The Economy’s Weekly Recap

8/5/24 - 8/12/24

Raymond Lin

Apologies for the delayed newsletter again. We were working on our new social media pages, where you can find 3 short videos about corporate greed, Citibank, and interest rates.

This Week’s Prominent Events

The Panic

• Last Monday saw a severe stock market panic, and the S&P 500 and Dow saw their worst days since 2022 when they fell 3% and 2.6%. The more volatile Nasdaq saw its worst day since July and fell 3.4%. Of the stocks impacted, the Magnificent 7 were particularly hard hit, losing $744 in valuation from July 24. 

• However, despite this major fall in stock prices, there only seem to be fairly minor causes. The most significant cause is the fear of a recession, which came about following the disappointing jobs report last Friday that saw fewer than expected jobs added and a substantial increase in unemployment. When combined with the lack of an interest rate cut the week prior, some investors began to fear a recession, pointing to a recession indicator called the Sahm Rule. The Sahm Rule, a fairly reliable indicator, predicts a recession when the 3 month moving average of the unemployment rate is higher than the prior 3 months by more than 0.5%. Another contributing factor is the disappointing earnings of several companies, especially major tech companies. This dragged stock prices down last week, but, when combined with fears of a recession, it further exacerbated the stock market decline. Lastly, Japan may have played a role as well. The reason is something called a carry trade. Essentially, a person borrows in yen, exchanges it to another currency like the dollar, buys financial securities, and watches as the yen devalues. Once that person sells their securities and exchanges the dollars back to yen, their profit is the original profit on the security plus the difference in exchange rates. This allows them to net more profit. However, with the Japanese yen’s recent appreciation due to higher Japanese interest rates, the carry trade was less appealing and many exited their carry trades, contributing to the stock market decline.

• While the recent panic and its causes are informative and interesting to read about, it was largely an overblown phenomenon, at least according to EY economist Greg Daco who thought the panic was “disproportionate”. This seems quite valid given that the rest of the week saw the stock market largely recover due to people buying the dip and news that weekly jobless claims fell from 250,000 last week to 233,000, which beat expectations of 240,000.

• By Friday’s closing, the S&P 500 was only down 0.04% from a week earlier, with the Dow’s 0.6% decline and the Nasdaq’s 0.18% decline telling a similar story. Due to this, it seems evident that Monday’s panic was overblown and not of much immediate substance. 

The Newest Monopoly

• In 2020, a lawsuit was filed against Google alleging that it engaged in monopolistic behavior. 4 years later, this landmark lawsuit has ruled that Google has illegally held a monopoly in search and text advertising. While the fact that Google controls 90% of the online search market isn’t enough evidence to consider a company a monopoly, given that the market share could be the result of genuine popularity, the court found that the $10 billion it spends annually to be the default search engine on many devices was strong evidence that Google had engaged in monopolistic behavior, shutting rivals out and maintaining dominance via increased data accumulation. As for the second allegation of text advertising, the court found that Google charged above market prices for advertising, suggesting Google utilized its dominant position to monopolistically raise prices.

• Google is trying to appeal the decision, highlighting Google’s superior quality as the reason for its popularity. Nevertheless, the lawsuit marks the first major antitrust success against the tech industry since the antitrust lawsuit against Microsoft in the early 2000s. 

• Unsurprisingly then, this case could have some major repercussions moving forward. Alphabet, Google’s parent company, could face major penalties like preventing it from making default search engine deals, forcing Google to offer choices to other search engines, a monetary fine, and even possibly a Google breakup. However, the penalties are unlikely to be finalized for months or years, especially if Google keeps fighting the lawsuit in appeals.

• Beyond Google though, the lawsuit could affect the ongoing antitrust lawsuits against Meta, Amazon, and Apple. According to Vanderbilt University professor and antitrust expert Rebecca Haw Allensworth, it is a “ huge turning point”. One reason for this is that major antitrust victories are very few and far between, so even one victory could galvanize antitrust action and momentum.

A Useful AI Detector

• Since the advent of ChatGPT and other generative AIs, a major concern among many has been how to detect AI generated content. This has been of special concern to educators, who often face AI generated work and have to support the learning of their students. However, with the rapid evolution and immense capabilities of AI, no reliable AI detectors have emerged, leaving many unable to successfully prevent AI usage. 

• Or so we thought until last week when the WSJ consulted OpenAI insiders and internal documents. From these sources, the WSJ found that OpenAI has had a 99.9% effective AI detector for ChatGPT that was created over a year ago but not released.

• The detector works through a series of patterns left when ChatGPT generates responses, also known as a watermark. While these watermarks are noticeable to humans, the detection software could easily detect them, which is why the detector has such a high success rate. 

• However, OpenAI has yet to release the detector for 3 major reasons. Firstly, the watermark could be tampered with by users, who could do something as simple as adding emojis or using Google Translate to remove the watermark. Secondly, rolling out the detector could allow bad actors to discover how the watermark works and find a way around it, essentially making it useless. Lastly, a survey OpenAI conducted found that 30% of users would use ChatGPT less if it had watermarks and rivals didn’t, creating a conflict between business and ethics that weighed heavily in OpenAI’s decision makers’ minds. 

• As recently as June, OpenAI’s senior employees met to discuss the technology, opting to continue looking for other less disruptive methods instead of launching the detector.

Losing $10 Billion

• Since the emergence of streaming on platforms like YouTube and NetFlix over a decade ago, traditional media has struggled. Where it had once been dominant, it now competed for eyeballs and advertising money. Unfortunately for those companies, traditional media has only continued to struggle, with companies that turned to streaming often still struggling. 

• A good example of this can be seen with Warner Bros. Discovery(WBD), which lost a shocking $10 billion in Q2 2024, mostly consisting of a $9.1 billion write down of its traditional media assets like CNN, TNT, and TBS. This massive write down demonstrates how these companies’ once lucrative media assets have become much less attractive and valuable over time. 

• This fact is also evident when looking at total revenue, which fell 6.2% from last year. The networks business, which contains most of WBD’s traditional media assets, saw revenue fall 8%. Even streaming revenue fell by 6%, an all around terrible quarter for the struggling media giant. Additionally, this decline is unlikely to be fixed in the near future as WBD recently lost the rights to broadcast NBA games to Amazon, something that will only exacerbate viewership and revenue decline.

• Sharing in these struggles, Paramount Global, another former traditional media titan, has also faced difficulties with its legacy assets and streaming, seeing little revenue growth and mounting financial losses.

Berkshire Hathaway’s Holdings

• Recently, Warren Buffet’s massive conglomerate Berkshire Hathaway has been in the headlines, and learning why helps provide some useful insight into investor sentiment. 

• In a rather surprising move, Berkshire Hathaway halved its stake in tech giant Apple during Q2, going from 790 million shares to 400 million shares. This means that Berkshire Hathaway now has $84.2 billion of Apple stock. While Berkshire Hathaway has previously sold Apple’s stock, like its sale of 1% of its shares in Q4 2023 and 13% in Q1 2024, a 50% reduction is still a sharp and unexpected action. This has resulted in an almost 50/50 split between cash and bonds versus equities at $287 billion vs $285 billion. This selloff and resulting change in how much equities Berkshire Hathaway owns demonstrates the cautionary attitude of many investors as the risk of recession and overvaluation looms large.

• Unsurprisingly, the over $200 billion of cash held by Berkshire Hathaway isn’t actual cash. Rather, it is mostly Treasury bills, which are safe U.S. government-issued securities that range in maturity from 4 to 52 weeks with an interest rate of between 4.3% and 5.3%. These T-bills have increased from $130 in Q4 2023 to $235 in Q2 2024, which means that Berkshire Hathaway owns more T-bills than the US Federal Reserve’s $195 billion. This move away from equities into T-bills reinforces the fact that Berkshire Hathaway is being cautious about the current economic environment, choosing to have safe guaranteed returns rather than investing elsewhere.

Future Events

Uses of AI

• When considering the impact of AI, it makes sense to focus on how it may disrupt jobs and enhance productivity. However, another dimension to its impact is in the defense industry, where there’s considerable investment into creating AI based software for entities like the US military. Two notable companies among the many that have sprung up in recent years are Palantir and Andruil.

• Palantir, which was founded in 2003, is a data analysis company that has, in recent times, greatly benefited from the ascension of AI. For example, it has just this month delivered its first Tactical Intelligence Targeting Access Node(Titan), which came about thanks to a $178 million contract to build prototypes. These systems help the military organize data by having AI parse it and reduce the time needed to make decisions. In May, Palantir also signed a $480 million contract to produce its Maven Smart System, which identifies enemy systems and analyzes real time data. With a new partnership with Microsoft to use Microsoft's generative AI in Palantir products, it’s likely the AI defense complex is going to expand in the coming years.

• Andruil, another defense technology company, recently raised $1.5 billion in a Series F investment round and is using it to develop its manufacturing capabilities for uncrewed combat drones and autonomous underwater vehicles. Unlike traditional defense production where software can be created and molded by many contractors, Andruil creates mature software and bases equipment on the software, better controlling how subcomponents operate in a weapon. 

• These breakthroughs are likely to expand in the future since the prominence of unmanned equipment like drones and the efficiency of AI will become evermore useful in combat.

Mortgage Rate Decline

• Since the Federal Reserve began hiking interest rates, the cost of borrowing on a plethora of things has increased. One major area that has affected consumers the most has been the housing market, which saw 23 year highs of around 7.8% in October. 

• Since then, the mortgage rate has decreased as demand and home sales fell because consumers cannot deal with high monthly interest payments and increasing home prices. This trend has stayed true recently as the quantity of homes demanded, as seen via pre-existing home sales, fell 5.4% from May to June. Due to this lower demand, mortgage rates have declined over the last few months. 

• As of last week though, mortgage rates fell rather dramatically. Mortgage rates dropped from 6.73% two weeks ago to just 6.47% last week, over 130 basis points lower than its peak almost a year ago. The cause for this drop was the fear of recession and strong belief in September’s rate cut that arose from the panic last Monday. These two factors lowered the yield of the 10 year Treasury bond, which directly translated to lower mortgage rates according to University of Illinois professor Julia Fonseca. 

• These lower mortgage rates make the actual cost of having a mortgage lower, incentivizing homeowners and renters to buy homes. This reduces the “mortgage rate lock” where households don’t move or buy new homes because of high mortgage rates. This means that demand for homes and home sales should rise, but the effect on home prices is uncertain. On one hand, higher demand means higher prices. However, more people selling their homes could increase supply and higher demand means more new home construction. 

Higher Loan Demand

• Once inflation and interest rates began increasing, fears of a recession and the cost of borrowing grew, which led to lower loan demand as firms and households moved to be more cautious. Lower loan demand leads to less consumption and investment in the economy, slowing growth.

• However, unlike previous quarters, Q2 saw loan demand improve in Q2. For instance, for the first time in 2 years, commercial and industrial loans didn’t weaken, according to a Federal Reserve survey. Additionally, the share of banks tightening standards for C&I loans fell while the share of banks loosening standards increased, although those tightening standards still outnumber those loosening them. This means that both the demand for loans and supply have been increasing, a positive sign for future growth.

• Household borrowing conditions have also seemingly improved. Lending standards for mortgages and car loans were unchanged this quarter after 2 years of tightening standards. Additionally, demand for mortgages weakened less than before, which suggests residential investments may increase in the near future. 

• Credit card debt also faced stronger demand as, for the first time in two years, banks reporting stronger credit card demand outnumbered those reporting weaker demand. However, while more loans do mean more spending, it doesn’t speak to the financial soundness or solvency of consumers, who may be struggling given existing high debt burdens and high interest rates. Nonetheless, it does seem likely that this higher loan demand could help economic growth in the coming quarters.

Weekly Question

Although last week’s panic certainly hurt investors at first, the market soon recovered, reaching its level prior to the panic. With this in mind, how much has the S&P 500 increased YTD?

• A: 8%

• B: 23%

• C: 21%

• D: 15%

Answer: D. The S&P 500 has done quite well this year, already being up 15%, with much of its growth driven by the AI hype surrounding tech stocks.