The Economy’s Weekly Recap

8/26/24 - 9/2/24

Raymond Lin

I’d apologize again for the late newsletter, but I’ll spare you the sob story and let you get to the news. But, when you’re done with that, make sure to check out our social media! We’re on TikTok, YouTube, Instagram, and Twitter!

This Week’s Prominent Events

Astounding AI Growth

• Making up 7% of the S&P 500 and being one of the most valuable companies in the world, Nvidia has come a long way in the past few years thanks to the growth of AI. As excitement and investment around AI have increased, so have sales of Nvidia’s AI chips that are used in training and running AIs like ChatGPT, Meta’s Llama, Google Gemini, etc. Thus, Nvidia has a special role as a bellwether for the wider AI industry, and its earnings, which were released last week, are important to note. 

• In Q2, Nvidia reported $30 billion in revenue, above estimates of $28.7 billion and up 122% from last year. Net income was $16.6 billion, above estimates of $15 billion and up 152% from last year. This means that, in Q2, Nvidia made more in profit than Amazon and Meta, a situation that would’ve been thought of as inconceivable just a few years ago. Additionally, Nvidia announced that it would spend $50 billion repurchasing shares, a boon for investors. 

• Despite Nvidia’s awesome growth though, investors were soundly disappointed as Nvidia’s stock fell 5% after hours following the report and remains down around 7% as of last Friday. The reason for this disappointment was a smaller beat than expected as investors hoped and had priced in that Nvidia would beat expectations by an even larger margin. Additionally, the continued delay of Nvidia’s new Blackwell AI chips didn’t bode well for investors either. 

• Although these two factors underscore the risk that AI growth could be unsustainable, there are no material signs that growth is slowing down or that progress in AI development is either. According to Nvidia, demand still far outstrips supply and growth remains blazing hot well into next year, with Meta, Alphabet, Amazon, and Microsoft reporting that they would each spend tens of billions on AI investments. AI development has also gone swimmingly as new and more capable versions of existing models are released, such as Llama 3.1 and Claude 3.5 Sonnet. Usage of these AI models has been prolific too as OpenAI recently said that 92% of Fortune 500 companies are using ChatGPT. Additionally, there are over 200 million users on the platform, double what it was last year.

Supermicro’s Struggles

• However, to counter the positive messaging of the prior story, there’s the Supermicro’s situation. Supermicro, a company that at its peak earlier this year was worth $50 billion, creates and manages servers for cloud computing, enterprise cloud centers, 5G, and AI. 

• That last service has played a significant role in Supermicro’s recent growth as its earnings in Q1 2o24 grew 200% from 2023 to reach $3.85 billion in revenue. Meanwhile, its net income rose 369% to $402 million. This impressive growth led to a remarkable high earlier this year, but the stock has since fallen tremendously, down almost 50% before the events of last week when short seller research firm Hindenburg Research released a report accusing Supermicro of “accounting red flags, evidence of undisclosed related party transactions, sanctions and export control failures, and customer issues”. 

• The report seems to have spooked investors as Supermicro shares fell 20%. The claim around accounting is of particular concern as Supermicro has had issues in the past with fraudulent accounting. In 2018, Supermicro was delisted from the Nasdaq for failing to file financial statements. In 2020, the SEC charged Supermicro with“widespread accounting violation”, resulting in a $20 million settlement. Additionally, Supermicro announced the following day it wouldn’t release its earnings on time, a suspicious action when being accused of accounting errors. 

• Supermicro, although just one of many players in the AI and wider tech space, serves as a good example of how a company can still do poorly despite an ascendant industry.  

Google’s Antitrust Kerfuffle

• A few weeks ago, a federal judge ruled that Google had violated antitrust law by maintaining a monopoly. Following the ruling, many were concerned about the punitive measures that the lawsuit might result in, such as ending Google’s payments to be the default search engine or breaking Google up. However, last week saw another repercussion of the lawsuit materialize: lawsuits from Google competitors.

• Last week, Yelp, the review website, filed an antitrust lawsuit against Google, saying that it dominated search and advertising via its monopoly. Specifically, Yelp claims Google promotes its own search offerings, such as Google Maps and its reviews, over other offerings like Yelp when people search on Google. This means that outside sources may never be used by people, “keeping users within Google’s owned ecosystem and preventing them from going to rival sites” according to Yelp. Yelp also alleges that this has hurt Yelp’s revenue, which is why it’s seeking monetary compensation and an injunction to stop Google from engaging in its “anti competitive practices”.

• However, the fate of this lawsuit is uncertain because, although the federal ruling pathed the way for Yelp’s, Google says the claims Yelp makes are “not new”, citing a lawsuit from a decade ago that made similar claims but was thrown out by the FTC. Nevertheless, Yelp’s lawsuit is probably only the first of many repercussions from the federal ruling, with more lawsuits possibly already on the way.

DEI Decline

• Diversity, Equity, and Inclusion(DEI) has been a major part of HR practices and social governance in the recent past as concerns of discrimination and systemic racism have become of paramount social importance to many. However, in recent years, there has been pushback from more conservative groups and commentators like Robby Starbuck who have found these measures to be unnecessary. Recently, there have been several triumphs for these groups, as you’ve seen in prior Phi Fiscal stories. Two additions can be made to the list this week: Lowe and Ford

• Lowes, the home improvement company, is downsizing and reviewing its DEI programs, combining its individual resource groups into one larger entity. Additionally, Lowes will no longer take part in external workplace surveys for LGBTQ+ employees and will stop sponsoring all events outside business areas. Ford has acted similarly, shifting the focus of its employee resources groups and ending the same external workplace surveys. This is quite the reversal as, in 2017, Ford promoted how it was one of the most LGBTQ+ friendly companies to work for. Although it is mainly for optics, these measures demonstrate the turn in some companies away from more inclusive, and in the eyes of its opponents, excessively progressive measures.

• A similar decline has happened with Environmental, Social, and Governance(ESG) decision making, where those factors play a role in corporate actions. It is perhaps best exemplified by the actions of major asset managers like BlackRock and Vanguard, who together manage trillions of dollars of assets. Blackrock supported just 20 out of 493 ESG shareholder proposals in the twelve months before June or just 4%. This is down tremendously from 47% in 2021 and even 7% in 2023. Meanwhile, Vanguard supported 0 out of 400 ESG measures, down from 46% in 2021 and 2% in 2023. 

• These companies claim it is mostly because the ESG issues aren’t beneficial to their clients, but it’s hard to imagine their decision making hasn’t been impacted by the broader social backlash against ESG. Regardless of the reason, it’s clear that more progressive approaches to corporate governance have been under attack for the past few years.

NFL’s PE Turn

• In the last few decades, the private equity industry has exploded in prominence, with just 4% ownership of US corporate equity in 2000 compared to 20% by 2021. From Subway to Airbnb, private equity has its ever growing financial tentacles in many sectors, but one area it’s been targeting for years has finally embraced it: the NFL.

• To give some background, the NFL has seen tremendous growth as The Cowboys were recently the first sports team to hit a $10 billion valuation, up 77% from 2020. The average value of an NFL team reached $5.7 billion last year, up 11% annually. With continued fan interest and substantial new income from streaming service payments, the future of the NFL is bright, which is why PE firms have been so interested. 

• However, the NFL has traditionally been owned by individuals and not firms. But with few people able to purchase multi billion dollar brands, the NFL has voted 31:1 to allow PE firms to invest in NFL teams. Some of the firms investing in the NFL are Blackstone, Carlyle, CVC, Sixth Street, and Ares Management. Of major sports, the NFL is the last to allow PE firms to invest in teams as the NBA, MLB, NHL, and MLS all allow PE firms up to 30% of PE ownership of teams. 

• There are some caveats however as PE firms can only purchase 10% of a team, must hold onto their investments for at least six years, can only own stakes in 6 clubs max, and cannot have governance rights. Nevertheless, the deal is positive for both sides as PE firms gain access to a good investment and NFL teams gain access to liquidity.

Future Events

Loss of US Privilege

• For much of the post WWII period, the US has had a special privilege as the world’s reserve currency. This role means that foreign central banks and foreign companies would purchase US debt in times of uncertainty, almost regardless of the state of the US economy and government. This enabled the US government to keep borrowing with low yields even as deficits grew larger and larger. 

• However, recent research by economists at the Kansas City Federal Reserve suggests that the US may have lost its special privilege and borrowing capability. The research focuses on the state of the treasury market during and after the pandemic. Traditionally, investors pour into US treasuries and increase their value while lowering their yield during times of uncertainty, but the treasuries saw their yields increase like most other countries as investors marked down their treasury investments, similar to other kinds of bonds. This suggests to some experts that treasuries have shifted to the risky debt model and that the US may not have its special privilege of continual demand for its debt. 

• When paired with the Federal Reserve’s purchase of treasuries, the researchers found that the US’ true fiscal capacity may be being overestimated as a result, with the result being temporary price support for bonds that subsidizes bondholders while hurting taxpayers. 

• However, there has been pushback against the research from US treasury officials, who point to the uncertainty of the pandemic as unique and that the Federal Reserve’s purchases, which funded the US fiscal response, were constructive for the economy. Additionally, officials have pointed out that yields have continued to drop despite large deficit spending post pandemic, suggesting strong demand for treasuries persists. Regardless, the research does demonstrate the concerning possibility that the US could lose its prime position in the future and that fiscal planning should account for that.

Rate Hikes

• After nearly a year of record high interest rates, the Federal Reserve is finally poised to cut interest rates in September in the face of weakening inflation and a weakening economy. However, the extent of September’s cut and future ones are still uncertain. 

• However, there is data that can provide guidance into those two questions. Firstly, July’s PCE inflation, the preferred inflation gauge of the Federal Reserve, rose 0.2% from the prior month and 2.5% from last year, continuing the recent trend of slowing inflation. Core PCE, which excludes volatile food and energy prices, rose 0.2% from the prior month and 2.6% last year, telling a similar story as non-core PCE. Both non-core and core PCE were slightly lower than expected too, allowing the Federal Reserve to prioritize the economic state and employment of the US over inflation in the coming months. 

• Secondly, the personal savings rate fell from 3.4% in June to 2.9% in July while consumer spending rose 0.5%. This suggests that the economy is doing rather well and consumers are still happy to open their wallets, but their personal finances are undergoing stress, giving further reason to cut interest rates. 

• The last important figure for September’s rate cut will be the August jobs report, which comes out right before the Federal Reserve’s meeting to cut interest rates. Depending on the severity of the jobs data, the Federal Reserve may be swayed to make a larger rate cut. 

• For future months and rate cuts, all these factors will have to be watched closely, but you’ll be able to find them in our weekly newsletter.

Corporate Usage Of AI

• When hearing about AI, the excitement around it can sometimes seem exaggerated, almost bubble-esque. However, there are some real cost savings and efficiencies that AI can bring about. This was recently highlighted in the corporate world by Klarna, a buy now pay later firm. 

• Over the last year, Klarna has laid off over 20% of its employees, going from 5,000 to just 3,800 workers. Much of this reduction has been in the field of customer service, where Klarna said AI was doing the work of 700 employees. Klarna also stated that the average resolution time for customer issues decreased from 11 to just two minutes. As a result of this efficiency and related layoffs, average revenue per employee increased by 73%, which has helped Klarna with profitability as labor costs are reduced.

• With this great success, it’s unsurprising that Klarna plans to further reduce its employee count to around 2,000 in the coming years despite projections of growth. Although Klarna’s situation may be unique, it nonetheless highlights how AI may hit the job market, with many mundane or basic roles being eliminated for efficiency and profitability.

Weekly Question

True or False: Prior to Nvidia’s earnings, it was the second most valuable company in the world

Answer: True. Prior to recent declines, it was the second most valuable company in the world, with its pre-earnings stock up over 160% YTD.