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Good morning. “Walmart is gaining popularity with richer consumers looking for savings at a time of high inflation . . . three-quarters of [its market share] gains came from shoppers with annual incomes of more than $100,000, executives told analysts.” That sounds like a different economic story than we have heard for much of the last year. What about you? Email us: email@example.com & firstname.lastname@example.org.
Buffett, TSMC and Taiwan risk
Berkshire Hathaway has a patchy record as a tech investor. What I mostly mean by this is that Warren Buffett’s conglomerate made a nightmarishly bad $10bn investment in IBM in 2011. Buffett argued at the time that IBM’s competitive moat was its very stable foothold in corporate IT departments. This was absolutely not the case, as subsequent events demonstrated, and Berkshire sold at a big loss. Unhedged wrote about this earlier this year, when Berkshire unveiled a $4.2bn stake in HP Inc, which sells printer cartridges (that stock has slightly underperformed the market since). On the other hand, Berkshire’s huge investment in Apple, which it started buying in 2016, has been a winner.
All three of these stocks have something in common with Berkshire’s latest tech purchase, a $4bn stake in Taiwan Semiconductor Manufacturing. When purchased, all three looked cheap, with price/earnings ratios in the low single digits or (in the case of HP) lower.
But TSMC is a lot more like Apple than HP or IBM. In addition to being cheap, it has been growing fast and is (for a company in a capital-intensive industry) very profitable. It has increased revenue at a five-year compound annual rate of 17 per cent, and has a five-year average return on capital of 16 per cent, according to S&P Capital IQ. Compare, for example, Intel on those two metrics: 2 per cent and 12 per cent, with a P/E ratio of 20.
Further, TSMC’s competitive moat seems wider than IBM’s (too annoying to fire) or HP’s (too annoying to buy a refilled ink cartridge). It has a virtual monopoly on manufacturing the fastest computer chips. TSMC will not always have that crown (Intel once had it, Samsung was once close) but making chips is hard and leadership changes hands infrequently.
So why is TSMC trading at 12 times forward earnings? I asked two semiconductor analysts — Stacy Rasgon of Bernstein and CJ Muse of Evercore ISI — about this yesterday. Both were unequivocal: TSMC trades so low only because of the risks posed by the tense relations between Taiwan, China and the US.
I’m not certain that this is true, but let’s assume it is. Is Buffett right to look past this risk? One argument would be that in the extreme case of a Chinese invasion of Taiwan, and the US becoming involved militarily, all of us (and every stock) are in so much trouble that putting a discount only on Taiwanese stocks does not make much sense. Either China-Taiwan-US relations will thaw, and TSMC will erase its discount, or the US goes to war with China, in which case everything gets a discount. This is awful stuff to talk about, but the logic sort of works. Perhaps some risks are too serious to price into a stock.
Praying for peace, and preparing for it
Unhedged doesn’t often talk about the war in Ukraine. We are a humble markets column and war is way above our paygrade.
But nine months into the war, talk of a Ukraine endgame is growing in the press and, reportedly, among some western officials. The Russian withdrawal from the strategic city of Kherson is probably a factor, as is the first known in-person meeting between Russia’s and America’s top spies.
We’ve no idea what’s going to happen on the ground; maybe no one does. But we do know that a de-escalation of the war, whenever it happens, will matter to markets. Some thinking ahead is due, so we asked around.
Most observers expect the conflict to end in some sort of deal between Russia, Ukraine, the west and possibly other players. It’s impossible to know what such a settlement would entail, and it may take a long time. But markets are forward-looking, and probably won’t wait for official negotiations to begin.
Matt Gertken, chief geopolitical strategist at BCA Research, told us, “As soon as we have a stalemate militarily, I think financial markets will start to sniff out an eventual ceasefire.” Ukraine’s battlefield victories, he says, create tail risks to the global economy: that Russia gets desperate and ups the ante. None of the potential fallout is good for markets, including a fresh energy shock, more sanctions, attacks on infrastructure abroad or nuclear brinkmanship. Removing those downside risks would move markets:
If you can remove those risks . . . either by the Ukrainians running out of steam, or the west convincing Ukraine they need to settle, or potentially Russian withdrawal, though I don’t think that’ll happen . . . global sentiment can start to recover.
The troubling converse, though, is that a string of Ukrainian military successes could pose a big risk to markets, Marko Papic, chief strategist at Clocktower Group, told Unhedged:
[Further Ukrainian wins] would be a problem because it would introduce to markets the reality that Ukrainians are an independent actor that cannot be easily swayed by the west. It adds uncertainty, another independent actor that you have to model.
How far would they go? Would they push to Crimea? . . . And what do the Russians do if they continually illustrate to us that they are terrible at fighting a war? . . .
Now, when you speak to investors they tell you things like, “Oh, the west will rein in Ukraine.” Why do we assume that’s possible? Everything the Ukrainians have shown us suggests they are capable and confident
What assets will be most affected? Grains, energy and metals, all of which surged as Russia invaded in February, come to mind. Simon Quijano-Evans at Gemcorp notes that good news on the Ukraine front could end up pushing on an open door, for example by cutting grain prices just as global supply chains fully normalise.
The US Federal Reserve might welcome a Ukraine-driven commodities slump. It would remove “one of the principal inflationary risks that the Fed must pay attention to”, says Anusar Farooqui of the Policy Tensor newsletter. Every Fed statement since Russia’s invasion has mentioned the war’s stagflationary effects.
Papic takes a different view on commodities. Cut-price Russian oil is still flowing through to international markets via intermediaries such as India, since the west hasn’t applied secondary sanctions, he argues. Thanks to a deal brokered by Turkey, Ukraine’s grain exports have mostly recovered, while Russia’s are surging. Metals, says Papic, are trading on global recession risk and Chinese demand prospects, not outcomes in Ukraine. He thinks impacts on the euro and European industrials are more salient.
Our best guess is that de-escalation in Ukraine would push commodities down some, but that interest rates and global recession risk now exert far more influence on prices. But we say that with a heaping of uncertainty. Let us know what you think. (Ethan Wu)
Google and TCI
The cost base of Alphabet is too high . . . The company has too many employees and cost per employee is too high. Management should publicly disclose an Ebit [operating] margin target, substantially reduce losses in Other Bets and increase share buybacks .
The Ebit margin of the Google Services segment contracted from 39 per cent in 2021 to 32 per cent in Q3  . . . During a period of high growth between 2017 and 2021, revenue increased at an annual rate of 23 per cent, cost discipline was not a priority. However, cost discipline is now required as revenue growth is slowing
Unhedged is sympathetic. We have very recently made very similar points about Meta and about Amazon’s retail business. The biggest tech companies need to prove that their investments are likely to earn an acceptable return. Activist rabble-rousing is good.
What we don’t know — and TCI doesn’t know, either — is how the Big Tech stocks will perform while they make this journey. What is the right valuation for slower-growing, higher-margin Amazon, Meta or Google? Whatever that valuation is, it could be a bumpy road getting there, as the investor bases of the companies shift.
One good read
This seems bad.