Shocking Revelation: Unveiling the Truth About Excess Savings! | You Won’t Believe What Financial Times Discovered!

Good morning. Unhedged’s short position on Coinbase in the Financial Times stockpicking contest continues to disappoint. Shares of the cryptocurrency exchange jumped 24% yesterday after a lower court issued a ruling uncomfortable decision saying that XRP cryptocurrency, when traded on secondary markets, did not count as security. This decision is important and we will think about it over the weekend. In the meantime, tell us what you think: robert.armstrong@ft.com AND ethan.wu@ft.com.

Also, hear from Rob and Lex editor Elaine Moore compete in a Big Tech stock draft in the latest episode of the Unhedged podcast.

Was the Excess Savings Debate a Big Conceptual Error?

We’ve written a lot about the US household savings glut. The basic story is simple. During the coronavirus pandemic, the US government sent checks to American families at the same time those families were spending less because they were stuck at home. Accumulated savings. Coming out of the lockdown, the money was spent quickly, providing great support to the economy. When the savings are all used up, the consumer economy is likely to slow down.

The story is gripping and a cottage industry has grown by measuring the extent of the excess and the speed of its decline. This represented surprisingly great intellectual challenge. Like us he wrote a few months ago:

Obtain an estimate of the excess savings. . . [requires] a guess about the underlying trend in household saving. “Excess” saving, in other words, only makes sense in the context of a “normal” saving trend. . . savings estimates are very sensitive to underlying assumptions, and it is difficult to know which assumption is best.

Even this amount of skepticism may have been insufficient. Dom White of Absolute Strategy Research says the whole concept is confusing. That’s because excess savings — money created by the government and sent to households — don’t disappear when they’re spent:

Fiscal policy easing has injected additional bank deposits into the economy. . . those deposits aren’t destroyed when they’re spent, as the concept of excess savings implies: they’re simply passed on to other consumers or businesses. . . one could say that “excess savings” are converted into “excess income”. And of course, while most of that excess income will later be spent, some will also be saved, so spending the excess savings creates new savings. Either way you want to frame it, the idea that those savings will dry up, and therefore spending will slow down, is just plain wrong.

This is a good point.

There is, however, one way to tell the story in a way that makes the most sense: by paying attention to income distribution and propensity to spend. When families spend their stimulus checks on Pelotons or pedicures or whatever, a lot of that money goes to corporations. Some of that money will then go back to other households in the form of paychecks or dividends, or it will be transferred to other companies in exchange for raw materials or equipment. But eventually some of it will go to someone who will simply keep it or use it to pay off the debt.

If the money is simply in a deposit account and the bank with the deposit doesn’t make a new loan on the back of that deposit, the money falls into something of a coma. On the other hand, if money pays off a debt, it is destroyed—the reverse process of the process by which lending creates money. The “person” paying off the debt and destroying the money could be the government, if it uses a tax payment to pay off a debt that is not replaced with a new one. Either way, as White told us in conversation, “it matters whether the money goes up or down.”

In short, the money came from a large cross-section of US households who had a high propensity to spend it. Eventually some of it will find its way to someone who has a low propensity to spend it. Probably stimulus money moving from household checking accounts to other places in the economy does have implications for the level of consumer spending. It’s just that those implications are far more subtle and complex than the underlying story suggests.

Where does it leave us? It lets us monitor spending trends the old-fashioned way: listen to company results, watch credit build-up, look at payroll, and so on. Let’s get back to work, everyone.

Some anecdotes from Japan

Corporate governance reform in Japan, by returning companies’ accumulated cash to shareholders, spin-off of non-core assets, etc., could revolutionize the country’s stock market. And the promised reform has contributed to the 20% increase in the market since the beginning of the year. But the reality of reform is that it remains beyond the reach of investors.

There are signs of warmer attitudes towards shareholders, notably a record level of share buybacks in 2022 and top-down pressure from the Tokyo Stock Exchange. Activists and hedge funds can target companies with the most receptive management. However, specialist stock pickers are not enough to keep the rally going. Global asset allocators need to rethink theirs low share weight about Japan. But how can a foreign investor evaluate a change of attitude?

“You’re a bit clueless as a Westerner,” says Nick Schmitz, portfolio manager at Verdad Capital, who spoke to us soon after returning from a series of AGMs in Japan. Outside of scattered surveys with small sample sizes, “You’re left with anecdotes, buyback levels and sales charts.”

We asked Drew Edwards of Schmitz and GMO, who was also on an extended research trip to Japan, what they’re hearing in the field.

The TSE’s recent directive to listed companies, ordering them to publish plans to raise price-to-book ratios or face penalties, was widely hailed in the financial press (including in Unhedged). But where an overseas investor might see an equity catalyst, some in Japanese management see TSE’s chief executive as a “self-promoting opportunist,” Schmitz says with a laugh. “This CEO realized that [corporate reform] it was already underway, and after it started, he placed an order to take credit for it! The TSE Ordinance “maybe adds a little bit of urgency [but largely] it just consolidates what is already happening,” he added.

Edwards says Japan is finally seeing the fruits of 2010 Abenomics reforms, including an official corporate governance code published in 2015. “If I look back on my early days in this industry in the early 2000s, it was often difficult to get meetings with management, especially if you’re a foreign investor and if you have any activism associated with you in any way,” he says. But more recently, “I can’t remember the last time I didn’t have a management meeting.”

A registration number of companies addressed shareholder proposals at this year’s general meetings. Yet hostility towards activists remains. “I have to tell every company I meet that we’re not activists, and then there’s an immediate friendly overture,” Schmitz says. “It’s not an overly hyped stereotype.”

For non-activists, however, management is increasingly willing to talk. Edwards tells the story of a company he invested in, Mitsubishi Electric, which he described as a “proud, traditional, rigid” electronics manufacturer. But the company, with its proud tradition of quality, has suffered a high profile quality control scandal in 2021 after many of its factories cheated on inspections. Much of the old top management stepped down in embarrassment and a new CEO took over with a mandate for change. Edwards says the new boss has started doing “all the things you learn in a first-year MBA class,” like winding down cross-shareholdings and spinning off unrelated lines of business. But Edwards was very impressed by another change:

“They were not [even] a 5% shareholder, but they will ask for our opinions, solicit our thoughts, which was not the case in a company like Mitsubishi Electric in the past. I highlight this as an example of a company where liquidity is high and our trading doesn’t move the needle. But we’re seeing the same pattern in smaller companies where you can really have a lot of influence by virtue of an outsized position.

The plural of anecdote is not given, obviously. But there are changes afoot. (Ethan Wu)

A good read

Bidenoms and big government.