The Economy’s Weekly Recap

8/12/24 - 8/19/24

Raymond Lin

This Week’s Prominent Events

A $36 Billion Snack

• Last Wednesday, M&M’s and Snickers owner Mars announced it was acquiring Kellanova for $83.50 per share in an all cash deal, a 33% premium to Kellanova’s closing price before news of the takeover. This values Kellonova at $29 billion. But when factoring in Kellanova’s debt, the deal reaches a total valuation of around $36 billion, the fourth largest M&A deal so far in 2024.

• Kellanova, which was spun off from Kellog last year, is the owner of snack brands like Cheez-It, Pop-Tarts, Pringles, and Eggo, a slightly different array of snack products than Mars’ more sweets focused brands. From these products, Kellanova generated $13 billion in revenue last year while Mars had $50 billion in sales. 

• This acquisition comes at a time of pulling back from consumers, who have become more selective about their purchases across the board. Via acquisitions though, Mars can ensure growth despite slowing consumer spending in the short term while also possibly creating cost savings between Kellanova and Mars.

• Although the two companies operate in a similar sphere, the snacks industry, Analysts from Jefferies believed there was minor overlap in their actual products, “likely limiting any roadblocks to the deal”. Due to this, the acquisition is expected to close in early 2025, although it may be subject to a government probe and further antitrust action. 

Retail Sales Resurgence

• Much of the panic from two weeks ago revolved around the fear of a recession, but, with hindsight, it seems quite clear now that those fears were unfounded. One such piece of evidence that counters the fears of recession came out last week: retail sales, which describes the sales of goods to consumers. 

• In July, retail sales rose 1%, significantly higher than the 0.3% estimate. However, removing car sales, which were higher than usual because of pent up demand during the June cyberattack on car dealerships, retail sales rose only 0.4%. Nevertheless, estimates were beaten, exceeding the 0.1% forecast that also excludes car sales. From the strong retail sales, one can deduce that US consumers and the US economy are still doing well despite continued higher interest rates. 

• A company that embodies a similar sentiment to July’s retail sales is Walmart, which released its earnings last week. Walmart saw its total US store sales increase 4.8% and comparable store sales, which the sales per store, grow 4.2%. This growth, which beat expectations, was accompanied by operating income growth of 8.5%. However, while Walmart’s earnings do show US consumers are still spending, it also highlights the tight spot many consumers are in. Instead of shopping in other grocery stores, Walmart has seen elevated growth as its value pricing has attracted more cost-concerned customers, highlighting how the habits of US consumers have been impacted by inflation.

• Another counter example to positive economic news of the growth of retail sales is Home Depot’s poor performance in Q2. While it did beat expectations for some metrics, Home Depot saw comparable sales fall 3.3% from last year, revenue increase just 0.6%(a decline when factoring in inflation), and net income fall 2.1%. Home Depot, which is reliant on construction projects for growth, has seen less demand as consumers decide to wait for lower interest rates in a few months before beginning projects, hurting sales. So, although retail sales and some company’s earnings suggest the economy is doing well, the economy is still suffering from the effect of high interest rates.

Q2 Earnings

• Despite the foreboding sentiment in the last paragraph of the prior story, the economy is doing fine, something that can be substantiated by looking at Q2’s earnings as a whole. Unlike prior stories, where specific companies in an industry were covered and analyzed, this one is an informative summarization of the Q2 earnings season as a whole.

• So far, 93% of companies in the S&P 500 have reported Q2 earnings. Among these, 79% beat profit expectations, above the 5 year average of 77% and 10 year average of 74%. However, the margin they beat expectations by has shrunk. On average, estimates were only beaten by 3.5%, lower than the 5 year average of 8.6% and the 10 year average of 6.8%. This suggests rather mixed performance, but the overall earnings growth is still estimated to be 10.9% annually, which would make it the fastest earnings growth since Q4 2021. 

• In terms of revenue, only 60% of companies beat expectations, below the 5 year average of 69% and the 10 year average of 64%. Additionally, they only beat expectations by an average of 0.5%, significantly below the 5 year average of 2.0% and the 10-year average of 1.4%. This suggests that profit growth is due to companies cutting costs or finding efficiency rather than overall sales growth. When comparing it to figures from prior years, the economic weakness of the current economy is apparent, even if not a major threat.

Prescription Drug Prices

• 2022’s ironically named Inflation Reduction Act(IRA) was an extremely large policy package that entailed spending hundreds of billions across sectors. One less apparent effect of the IRA, which enabled the Federal government to negotiate with drug makers for Medicare, was just recently finalized last week as the Biden administration and drug makers came to a consensus over the price of 10 of Medicare’s costliest drugs. 

• The deal created will lower the prices of many drugs by between 38% and 79%, saving $6 billion for taxpayers and $1.5 billion for medicare recipients who still partially pay out of pocket for those drugs. However, the deal only comes into effect in 2026, by which point Trump may change the deal. If Harris wins the election though, then it is likely that the list of drugs affected by Medicare negotiations will increase as Biden has supported price negotiations for 500 drugs over the next decade.

• Pharmaceutical companies, which would likely see their profit margins and returns severely cut down on, have tried to resist the negotiations. Although it have had little success so far, the primary pharmaceutical lobbying group Pharmaceutical Research and Manufacturers of America has called the negotiation program a “price-setting scheme to drive political headlines”, adding that lower prices will stifle innovation and discourage new drug development.

Starbucks’ Coup

• While it once had extensive growth and was viewed as an immensely successful example in the food industry, Starbucks has recently faced a growth slump. Last quarter, Starbucks missed expectations for revenue and just barely met profit expectations, with revenue falling 1% from last year and profits decreasing around 8%. Same store sales fell 2% in the US and 14% in Starbucks’ second largest market China, where it has faced fierce competition from rivals like Luckin Coffee. Due to this, the stock was down around 20% YTD.

• This disappointing performance by the company led to a $70 billion hedge fund and activist investor Elliott Management investing $2 billion into Starbucks. As an activist investor, Elliott Management wished to pressure Starbucks into making changes that would maximize shareholder value and increase the stock price. As a first step, Elliott Management entered into talks with Starbucks and its board of directors. As info was leaked to the press and public pressure mounted for change, the board came to a surprising decision that Elliott Management had not explicitly advocated for: replacing Starbucks CEO Laxman Narasimhan.

• In his stead, Starbucks pursued Chipotle CEO Brian Niccol. Niccol, a food industry legend due to his role in Chiptole’s successful turnaround and near 800% increase in share price since his arrival in 2018. His experience in revitalizing companies led to a surge of excitement for Starbucks’ stock, which rose 25% following the news. However, stark challenges lay ahead for Starbucks and Niccol as competition and slower economic growth in China, union struggles, and the complex issue of attracting customers hinder Starbucks’ growth.

Future Events

Record Low Inflation

• The beast that was inflation in 2022 and 2023 has been on the retreat for the last few months as high interest rates have taken their toll on economic activity and lowered inflation. Fortunately, this continued in July as CPI inflation came in at a 0.2% monthly increase and 2.9% yearly increase, meeting expectations for the monthly and slightly beating expectations on the yearly increase. The 2.9% yearly increase is the first sub 3% and the lowest rate of inflation since spring 2021. 90% of this increase was due to shelter costs rising. 

• Meanwhile, core inflation, which excludes volatile food and energy prices, rose 0.2% monthly and 3.2% yearly, matching expectations. 

• This continued trend of decreasing inflation means that the Federal Reserve won’t have any hesitations about cutting interest rates, which would spur economic activity. However, if the trend is broken by PCE inflation increasing, which is another way of tracking inflation that is slightly different than CPI, or unemployment increasing, then it is possible interest rates could be held still.

• However, that is an unlikely result as PPI inflation, which tracks inflation for producers and is often seen as a predictor for consumer inflation, rose just 0.1% monthly and 2.2% yearly, down from 0.2% monthly and 2.7% in June. This slowing inflation for producers will likely translate into slower inflation for consumers as well, suggesting that it’s unlikely inflation will spike anytime soon. 

Presidential Promises

• As the 2024 election approaches, both candidates have begun to share their economic vision for the US. While most of their policies would require congressional approval and could be seen as empty promises, it is nonetheless still worth covering to understand the direction the nation could be heading in. However, there’s no way to cover all of their policies in merely one story, so there’ll be scattered breakdowns of both candidates’ policies in the coming months in the newsletter as well as our social media pages, so make sure to follow our social media accounts.

• The one I’ll be covering this week is one that’s had a lot of headline attention: ending taxes on tips. Originally a Trump policy, it has since been adopted by the Harris campaign as well, making it a promise both parties are trying to fulfill. Additionally, with a proposal making its way through the Senate and House, it is likely to be passed. 

• However, although the policy might be popular for some workers and could be seen as supporting the working class, the policy is riddled with flaws. According to Steve Rosenthal of the Urban-Brookings Tax Policy Center, the policy has 3 major flaws: equity, efficiency, and revenue. 

• Ending taxes on tips could disproportionately benefit those who make more from tips rather than wages, which could create a situation where two servers doing similar work end up making different paychecks. Additionally, only a Yale University study found that only 2.5% of workers would benefit from such a no tax on tips policy. Furthermore, only ⅔ of these workers pay any federal income tax at all, further nullifying the actual impact of the policy. This creates a strange situation where 97.5% of workers take on the tax burden of less than 2%.

• However, even if the equity argument isn’t convincing, the efficiency issue certainly is. Ending taxes on tips is inefficient because tips are extremely hard to regulate. While total income can be tracked easily, a tip is harder to regulate and many jobs could begin to have “tips” to avoid taxes. By incentivizing tips over normal wages, both workers and employers will want to use tips whenever possible, possibly leading to a legal form of tax evasion.

• Lastly, the no tax on tips policy is estimated to cost between $150 billion and $250 billion over the next decade, a steep cost given the growing deficit and national debt. 

Millennial Rebound

• In the 2010s, a common joke about Millennials was that they spent frivolously on things like avocado toast, a symptom of the fact that they were a lost generation of sorts. They entered the workforce around the time of the Great Recession, had substantial student debt, and were unable to purchase homes or build wealth. 

• However, Millennials have been able to make a comeback in terms of wealth in the last few years. In fact, the median household wealth of older millennials born in the 1980s was $130,000 in 2022, nearly double their $60,000 net worth in 2019 adjusted for inflation. For younger millennials, the median wealth quadrupled to $41,000. Additionally, a St. Louis Fed study found that Millennials and older Zoomers had 25% more wealth than baby boomers did at a similar age. Collectively, Millennial and older Zoomers wealth stood at $14.2 trillion in Q1 2024, up $4.5 trillion from 2020.

• The main contributors to this increase in net worth are real estate, stocks, and lifestyle. Much of the real estate purchased prior to the Covid pandemic has increased in value since, especially so if one purchased a home in the years after 2008. Meanwhile, the growth of the stock market in recent years has amplified this increase in wealth. The fewer children Millenials have has also lowered spending for Millennials, allowing them to grow their wealth.

• But while Millennials as a whole are better off, the wealth gain is more unequal than in the past. While the gap between the 20th and the 80th percentile for Baby Boomers was $286,000 adjusted for inflation, the Millennial gap is $343,000. In addition to economic inequality, there are also racial disparities. Black Millennials are half as likely to own a home as white Millennials, the largest gap of any generation. 

Weekly Question

In terms of revenue, which of the following private companies is the largest?

• A: McKinsey

• B: Bloomberg

• C: Fidelity 

• D: Mars

Answer: D. Mars, with its annual revenue of $50 billion is the 4th largest private company in terms of revenue according to Forbes. If you’re interested in more Phi Fiscal, follow our social media pages!