the decline began slowly. The rise of the internet brought with it the rise of online shopping. The financial crisis of 2007 – 2008 brought a blow to retail that led to a drop in sales and foot traffic at big-brand retailers like Sears, JCPenney and Macy’s that anchored many of the country’s malls. Between 2010 and ’13, mall visits during the holiday season, the busiest shopping time of the year, dropped by 50%. It is clear from the chart below that Sears was badly wounded in 2007 and never recovered, in spite of all the promises of Eddie Lampert to turn the struggling retail giant around.

The Hutch Report

When Sears merged with K-Mart in 2005, the two chains had a total of 3,500 US stores between them. As of May 5, 2018, Sears Holdings operates 894 retail locations under the mastheads of Sears (506 full-line and 23 specialty stores, for at total of 529 locations) and Kmart (365 locations), though after a round of closures announced on May 31, that number will drop to about 820.

In August 2016, Macy’s announced the planned closure of 100 stores, or about 15% of Macy’s store base at the time. 

JC Penney has about 600 mall-based stores and another 400 smaller standalone stores in smaller markets. JC Penny announced and closed 140 stores back in 2017. The King of Prussia Mall is a 2.8 million-square-foot shopping center outside Philadelphia. The 50-year-old complex has more than 50 food venues and a concierge lounge. However, a J.C. Penney department store closed in 2017 as one of the planned closures, created a hole in the anchor-store lineup.

The Hutch Report

The closings of these stores are having an obvious impact on shopping malls across America. The malls that are not able to find an anchor to replace the legacy department stores are seeing their foot traffic dry up as the remaining stores in the mall close up or move, leaving an empty shell. Industry experts say 25 percent of US malls likely will close in the next five years, or about 300 out of the existing 1,100.

According to a recent Credit Suisse report (Credit Suisse US Retail Store Closure Index), 2018 is on track for another peak footage closure year. It shows the US retail industry is tracking to an annualized -59% YOY reduction in store unit closures in 2018 (after hitting an all-time high in ‘17). The closures are skewing toward much bigger box concepts (Toys R Us, Sears, Sam’s). The report states, “We expect elevated closures to remain a primary operational distraction and stock risk for the US retail space for several years.”

The Hutch Report

A report by Cushman & Wakefield, states, “There were nearly 8,500 store closures in 2017, surpassing the number that occurred during the Great Recession. Closures in 2018 are expected to match or exceed that level. Announced store closures have reached approximately 4,500 year to date.” Cushman & Wakefield estimates that this figure will reach over 9,000 this year.

As we have seen many times before, there is also that familiar Gorilla at the front door waiting to make its mark on the brick and mortar market! Jeff Bezos and Amazon are making inroads into the apparel space. According to Morgan Stanley, the e-commerce giant will become the top player of the US apparel industry in 2018, having gained 1.5 percent of market share last year. To date, Amazon trails only Walmart to claim the top spot among other apparel retailers Target, Kohl’s and TJ Maxx.

The Hutch Report

Should this be something for brick and mortar retailers to be worried about? Last year Fitch Ratings published a report that presented how a “hypothetical” rapid rise in Amazon’s U.S. apparel market share could have significant credit implications for existing retailers, REITs and CMBS (Commercial Mortgage Backed Securities) transactions.

“The Fitch shock scenario assumes an accelerated three-year apparel market share shift to Amazon.com as a price-competitive and convenient alternative to traditional in-store purchases. The hypothetical rapid growth in Amazon’s apparel market share to 25% by 2020 could cut apparel retailer margins by around 300 basis points, pushing several retailers toward financial distress. Assuming Amazon’s share gains are concentrated in lower price points, low to mid-tier apparel retailers, including JC Penney, Kohl’s and Dillard’s, would face intense competitive pressure in such a scenario.”

The focus of our article on troubled anchors did not go unnoticed by Fitch. 

“REITs owning regional malls with high exposure to troubled anchor stores and a less diverse tenant base would face heavy cash flow pressure. We estimate that as many as 400 of approximately 1,200 US malls could close or be repurposed as a result of retailer liquidations and square footage reductions.”

Although online has picked up some of this business and will continue to do so, the reduction cannot all be attributable to e-commerce. The desire to grow and get bigger clearly over stepped its boundaries leaving a glut of retail space on the American market. Increasing consumer debt loads in the way of car loans, credit card loans, and student loans are not positioning the consumer to be in any position in the future to come to the rescue. In fact, roughly 10% of employment in the US is in retail. All these additional closing will only put the consumer in a more precarious situation.

The death of the great American shopping mall may be a bit premature, but for the moment it is “Anchors Away” and unless these malls find a way to fill the hole or reinvent themselves fast the future doesn’t look so bright. 

The US Economy – Miracle or Mirage?

By | Business, Economics

The economy of a country is a key talking point of most politicians, and rightly so. If you preside over a strong and growing economy, your political reign is reflected in a positive light.  If the economy of a country is weak as you enter, it will often be deflected and blamed on the predecessors faulty policies. However, there are times when the economy is struggling and the incumbents in power, making changes to improve it, will often point out the most impressive aspects, and mask over the weaknesses in order to convince the voter base that they are succeeding. 

My uncle had a saying, “When your neighbour is out of work, it is a recession; when you are out of work, it is a depression.” Your current personal economic situation will influence how you perceive the strength of the greater economy and what people are saying about it. If you are working in an affluent environment you may not perceive anything is wrong. You have money to go out to dinner, go on vacation or buy that new car you have had your eye on. In other words, your confidence in the greater economy will dictate your spending patterns. There is the counter situation, where you have no work and have essentially stopped looking, yet the financial media and politicians in power are telling you how strong the economy is. If they believe it, it may motivate people to go back to school and adapt their skills to the current job market. If they don’t believe it, they may weather the storm and pull back their spending (Nordstroms is off the table for now, time to head to Walmart). If enough people don’t believe it the true economy will eventually show its true colours no matter what the media and politicians say. 

So what is the true story? There are many economic indicators that are used to track the health of the economy. We looked at these indicators to see if they do provide some kind of clarity or, like many things, it is basically our perception of the current economic state that makes it strong or weak. 

Gross National Income (GNI) and Gross Domestic Product (GDP) are often used to judge the growth of the economy. For most nations there tends to be little difference between GDP and GNI, since the difference between income received by the country versus payments made to the rest of the world tends not to be significant. For example, according to the World Bank,  the U.S.’s GNI was only about 1.5% higher than its GDP in 2016. 

The graph below shows the Real GDP growth rate of the United States from 1990 to 2017 (GDP being the market value of all final goods and services produced within a country in a given period). The Real GDP growth is adjusted for price changes, as inflation or deflation and is chained to the U.S. dollar value of 2009. The Real GDP increased by 2.3 percent in 2017.

The Hutch Report

It takes capital to fund growth and countries will increase their debt loads to increase that growth but if the growth doesn’t come they find themselves in the difficult situation of struggling to pay back the debts. The debt-to-GDP ratio is the ratio of a country’s public debt to its gross domestic product (GDP). By comparing what a country owes with what it produces, the debt-to-GDP ratio indicates its ability to pay back its debts. The US recorded a government debt equivalent to 105.40 percent of the country’s Gross Domestic Product in 2017. Government Debt to GDP in the US averaged 61.70 percent from 1940 until 2017, reaching an all time high of 118.90 percent in 1946 (funding for World War II had something to do with that) and a record low of 31.70 percent in 1981. At the moment, it doesn’t appear to be moving in the right direction.

It should be pointed out that the GDP is made up of Personal consumption + Investments + Government expenditure + Net Exports. Consumption makes up 70% of this GDP number. As mentioned above, if the consumer is in a good mood and confident about the future they will go out and spend. Many will even use credit to charge those purchases and pay another day. However, if they get worried they will pull back their spending and start saving. So in a sense, “So goes the consumer, so goes the economy.” 

The personal saving rate is calculated as the ratio of personal saving to disposable personal income and refers to these strategies of accumulating capital for future use by either not spending a part of one’s income or cutting down on certain costs. In 2017 it amounted to 2.4 percent, as opposed to 10.4 percent in 1960. This was equivalent to just over 384 billion U.S. dollars in the fourth quarter of 2017. In June 2018, the personal saving rate in the US suddenly spiked and amounted to 6.8 percent.

The Hutch Report

It is also worth looking at the household debt to income levels of the consumer to know if they are tapped out or not. Households debt in the US increased to 78.70 percent of GDP in the fourth quarter of 2017 from 78.50 percent of GDP in the third quarter of 2017. The households debt To GDP in the US averaged 57.79 percent of GDP from 1952 until 2017, reaching an all time high of 98 percent of GDP in the first quarter of 2008 and a record low of 23.80 percent of GDP in the first quarter of 1952. The consumer, not surprisingly deleveraged after the 2008 financial crisis, however on a historical level they are still indebted well above the average. 

The Hutch Report

We won’t even bother looking at retail, as many in the financial media do, to determine the health of the consumer. An increase in Target’s earnings or any other retailer could have a myriad of reasons behind better numbers. Better revenues could be the result of taking advantage of the demise of other retailers (JC Penny or Sears for example). It could be more astute marketing or just better managed. Equally, increased earnings could come from stock buy backs, one off charges or any number of other accounting engineering tricks. 

A much better indicator reflecting the potential health of the consumer are the employment levels. These figures, particularly the unemployment rate, tells us the percentage of the labor force that is unemployed. Since unemployment insurance records relate only to people who have applied for such benefits, and since it is impractical to count every unemployed person each month, the government conducts a monthly survey called the Current Population Survey (CPS) to measure the extent of unemployment in the country. The CPS has been conducted in the United States every month since 1940. In 1994, the CPS underwent a major redesign in order to computerize the interview process as well as to obtain more comprehensive and relevant information. There are about 60,000 eligible households in the sample for this survey. This translates into approximately 110,000 individuals each month, a large sample compared to public opinion surveys, which usually cover fewer than 2,000 people. However, they are essentially polls and we have seen in the recent past how accurate polls can be. 

The chart shows a clear decline in unemployment, yet does it really tell the true story? As campaign Trump said (video below), “Don’t believe those phony numbers.”

That was an impressive speech by candidate Trump. So what do the UI numbers tell us. We took a look at the numbers from the NFP back in June (video below).

The current UI numbers are indicating a very tight labour market. Companies just can’t find the workers. However, normally when that happens a company is forced to become more competitive with other employers and increase wages in order to attract the workers they need. Yet, that doesn’t look to be happening as we see from the chart that wage growth has been pretty stagnant. 

Currently there are roughly 96 million Americans no longer in the workforce. How has that affected the poverty levels? The official poverty rate is 12.7 percent, based on the U.S. Census Bureau’s 2016 estimates. That year, an estimated 43.1 million Americans lived in poverty according to the official measure. According to supplemental poverty measure, the poverty rate was 14.0 percent. This should be considered high considering that it exists in the most affluent country in the world. 

The Hutch ReportPoverty rate in the US as a % of population – US Census Bureau

At the moment, it is not worth looking into the country’s import/export situation considering that President Trump has pulled the country into a trade war. Nobody knows how this will turn out and what the repercussions will come from it.

So in summary the charts show that US GDP growth is relatively stable, US government debt is increasing, US households savings are trending up and household debt is decreasing albeit it is still high, there is low unemployment but no wage growth and poverty is increasing. Some of the signs are a bit paradoxical such as the low wage growth which could be a partial reason why the poverty levels are increasing and consumer spending is decreasing.

So we have looked at some of the principle indicators that should provide some insight into the true health of the economy. You can take it how you see it but regardless, you have to admit that the picture is not crystal clear. Despite that, the financial media’s use of exaggerated claims such as, “Strong,” “Booming,” or “Firing on all cylinders,” gives the indication that we have entered a new era. President Trump seems to have changed his stance on the figures, touting and taking credit for the unemployment numbers that he criticized as candidate Trump. He also recently said, the US is “setting records on virtually every front” and is “probably the best our country has ever done.”

In the end, if the general public truly believe these claims, experience it in their neighbourhoods and families, they will have the confidence to go out and spend. Greater consumption patterns will improve the health of companies and they will hire. You would expect wage growth thereby lifting the standard of living across the nation. If the public does not believe the hyperbole, they will pull in their spending and try to reduce their personal debt levels. They will protect themselves.

In the end perception wins out. You be the judge.