The Investor August 2020

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The State of Play

By Richard Cluver  August 2020

The stark reality of the seriously contested future lying ahead for a South Africa brought to the brink of economic destruction by ANC plunder, has left many of my readers questioning whether they still have a future in this country. After doing the numbers I believe it’s best to stay!

Many readers who tuned in last month to my Zoom conference in which I laid out the appalling numbers within the Tito Mboweni Budget have been shaken to the core because few had realized how bad things really are. Unable, however, to join the eight percent of wealthy South Africans who have quit the country in the past year, the majority now face the challenge of personal economic survival. Inasmuch as they share this concern with 60% of the population who are without formal employment and do not know where the next meal might be coming from, there is perhaps some consolation in knowing that we are all in this sinking ship together.

To understand the causes of our problem, the first fact we need to recognise is that in the face of dwindling tax revenue, the tax base is in actual collapse, being made infinitely worse by irrational National Command Council decisions that are clearly unsupported by fact and logic. So it is important to realize just how few taxpayers the government now relies upon for its income. So note that 67.6 percent of all the income tax collected last year came from just 240 756 to taxpayers. Add in the next layer of taxpayers who number another 115 425 and you get to 99.99 percent of all income tax collected. That top group earns R500 000 a year or more while the second group earns between R70 000 and R500 000 a year.

Think about that; to be in the TOP TWO tax brackets you need to earn over R5 833.33 a month. It illustrates what a poor country we really are.

Nobody knows at this stage what percentage of these taxpayers will be left in the aftermath of the Corona virus, but it is likely to be a seriously-diminished number. The Treasury is taking a conservative view that fully a quarter of them will be lost this year. Minister of Labour Thulas Nxesi has, however, presented a worst-case scenario in which 53.7 percent of workers lose their jobs.

Meanwhile, at the level that hurts the average South African the most, ANC municipalities with their heads buried deep beneath the sand seem to believe they can simply keep on increasing the rates burden. The South African Property Owners’ Association has produced figures that show on a five-year rolling basis, annualised growth in property taxes has exceeded CPI since 2008. As a result, rates have grown by a cumulative 318% since 2008, compared to the 78% of CPI.

Work all of this out and you can readily see that the tax burden of servicing the needs of 59,308,690 South Africans rests squarely on the shoulders of just 356 181…yes that’s right, on just 0.6 percent of the population. Given, furthermore, that the wealthy have been leaving at the frightening rate of 8 percent a year, it is quite clear that the State cannot look to taxpayers for any meaningful increase in revenue. Nevertheless Minister Tito Mboweni has told the IMF he will be raising additional tax income in the coming year.

Clearly, as I have said frequently lately, the ANC has run out of road. It would be economic suicide to try and increase tax rates above current levels; the current 45 percent marginal tax rate coupled with the political uncertainty of the country and the reality of Zimbabwe style land invasion, is why wealthy taxpayers are leaving the country in droves and, more importantly, taking their money and their entrepreneurial ability with them to more benign tax environments.

Against a budget gap this year that is expected to be R800-billion odd adding in the fact that there is R500-billion of Covid-19 emergency spending to be found if government carries on as usual, the Government has so far realised:

IMF R70-billion

BRICS Bank R17-billion

Where will the remaining R1 213-billion come from?

Amid fierce opposition from the unions, some ANC leaders think that prescribing pension fund money might solve the problem but the maximum annual income of all pension funds in this country is R500-billion.

So the remaining shortfall is R713-billion.

We can thus be VERY grateful that President Ramaphosa has reappointed Lesetja Kganyago as Governor of the Reserve Bank for a period of five years. Mr Kganyago has been emphatic that he will not allow the Bank to follow Zimbabwe down the Quantative Easing route down which folk like ANC secretary general Ace Magashule would like us to go.

There is thus, under the present setup, ONLY ONE option which in any case is part of the IMF loan requirement; we must DRASTICALLY trim government spending. Of that the civil service pay cheque which currently consumes 45 percent of all tax revenue, stands squarely in line. Furthermore, if the Finance Minister loses his struggle to contain the public servants wage bill it will in the current year soar to represent 60 percent of all taxes collected.

Let me be clear about this struggle. Taking up the opportunity to source a Covid-19 loan from the IMF at this point made absolute sense since, at a cost of one percent, it is very cheap money with no particularly onerous conditions attached. But it is far more important than that for it has drawn a line in the sand that the government, at its peril, dare not cross for it has to be seen as a test from the world body as to whether we can be viewed as a responsible borrower. In order to obtain the loan, we had to offer a letter of intent in which we set out a promise to reform our ways so that in future we would eliminate our annual budget deficit.

More progressive governments might see their way out of this problem by going for economic growth. And we do know precisely what we need to do to achieve growth. Starting with GEAR we have created a whole series of growth plans that have been resoundingly praised by renowned international experts but, despite repeated lip-service to the concept by each new ANC administration, the table on the right makes it clear that it has never been an ANC priority. Indeed, other than clearing the way for fresh waves of looting, it has been difficult to see any real economic plan in operation since Nelson Mandela ended his term as President. Year by year our economy has stagnated!

Instead, in the face of declining support at each successive general election, the ANC appears intent on finding additional ways of buying public support by spending money it patently does not have, such as the current emergency relief grant for the unemployed which political analysts say will be nearly impossible to terminate amid a rising clamour for a basic income grant which has been costed as likely to burden the fiscus with at least another R200-billion a year.

Then, notwithstanding the conclusive proof uncovered by pandemic pressure of just how catastrophic has been the ANC’s inability to administer our present health service, health minister Zwele Mkhize (who is tipped as the likely successor to Cyril Ramaphosa) is determinedly pressing ahead with his dream of a R513-billion National Health System.

And now we are assailed by a whole new wave of the worst kind or corruption imaginable; by a politically-connected elite stealing emergency funds destined for the relief of the poor! It is as morally repugnant as is the terminal levels of public frustration at the rapacious hopelessness of the ANC. Couple that with criminally tainted people like the former mayor of Durban being promoted to high office in KZN and the contempt with which ANC leaders view the electorate is made manifest!

As a young journalist many years ago I was taken by a Natal senator to view his frustration at then ANC political posturing that the white man had stolen the best land and left blacks with the dregs. His farm ended at a fence line atop a koppie that was lush and green on his side and a barren rock-strewn wasteland on the other.

“It looks like they have a point,” he said ruefully. “Except that I grew up on this farm and we managed the veld properly. On their side they burned the grass to create new green shoots to feed the cattle and so, when the rains came the soil was washed away. And when there was no grass left they put in the goats which used their hooves to dig out the roots.

“So the next rains washed away all the soil and now all they have is rocks and they are putting pressure on the Government to give them my farm…so they can ruin that as well.”

Of course there was a second story about too many people being crowded onto over-used land and the failure of the then education system and the agricultural extension officers of the time, but I guess I will nevertheless be labelled a racist for recounting this story. But there is nothing racist about the issue of failing to prudently conserve what you have. And, to be fair, the ANC is hardly the worst example of fiscal irresponsibility. MOST major world governments are far worse in that respect. The universal lesson is simply the fact that if you fail to live within your means you are likely to end up with nothing.

$69 Trillion of World Debt in One InfographicAs someone colourfully put it recently, Governments are acting like the person who mortgages his house to pay for lunch. So consider if you will the infographic on the right. If you look very carefully you will see how insignificant our debt is. We are at about one o’clock with just 0.3 percent of the total world debt.

So, if you are thinking of leaving, where would you escape to?

Let’s start by recognising that the quantum of a nation’s debt is far less important than its ability to repay what it owes. That is why economists habitually use the measure of a nation’s debt to its Gross Domestic Product (GDP ratio). Since GDP is the measure of total economic activity then, simply stated, when South Africa reaches a debt to GDP ratio of 100 percent which is now in sight, then if the government taxed every individual and every business all of their earnings for a full year and used all of that money to pay off our national debt, it could be eliminated in just one year.

The problem, of course, is that people have to eat and pay for a whole lot of other expenses each year and so a 100 percent tax rate is clearly impossible though it might be sustainable for a year or two in countries whose people, like Japan for instance, have high levels of thrift. Britain for instance-imposed 99.5 percent during World War 2.

More important when you want to judge how well a country’s economy is being managed is to look at how the debt to GDP ratio is either rising or falling. So please note in my next graph what a disastrous course we have been on since successfully taming the beast between 2001 and 2008 during which, while running successive fiscal surpluses and simultaneously growing our economy, Finance Minister Trevor Manuel won world acclaim for bringing us back from a ratio of 43.5 percent to a low of 27.8 percent.

But then, in the face of a worldwide recession brought on by, calling it for what it was, the criminal behaviour of Wall Street banks, we began spending like a drunken sailor on vanity projects like football stadia and plunderable power generation stations which saw our debt ratio explode exponentially.

The debt to GDP ratio has its critics as a measure of how well a country is being governed economically but it does give one an easily-understood comparable measure of the magnitude of the problem in various countries. And the steep ascent of the graph illustrates that the South African government has been doing absolutely nothing about mending its ways.

It should thus be no surprise that my own sense of optimism about South Africa has, in keeping with most of my friends, lately been wearing rather thin in the face of the ANC’s seeming inability to admit its own abject failure and seek practical help. I have, as a result, given serious thought to joining the general exodus and in that respect I am fortunate inasmuch as there are few countries in this world that I have not visited and, while there, have not asked myself whether I could be comfortable living there. Furthermore there are several, like New Zealand, where I could be very comfortable if I decided to make the move.

So, setting aside for a moment the obvious issue of leaving behind family and friends which is I suspect one of the greatest imposts preventing a majority of us from leaving South Africa, if it is mismanagement of the economy that would be my primary driver, would I be better off in most of the countries on my possible list?

Well, if you accept that economic policy success and failure can be summarised by numbers, then I cannot think of a better one than the extent of a nation’s debt as a percentage of its GDP. So please consider the list on the right which details that percentage in descending order. Notice that South Africa is currently only 17th on the list at a current 62.2 percent.

Now since I mentioned New Zealand as one country in which I could live very comfortably, it is worthwhile noting that in respect to their national debt to GDP ratio, this is one country in a far happier place with a debt to GDP ratio of just 19 percent. More to the point, however, New Zealand has been where we are and fought its way back after steadily winding down its debts between 1995 and 2008.

They got their debt to just 5.4 percent of GDP and then let it explode to 25.5 percent in 2013. But since then they have been unwinding it once again and last year got it to just 19 percent.

More sobering though is the percentage of total national income that is being siphoned off by our government. So consider in my next graph how it has been rapaciously consuming more and more of all South Africa’s economic activity to the extent that last year it took a total of 27.47 percent.

However, since I highlighted New Zealand as a country where I could feel very much at home, the following graph lists total government revenue of all OECD countries as a percentage of GDP. Note, highlighted in black, that New Zealand takes far more than the South African government does at 32.7 percent, a figure which is nearly equal to their current maximum personal income tax rate of 33 percent on sums greater than $70 000. So New Zealand is clearly even more rapacious than South Africa despite a seemingly lower personal tax rate. What they are not taking in income tax they are, in other words, gathering up in other taxes.

Looking thus at all the evidence that economic numbers can offer us, we might consider ourselves quite well off in respect of how big a slice of the national income the ANC government consumes inasmuch as the average of all OECD countries last year was 34.3 percent. What this implies that if the SA Government could be more efficient in tax collection – rather than simply increasing tax levels to such levels that most of us will conclude that emigration is our only option – our path to economic recovery might look a little more optimistic.

It also goes without saying that we will need to end corruption, a seemingly impossible objective but one which other nations have shown is a relatively easy task to send out the right message to the public by putting a few high-profile offenders behind bars! Wait for it. My sources say just that might happen sooner than most of us expect.

Things might look quite gloomy here at present. I think, however, the IMF loan could just be our saving grace because the government now knows that if it refuses to turn over a new leaf and manage our finances responsibility, the IMF will be extremely unlikely to come to our rescue when we thus inevitably face a debt crisis; conceivably within less than a year.

The writing is clearly on the wall and we dare not ignore it. Furthermore, the stark reality is that governments the world over are not doing a good job…mostly they are doing a worse job than the ANC. So, I think I am going to stay here and manage my finances to make sure I remain ahead of whatever is coming!

The Second Great Depression… But Not Really

By John Mauldin

John MauldinIn recent weeks, numerous commentators started to suggest the US and the world are entering a depression.

For some areas of the economy, that is clearly true. But not every area.

Today we will explore what some smart minds are saying about the current economic environment. I’ll also aim to help you navigate through its complexity.

Here’s one thing I think we can all agree on:

This recession/depression is unlike anything we have experienced.

I am at a loss to find anything like it in world history. That is because we have never experienced an economic disaster—and that’s the correct phrase—like we are witnessing today. Furthermore, the recovery—when it happens, and it will come—is going to be very uneven.

Part of the economy will be in what can only be described as a depression for quite some time. Another part will recover, albeit a little slowly, but faster than the Great Recession. Other parts of the economy are going to take off like a rocket ship.

The media and politicians tend to talk about “the economy” as a general term. But I think that will be a misnomer. How fast you will see recovery, or how long you will see depression, depends a great deal on where you are and what part of the economy you are in.

My friend George Friedman of Geopolitical Futures suggests that our search for answers starts with September (emphasis mine):

“I have argued that unless a solution is found by September, the probability that the recession could turn into a depression would mount. A recession is a normal part of the economy, a primarily financial event that imposes disciplines on an overheated economy. A depression, from a geopolitical standpoint, involves the physical destruction of the economy, something that lays waste to businesses, dislocates labor and vaporizes capital. A recession is the economy cycling. A depression is an economy breaking.

“I chose September because two quarters of intense economic contraction is instructive. Economists’ definition of a recession is two successive quarters of negative growth (also known in English as decline). This is generally enough time to understand how resilient an economy is. Un-coincidentally, it is also the point at which economies begin to recover in normal cycles. Under normal circumstances, basic economic structures remain intact during recessions so financial stimulus measures can restart the system. “

Just for the record, there have been five depressions in the history of the US: 1807–1814; 1837–1844; 1873–1879; 1893–1898; 1929–1941. I believe all of them were associated with banking crises and financial panics.

A little history is in order to understand why the current situation is different from anything we have seen…

The first four “depressions” were indeed banking panics. But they were also associated with the agricultural cycle. Farmers would borrow money in the spring and pay it back after the fall harvest. Money would move from money-center banks in the big cities, especially New York, to smaller banks out in the country. And then back.

(Think about the old piece of market wisdom here: “Sell in May and go away.” The money-center banks would have less money to lend for speculation during the summer.) If you’re as fascinated by this topic as I am, Art Cashin turned me on to a book by Walter Lord called “The Good Years.” Truly the best 99 cents you can spend. Click on the chapter heading “1907” and read how J.P. Morgan essentially forced bankers and financiers to save the country.

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It was actually quite the harrowing tale. And it was what led governments and banks to create the Federal Reserve in 1913, to have a lender of last resort.

Things indeed changed. Not long afterward, the US became less dominated by the agricultural cycle and more dominated by the manufacturing cycle.

As my friend Dr. Woody Brock says, when Henry Ford would lay off 10,000 workers, that also meant steelworkers, tire manufacturers in Akron, and so on were also laid off.

That percolated throughout the economy. And we got what we called the Great Depression. (I know this is a huge oversimplification: Herbert Hoover allowed Smoot-Hawley in 1930. He also raised taxes in the teeth of a depression/recession. Monetary policy was not helpful.)

After World War II, “recessions” became more frequent. (Sidebar: You won’t find the term “recession” in the historical literature prior to World War II.)

Up until 2000, recessions were associated with the manufacturing cycle. But those became milder over time. That is because manufacturing had less of an impact on the economy. Going into 2020, 85% of the US economy was in the service economy. The Great Recession was caused by financial excess, but we worked through it.

And then we get to the current crisis. And something happened that never happened before… We literally shut down 30% to 40% of the service economy. Wiped it out. Restaurants, hotels, gyms, airlines, tourism, all manner of personal services. The list can go on forever.https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Chart_1_20200814_TFTF.png

The Independent Restaurant Coalition conducted a poll by Compass Lexecon, a Chicago-based consulting firm. The report predicts a grim future for roughly 500,000 (of 660,000) Main Street restaurants unless a more robust financial assistance program is established.

That’s potentially 85% of independent food establishments, gone forever. I am told by a member of the National Restaurant Association that, as things stand, some 30% to 40% of restaurants will likely close by year-end without further aid. Yelp is a surprisingly good source for information on business closings. Some 55% of businesses that are listed as closed on Yelp have been closed for good.

It’s not just restaurants…

Half of hotel rooms in the US are empty as of six days ago. They need at least 80% occupancy to break even. Some 70% of hotels in India are expected to close. Hotels that depend on tourism? Toast. Airlines? The list goes on and on.

And it’s not just the US…

Other countries around the world are having their own problems. Liz Ann Sonders gives us this graph:

Emerging markets and frontier markets are having their own even worse crises brought on by COVID-19.

The Eight-Body Problem

If you have three large objects that have a gravitational impact on each other, you can determine where they have been in the past. However, you cannot predict where they will be in the future. At least, not without great difficulty.

In physics, this is called the three-body problem.

In economics, we are well beyond the three-body problem. I think it is more like an eight-body problem. See if you agree:

Body No. 1: The service economy has imploded. We don’t know when it is coming back. I am not going to argue the correctness of whether we should lock down or open up. I am simply talking about what is. And it appears that much of the economy is going to be locked down for some time. There is simply no telling when that part of the economy will normalize.

Body No. 2: We have seen the largest central bank intervention, not just in the US but in many parts of the world, ever in history. Clearly that is keeping markets up. Furthermore, governments are providing fiscal stimulus in an unprecedented manner.

In essence, the government borrowed money to give people the money that they would’ve  earned in their jobs. Interestingly, not all of it was spent. We have seen a record amount of disposable income being added to savings.

The US government is in a food fight over the next round of stimulus. Not that the purpose of this letter is to argue what is correct. Some amount will likely be determined. Your guess is as good as mine. But can we keep that up in 2021? How long? That is a major economic gravitational body, and we have no idea what it will look like this year, let alone next year and 2022.

Body No. 3: Federal Reserve policy and, to some extent, government policy has short-circuited both Schumpeter’s creative destruction cycle and moral hazard. We literally have no idea how that’s going to impact the future, but those are big deals. Companies with the lowest-rated junk bonds are refinancing their debt at lower rates. We are keeping zombie companies afloat. Is every company that accesses the market a zombie company? No, of course not. But many are.

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Body No. 4: Global trade is beginning to implode.
Like it or not, we truly live in a global economy. This is a global depression and it affects everyone. I was writing 20 years ago that the biggest threat to prosperity in the future would be protectionism and tariffs.

I have made it clear that China is not a good actor, and we need to review our policies and our reliance upon them. But tariffs are just a bad idea, whether it’s China or Europe or whatever country. Can we say Smoot-Hawley?

Body No. 5: On average, six companies with assets larger than $50 million have filed for bankruptcy every week since April. This is going to increase and become a tsunami. Small local companies don’t even bother filing because it’s too expensive. Every one of them represents jobs.

This is the hard one…

Body No. 6: The working class will be last to see the recovery. Most of the jobs that are being lost are by the least-well-off in our society. They can’t work from home. Those with children have to figure out how to take care of them in case schools don’t open… or if they don’t want to send them back. Unemployment insurance won’t cover the bills when the federal money runs out.

This represents tens of millions of workers. Unemployment is not going to bounce back miraculously in the first quarter of next year. It is going to be a long, slow climb.

Now for some good news…

Body No. 7: Entrepreneurs will re-emerge, and new ones will seize this moment to shine. All those businesses going bankrupt or out of business? They are run by entrepreneurs who have the entrepreneurial bug. It is part of their DNA.

I was talking to a Dallas restaurateur who is “down” to three restaurants. He is stretching his cash and hoping for another round of PPP. He will breathe easier when he can get his normally booming restaurants up to 50% occupancy.

Depressed? Not at all. He believes this will all eventually normalize, and he will have the greatest opportunity he has ever had. He can see 10 restaurants in his future. This is the kind of vision that accelerates recoveries.

He and hundreds of thousands of other entrepreneurs throughout the country and the world look for opportunity. It’s just what they do. They can’t help themselves.

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It will take time, and they have to figure out where the capital will come from. But I am convinced that entrepreneurs will be the ones to dig us out from this, not governments.

Body No. 8: We are in the midst of The Greatest Transformation in history. Elon Musk just launched and landed a massive rocket as a test. That is just a very visible example of tens of thousands of new technological revolutions happening all around us.

These disruptive technologies will truly change the world. I can’t even begin to describe what is happening in the biotechnology and aging space. Artificial intelligence, robotics, self-driving cars, incredible advances in agriculture, shipping, quantum computers… you name it. The list is just too long. And it’s growing.

We are about to witness history-making advancements… potentially in record-breaking time.

What the Recovery Looks Like

I frankly think it is misleading to draw a graph and say this is what the economic recovery will look like.

Talk about a V- or U-shaped recovery is simply silly. Every one of the “bodies” I mentioned above will have a significant recovery impact. We don’t know how they will interact.

My guess is that we are going to see several different economies. Heather Long illustrates this for The Washington Post.

This dichotomy is evident in many facets of the economy, especially in employment. Jobs are fully back for the highest wage earners, but fewer than half the jobs lost this spring have returned for those making less than $20 an hour, according to a new labor data analysis by John Friedman, an economics professor at Brown University and co-director of Opportunity Insights.

If we have to choose a letter for the economic recovery, maybe it should be a “K.” Some go up and others go down.

I have two more charts for you today. The first is what I call Economy Part 1. This graph goes back to 2000, and the red lines roughly show the trajectory of the recovery. The St. Louis Federal Reserve database has not updated the second quarter, but I tried to represent it.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Chart_3_20200814_TFTF.png

For a large part of the economy—maybe the largest part—recovery is going to be slower than that of The Great Recession. And it is going to be lumpy. Notice that I have a recovery with a lower slope.

That is in part because of the research by Dr. Lacy Hunt and others demonstrating that growth is slower in high-debt economies. Just a fact.

Note that we do recover; it just takes longer for this portion of the economy.

Then we come to Economy Part 2. Faster recovery and the slope of the recovery is higher. More like what I call the Stumble-Through Economy. It still doesn’t look like the recoveries of the past, but perfectly acceptable given the problems.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Chart_4_20200814_TFTF.png

On this second chart, I want you to look at the yellow line I call the Disruptors. These are the companies that are truly changing the world and their growth is, well, through the roof.

I think by now most investors are well aware of the FAANG or FAAMG stocks, or whatever acronym we use. I am not including them in my thought experiment version of Disruptors. I mean, they are, but they have been around for a while.

Rather, I’m talking about the new companies that will not replace them, but will join them in the pantheon. (Though some of them may get replaced. Don’t ask me which ones.)

Some of the Consequences of a Three-Part Economy

Whether it’s K-shaped or some other to-be-determined letter, there are three economic takeaways:

1. This is going to change the way we live. We have already seen savings increase, not unlike our parents and grandparents during the Great Depression. It is going to change spending and saving habits. It is going to force businesses and entrepreneurs to adjust in ways that they never dreamed they would need to.

I think it is fair to say that many of us have looked at our lives and decided we don’t need quite as much “stuff” as we did before. We are not going to hunker down in caves, but we may pack them with less paraphernalia. Each one of those choices represents a buying decision that impacts some entrepreneur who provided that product.

This crisis is simply the greatest demand destruction of our lifetimes. It will come back, but it is not going to come back to what it looked like in 2019. Our future economic buying decisions are going to be different.

Everything, I mean everything, is going to be re-priced and thought through. You can’t take anything for granted. Inflation numbers and measures are going to be warped for at least a few years. We are using old tools to measure a new economy. We are going to have to develop new models to appropriately analyze the world we now live in.

How do we value the price of a home or apartment? I don’t think it is unreasonable to expect 10% unemployment, or something close to it, in the middle of 2021. That is going to affect prices up and down the housing value chain.

How do you value retail and office space? If your tenants are gone, do you pay the mortgage? Hotels will come back, eventually, but who is going to own them? The old private-equity owners or the new ones? At what price? We already knew we had too many retail stores. What is the correct number in the future? How will malls and commercial space be repurposed?

Hundreds, if not thousands of planes are sitting on the tarmac. Who is going to own them? There are thousands of scenarios playing out in thousands of industries all over the world. What they have in common is that…

Everything is going to be repriced.

That makes me very uncomfortable.

2. Inequality is not going to get better. Thought experiment: It is more than probable we will see some form of universal basic income in the future. It will not solve the inequalities of either income or wealth, but it will still be tried.

Those individuals who were part of the devastated service economy will still struggle for jobs, and they are in the lower income group already. The second part of the economy will be growing and pulling away from that first part. And that doesn’t even begin to describe what happens to the disruptors.

Just for the record, in this letter and on op-ed pages in various publications, I outlined a methodology for increasing taxes while actually improving the ability to create new businesses and to help those in the lower echelons of income. I am not a priori against higher total revenue for the government. It’s all about how we collect it. Social justice as our driving mechanism for tax policy is not going to improve the comity in our country.

3. We have two major cycles coming into play at the same time in this decade. One I have written about on numerous occasions: The End of the Fourth Turning. It is always a time of great social unrest, and we are just at the beginning of the end. I expect the period between the middle of this decade and the end to be far more disruptive than where we are today.

Second, my friend George Friedman has written a book called, “The Storm Before the Calm: America’s Discord, the Coming Crisis of the 2020s, and the Triumph Beyond.” In it, he discusses two separate cycles in American history, an 80-year cycle and a 50-year cycle. Both are disruptive. For the first time, they coincide in the latter part of this decade. He predicts that the 2020s will bring dramatic upheaval and reshaping of government, foreign policy, economics, and culture.

A two-part/three-part economy, where the outcomes for significant portions of the population are dramatically different, is a recipe for the types of crises both of their books outline.

And just so I can pile on, just as we are in the middle of their crises, we get to experience The Great Reset. It is a toss-up whether we will have a $30 trillion national debt by New Year’s Day. We will be at $40 trillion by 2025. Plus massive corporate debt, multiple pension crises that will boggle the mind.

All of the debt MUST be “rationalized.” We have absolutely no idea how, because we don’t know who will be in charge or what the crisis will look like. All while disruptive technologies are changing the very foundations of our society and job. Various people will read this letter and have different reactions.

I hope most of you come away with the idea that you want to find out who the disruptors will be and how you can participate, rather than hunkering down.

I am a believer in the entrepreneurial free market society, and I believe that is what will ultimately bring us into that period that George Friedman calls “The Calm” after the upheaval of the ’20s. I am excited about the future. I truly think we are on the cusp of actually reversing aging in our lifetimes, if not this decade. And that’s just one of many other wonderful things.

As my dad would say, don’t let the bastards—the crisis around you—get you down. Look for the opportunity. There’s a pony in there somewhere.


The relative price matters

Professor Brian Kantor

Brian Kantor headshotWhen it comes to prices, what matters is whether a good or service has become relatively more or less expensive, rather than the absolute price. Relative prices can change a great deal even as prices in general rise consistently or remain largely unchanged.
 
For example, the prices of food and non-alcoholic beverages in SA have risen much faster than the price of clothing. Since 1980, the prices of the goods and services bought by consumers have risen on average (weighted by their importance to household budget) by 31 times. Clothing and footwear prices are up a mere 8 times over the same 40 years. And food prices have increased 43 times since 1980, making food about 5.4 times more expensive than clothes.

Consumption of goods and services
LHS: Deflators for different categories (1980 = 100)RHS: Multiple increases (1980 – 2019)Consumption of goods and services graph

Source: SA Reserve Bank Quarterly Bulletin, Investec Wealth & Investment

Inflation rates:  All consumption goods and services, food and beverages, clothing and footwear (2010 – 2019)

Inflation rates: All consumption goods and services, food and beverages, clothing and footwear (2010 – 2019)

Source: SA Reserve Bank Quarterly Bulletin, Investec Wealth & Investment

Other relative price movements are worth noting.  Over the 10 years 2010 to 2019, furnishings and household equipment became 20% cheaper in a relative sense, while education has become 25% more expensive. Utilities consumed by households (water, electricity) have increased by only 6% more than the average consumer good.  Health services (surprisingly perhaps) have only become 3% more costly in a relative sense. More powerful pharmaceuticals and less invasive surgical procedures may well have compensated for these above average charges. Communication services have become about 37% cheaper in a relative sense, helped of course by the price of many a phone call falling to zero.

Relative prices (individual price deflators / consumption goods deflator) (2010 = 1)

Relative prices (individual price deflators / consumption goods deflator)
 Source: SA Reserve Bank Quarterly Bulletin, Investec Wealth & Investment

Businesses that serve consumers (retailers and service providers) are likely to flourish when passing on declining real prices. Producers are likely to suffer declining profitability as the prices they are able to charge decline, relative to the costs they incur. 
It will be the changing supply side forces that will dominate real price trends. Temporary surges of demand in response to changes in tastes that force real prices higher will tend to be competed away. Constantly improving intellectual property or technology can give producers the opportunity to consistently offer competitive real prices, yet sustain profit margins and returns on capital to fund their growth.
 
The dominance of China in manufacturing has been an important supply side force acting on real prices, for example on the real prices of clothing, household furnishings, equipment and communication hardware. Having to compete with lower real prices has decimated established manufacturers everywhere, including in SA though often to the benefit of consumers.
 
Predictably low inflation makes for more easily detected real price signals that consumers and producers should respond to. Unpredictable inflation rates make it harder for businesses to separate the real forces acting on prices from what is merely more inflation, common to all buyers and sellers.
 
There is however one important real price that shows no sign of stabilizing. That is real value of the rand, in other words the rand after it has been adjusted for differences in SA inflation and inflation of our trading partners. The real, trade-weighted rand is now about 30% below its purchasing power parity level.

SA producers exporting or competing with imports must hope that it stays as competitive, but there would be no reason to expect it to stay so. It is an important real price given that imports and exports are equivalent to 60% of SA GDP.
 
The real value of the rand moves in almost perfect synch with the market rates of exchange, which tend to be highly variable. The real and the nominal rand exchange rates have been almost equally variable. The average three month move in the real exchange rate calculated each month since 2010 has been 2.03% with a wide standard deviation of 19.8%.
 
For an economy open to foreign trade, this real exchange rate volatility adds great uncertainty to business decisions. It disturbs the price signals to which businesses must react. Until SA gets a higher degree of exchange rate stability, the price signals will remain highly disturbed, regardless of the inflation rate.

Quarterly percentage movements in the nominal and real traded-weighted rand exchange rate?

Quarterly percentage movements in the nominal and real traded-weighted rand exchange rate chart


Source: SA Reserve Bank and Investec Wealth & Investment

Brian Kantor is the former Chief Investment Strategist of Investec Wealth & Investment SA. He is Professor Emeritus at the University of Cape Town, where he was the Dean of the Faculty of Commerce and Head of the School of Economics. Brian holds a B.Com and a B.A. (Hons), both from UCT.

Data Trends That Will Digitally Transform the 2020s

By Dawn Pennington & Kevin Brekke

The coronavirus has brought massive changes to the way consumers and companies interact. We find ourselves in a new, more digitized economy.

This revolution was already on its way. It just arrived earlier than many expected because of the pandemic. And now, there’s no turning back. That’s good news for all kinds of transformational technologies that have been waiting in the wings for their time to shine. Things like high-speed networks, connected devices, and artificially intelligent everything aren’t just possible. Now, they’re imminent.

The great news is that many of these trends are as unstoppable as they are investable. Where do you start? With the one thing that makes them all possible…

Data: The Backbone of Digital Transformation

In 1980, IBM produced the first 1 gigabyte capacity disk drive. It weighed over 500 pounds and cost $40,000. Fast-forward to the appearance of Windows 95. Computers still set you back $700 to $3,000. But at the higher end of that range, you could get a 1 gigabyte hard drive that fit in a personal computer.

At the time, it was hard to fathom filling up all that space. We weren’t backing up thousands of emails, photos, and favorite songs. Today, you can fit a 128-gigabyte flash drive easily in your pocket, and it will only set you back $18.

How Do You Measure Change? In Zeroes (21 of Them!)

The new reality is that a gigabyte is nothing these days. We moved on to the terabyte, which is 1,000 gigabytes. This is about as far as we go when talking about personal computers. But these days, collecting data (including our personal data) is equivalent to mining gold in the 1800s. So, a terabyte won’t suffice. We moved to the petabyte, which is 1,000 terabytes. Then the exabyte, which is 1,000 petabytes. And finally to the zettabyte, which is 1,000 petabytes.

Of all the numbers we’re talking about today, this is the ONE we want you to remember…The global datasphere is expected to reach 175 zettabytes by 2025.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Chart_1_20200811_RC.png

That’s the number 175 with 21 zeros after it… the equivalent of 175 trillion gigabytes.

Cisco Systems (CSCO) calls this the “Zettabyte Era.” Here’s what one of its analysts, Taru Khurana, said that could physically look like: “If each Gigabyte in a Zettabyte were a brick, 258 Great Walls of China (made of 3,873,000,000 bricks) could be built.”

That’s huge… and getting bigger. Data scientists already have a name for 1,000 zettabytes: a yottabyte. In other words, big data doesn’t sleep. It snowballs. For investors, that means…

The Bigger the Data, The Bigger the Opportunities

It really can be compared to the Forty-Niners invading California during the Gold Rush. This time, it’s companies rushing to collect—and analyze—as much data as they can. That’s because data equals money. The term “big data” refers to data whose size or type is beyond the ability of traditional databases. It’s classified by the three Vs:

    • High volume,
    • High velocity, and
    • High variety.

These are massive collections of sensor readings, network statistics, log files, social media posts… anything and everything being funnelled into storage rapidly and in real time. The concept of massive amounts of data being valuable is nothing new. Even in the 1950s, massive amounts of data were compiled into spreadsheets for analysis. Then in the 1970s, the biggest companies with the most money could afford room-sized computers to minimize analysts’ time. More recently, big data was only available to the largest companies with the biggest technology budgets.

But that is all changing with the adaptation of artificial intelligence.

Data is only useful once it is analyzed. And it can only be analyzed after being turned into structured data. Data scientists spend 50% to 80% of their time collecting and preparing data for use. By using AI and machine learning to streamline the process, data scientists can focus more on making their conclusions.

What we’re seeing now is a complete change in how all this data is handled.

It’s partly because of an exponential increase in the size of the global datasphere, and partly because the technology is finally catching up.

4 Digital Trends That Are Already Transforming Our World

The adoption of 5G plays a big part in reducing latency and increasing speed for the handling of this data and the related processing.

This is resulting in explosive demand for certain areas of the technology sector.

Here are a few of those trends that we’ll be following closely here in Reality Check:

Machine Learning is a specific subset of AI that trains machines.

Yes, it trains AI how to learn and adapt. This development is useful in the sorting and analysis of data, and in the implementation of the conclusions. Without the latency of human-driven decisions, efficiency can be at the forefront.

Data Management refers to the process of organizing and sorting data. This process has to be repeatable and adaptable. Machine learning will no doubt be a part of this task. But at the base of this will be software and open-source code.

Data Mining is the process by which all this massive data is collected. It has to allow for chaotic and repetitive data to be identified and ignored. Only the highest-quality data gets moved to the data management phases. This will usually include a separate process for each type of data that is collected.

Data & Cybersecurity protect both the data and the network.

This last one alone has been growing rapidly over the past few years…

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Chart_2_20200811_RC.png
Source: Statista

Protecting data against cybercrime is set to be a $250 trillion industry by 2023. Here, we’re talking about more than your computer zapping some malware that gets downloaded to it. Some of today’s cyber-defense programs can notice a SQL query that takes a few milliseconds too long on a server. This can help companies and individuals identify a potential attack as it begins.

It’s no wonder companies are pouring billions of dollars into all aspects of big data. Management teams everywhere want to:

    • Reduce production costs and improve efficiency with faster and better decision-making.
    • Develop new products and services around what consumers actually want and need.
    • Recommend products in real time based off of browsing history or by the customer answering a few questions.

Data collection, analysis, and deployment is an important trend that’s like a runaway snowball traveling down a steep incline. It’s picking up more and more momentum as it rolls.

The second order effects of machine learning progress

By Mat Clifford

What’s holding back progress in AI? One of the features of GPT-3, OpenAI’s natural language processing (NLP) model, that seems particularly important is how well this kind of model appears to be scaling. GPT-3 didn’t represent a technical breakthrough relative to GPT-2 so much as an engineering one: it’s a much larger model in terms of the number of parameters – and the results are much better.

Pseudonymous investment analyst Mule has an excellent new post on this theme. One interesting question is, if all that’s required to reach new heights of achievement in NLP is more computational power (“compute”), why haven’t we done it already? Mule links to a fascinating post (the comments are excellent too) that argues that the answer may simply be that until GPT-3 was released no one realised it was possible. But now they do, we might expect very rapid progress, especially from the tech giants for whom the required capex is a rounding error.

Mule suggests this has important second-order implications. The rise of models like GPT-3 (and its successors) are an extraordinary demand shock for compute; demand may increase by orders of magnitudes over the next decade. Mule sees a world where semiconductors are >1% of global GDP. Some companies are poised to benefit, but it will also make the geopolitics of semiconductors, which we’ve discussed recently, even more important. 

Is AI development a geopolitical “arms race”?

Georgetown’s Center for Security and Emerging Technology (CSET) has a new report on a favourite TiB topic – the framing of AI development as a geopolitical competition. CSET’s team looked at 4,000 English language articles since 2012 and examined how they use the “arms race” rhetorical framing to discuss countries’ approaches to investing in AI R&D.

The findings are interesting. The “arms race” framing accelerated rapidly from 2012, but peaked in 2015. Use of the metaphor varies by sector and country too. In the US, the tech and (perhaps unsurprisingly) defence sectors are most likely to talk of an arms race; among governments, it’s France and Russia who most commonly use this language.

Why does this matter? As CSET notes, arms race framing may make AI practitioners and regulators less likely to invest in collaboration and safety. More broadly, rhetorical framing affects behaviour, particularly among elites who lack familiarity with the underlying technical material, as politicians typically do with AI. The superb Jeff Ding has an excellent piece from a year ago on how this phenomenon shapes China analysis more generally. As he argues, the metaphors that “knowledge gatekeepers” use are important, so it’s important to understand (and challenge) them.

Don’t learn too much about your organisation!

Most of us work in organisations and it’s a convenient belief – both for the organisation and its members – to think of these as well ordered and legible. What happens when we’re forced to interrogate this belief and confront reality? Ruthanne Huising has a fascinating paper on this question (discovered via Ethan Mollick) – or see her accessible write up in HBR.

Huising ran an experiment where she got high performers in general management roles to undertake projects to redesign operations for their organisation as a whole. She found that the participants quickly realised that their organisations, far from being planned and ordered, were more like emergent phenomena. As Huising says, this realisation turned out to be both empowering and alienating – and had long lasting effects. 

Half the participants later chose to move out of general management and into organisational change roles. They cited “inventing the board, not just playing the game”. But many also referred to the depressing realisation that no one was actually in charge and that their agency was limited. There is a connection here to David Graeber’s idea of “bullshit jobs”, but I wonder if this also contributes to the popularity of entrepreneurship? If you’ve had a negative reaction to large organisations, the (illusion of the?) chance to start again with a blank sheet is enticing.

 

South Africa’s take-home pay shock – here’s how much money people took home in June

Reprinted from Business Tech

The number of monthly salaries paid in June 2020 showed an annual decline of 20.7%, affecting a fifth of employees’ salaries, new data from the monthly BankservAfrica Take-home Pay Index (BTPI) shows.

“We have seen this massive slide in salaries processed by BankservAfrica and through the National Payment System in recent months,” said Shergeran Naidoo, head of stakeholder engagements at BankservAfrica.

“However, the figure in June is most reflective of the heavy toll that the current Covid-19 crisis has placed on employers and employees who are faced with major financial distress under the current circumstances.”.

The majority of payments recorded in the BTPI feature large corporates and a fair number of medium-sized firms that are served by payroll service providers and firm-owned payroll administrators.

As such, this recent decrease may not reflect the full impact of salary declines on small firms.

However, with the BTPI over representing civil servant and state-owned entity payrolls, it becomes evident that the reduced salary numbers are most likely to be in the private sector.

This is supported by data showing an estimated 30% of the BTPI monthly equivalent payments are paid by the broader government sector compared to 21% shown in Stats SA’s Quarterly Employment Survey.

“We surmise that a fifth of employees in the private sector did not receive a salary in June 2020. The 20.7% decline could be the result of job losses or it could due to a temporary pause in payments,” said Mike Schüssler, chief economist at economists.co.za.

He cautioned that while the BTPI numbers cannot be used as a measure of the unemployment rate, the salary data provides a quick and effective indication of the employment statistics on the ground through the number of salaries paid.

“In June, the actual average take-home pay declined by 0.5% in real terms. This could be the result of instances where salaries may have increased or that the personal income tax provided relief above the current inflation rate,” said Naidoo.

With tax relief of over 5%, a 1.7% nominal increase in actual salaries is extremely low. Moreover usually when inflation declines, as it currently has, real take-home pay increases even with low salary adjustments, said Schüssler.

“As many expected, daily/casual workers (-35.2%) followed by weekly workers (-17.1%) have been hurt the most. We are seeing a decline in monthly salaries of -9.1%,” he said.

https://businesstech.co.za/news/wp-content/uploads/2020/07/BankServ.png

BankservAfrica noted that the seasonally adjusted nominal take-home salary in June was R15,869, which was 1.7% higher than in June 2019. The real monthly take-home pay was R14,197.

“The real take-home pay declined by 0.5% on an estimated inflation rate of 2.4% in June 2020,” said Naidoo.

Meanwhile, the BankservAfrica Private Pension Index (BPPI) declined for the second consecutive month with a fall of 0.3% to reach R7,355 in real terms.

“Real pensions could be declining as a result of the interest rate reductions and the pressure that other assets have come under,” said Schüssler.

“The numbers are extremely concerning and will have a profound impact on the South African economy. The knock-on impact is also likely to be larger than many have estimated. Lower confidence levels and growing concerns over job security will have a severe impact on retail sales and consumer spending,” Schüssler said.

What IBM’s Latest Quantum Leap Means for Investors

By Dawn Pennington

IBM just hit a major computing milestone. One that puts it on track to have the fastest quantum computer in the world.

You might have missed this news. After all, most of us won’t need a system that can solve the world’s most complex mathematical problems. Besides, the use of quantum mechanics to build more powerful computers doesn’t move markets. Not materially, anyway. And, at least, not yet. Here at Reality Check, however, we believe that whoever owns this early-stage technology wins. And wins big…


To be clear, IBM has not won the race to quantum supremacy. In fact, several other formidable frontrunners are working on the technology that future generations will wonder how we lived without. Last year, Alphabet (GOOGL) said it built a quantum computer that took 200 seconds to solve a problem that would have otherwise taken a supercomputer 10,000 years to crack.

And IBM said, “Game on.”

Well, someone there probably said that. Here’s what we know they did. Last week, IBM announced that it had expanded the computational power of its cloud-accessible quantum computers. Through a series of new hardware and software upgrades, one of its 27-qubit systems achieved a Quantum Volume 64.

The more qubits involved in the process, the more complex the problem that the computer can solve. The qubit is what makes quantum computing so different from classical computing. Classical computing uses bits to make a series of 0s and 1s. This binary logic performs the operations following a code with the parameters: If this is true, then do this.

With classical computing, you pose a question and it spits out an answer. Quantum processing has the capability to take all the parameters that you set and come up with 1 or many optimal solutions.

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Source: Medium

What We Can Do with All That Power

As the legendary physicist Richard Feynman said in 1981, “Nature isn’t classical… and if you want to make a simulation of Nature, you’d better make it quantum mechanical.” Just remember that quantum computing is completely different from classical computing. It has the ability to perform complex problem-solving simulations that classical computing doesn’t.

But in the end, it will only be able to perform certain tasks faster. It is not a replacement for classical computing. Those tasks include things like weather forecasting… powering artificial intelligence… financial modelling… developing life-saving treatments and therapies… and so much more. And plenty of companies are relying on these quantum leaps to take their own businesses into the future.

With a Little Help from IBM’s Friends…

IBM has made a total of 28 quantum computers available on its IBM Q Network. The network is a community of Fortune 500 companies, academic institutions, start-ups, and national research labs. There are more than 250,000 registered users of the IBM quantum experience.

You’ll recognize some of the partners on that list. We’re talking about Samsung (SSNLF), ExxonMobil (XOM), JPMorgan Chase (JPM), and Boeing (BA)… just to name a few.

The IBM Q Network is all about fostering a community ecosystem that will advance the field of quantum computing. That’s why IBM Q Network members receive support and training from industry-leading experts.

Millions of experiments have already been performed over the cloud using IBM’s quantum computer. And just like every piece of technology before it, we know that the more applications it’s used for, the more data that can be collected. That data leads to improvements until the technology is perfected.

How IBM’s Q Network Will Make QC Work

When partners use the IBM cloud quantum computer, they enter instructions and parameters on an interface on a classical computer. That is then transmitted via the cloud to a quantum computer at IBM. The quantum computer turns those instructions into microwave pulses. These microwave pulses travel through cables in which they are cooled to negative 459 degrees Fahrenheit to then interact with the qubits.

The cooling of the microwaves mitigates the quantum effects of heat. This whole process takes only 0.001 seconds. The microwave pulses change the quantum state of the qubits. All the interactions are then analysed and sent back to the classical computer.

Is It Time to Invest in QC?

IBM’s announcement tells me this is the perfect time to introduce quantum computing as a trend the Reality Check research team is watching closely. Quantum computing is already being used to reinvent aspects of cybersecurity. The ability to break codes and encrypt electronic communications is extremely useful as cybersecurity mutates to fit an ever-changing computing environment.

And really, who knows what else we will need quantum computing for in the future. Quantum computing is designed to make calculations that we can only dream of today… and surely some that we can’t even fathom yet. Companies like Lockheed Martin (LMT) and government outfits like NASA have actually purchased their own quantum computers. And with multiple start-ups and giants working on quantum solutions, it’s only a matter of time before more companies jump on the bandwagon of having one in house.

IBM is working hard to be that leader, and this most recent achievement puts it on the tail of Honeywell International (HON). Honeywell achieved a quantum volume of 64 back in June. At the time, IBM could only tout a volume of 32, but now it has caught up.

Honeywell is in the race because it wants to discover new kinds of materials. This would involve working out how different molecules interact to form materials with the right properties. One specific example is trying to identify a refrigerant that is more effective and better for the environment. Honeywell says it will use QC to identify better refrigerants.

Now, the two are neck and neck. So, we’ll be watching to see what the next improvement is. As well as taking a deeper dive and looking for the start-ups and disruptors in the field.

Both Honeywell and IBM are technology giants and solid dividend payers.

I’m not saying that either one is your next triple-bagger. But they sure are two of the leaders in this field. If you have a legacy section of your portfolio, you should have one or both of these names in it.


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