Tariffs, Tiffany & Tech -- The Capital Note


Tiffany & Co. jewelry displayed in a store window in Paris, France, November 25, 2019. (Gonzalo Fuentes/Reuters)

Welcome to the Capital Note, a newsletter about finance and economics. On the menu today: the unraveling of LVMH’s Tiffany acquisition, the tech selloff, and the economics of the Olympics.

Tariffs & Tiffany

A U.S. tariff on luxury imports from France seemed like bad news for LVMH, the Paris-based conglomerate helmed by Bernard Arnault. But the new tax — imposed earlier this summer in response to a French tariff on U.S. technology — just offered Arnault a get-out-of-jail-free card.

Last November, LVMH agreed to acquire Tiffany, the U.S. jewelry company, for $16.2 billion. With the pandemic hammering retail, that price tag now looks steep. As of yesterday, shares of Tiffany traded for roughly 10 percent less than the purchase price. Not to worry, the French government kindly requested that LVMH pull out of the deal, citing ongoing trade tensions. “I am sure that you will understand the need to take part in our country’s efforts to defend its national interests,” reads the letter from the Ministry of Europe and Foreign Affairs.

Predictably, LVMH says the letter represents a government order, while Tiffany argues that it is a pretense for renegotiating the acquisition. The truth likely lies somewhere in between. As a sell-side analyst told Bloomberg, it “is ‘convenient,’ but it’s not an ‘excuse you can invent.’”

Whatever the eventual outcome (it will surely be litigated into oblivion), the unraveling of the acquisition highlights the perils of protectionism. Every cross-border transaction — not just those between adversaries — now carries acute political risk. That doesn’t bode well for industries such as luxury retail, where brands see increasing returns to scale.

— D.T.

Nasdaq

I have held off writing about today’s market movements for as long as possible, as under current circumstances the wisdom of (checks watch) 11:41am can be nonsense by noon.

As I write, U.S. markets are up over 2 percent, including the tech-heavy NASDAQ (and Tesla is up nearly 6 percent), but as to whether we have seen the bottom of the selloff, who knows?

Over at Bloomberg, John Authers looks at a chart comparing the most popular exchange-traded funds tracking large-cap U.S. stocks and long-dated U.S. Treasurys. “Stocks have rallied greatly compared to bonds since March, but did not,” Authers observes “threaten the all-time high they registered in October 2018.”

That is not uninteresting given how the long-term outlook for bond investors has deteriorated in recent months.

After all, Fed Chairman Powell is saying that the interest-rate outlook is not going to change any time soon.

Speaking on Friday (via CNBC):

Interest rates are likely to stay low for years as the economy fights its way back from the coronavirus pandemic, Federal Reserve Chairman Jerome Powell said in remarks published Friday afternoon.

“We think that the economy’s going to need low interest rates, which support economic activity, for an extended period of time,” Powell told NPR in an interview after the nonfarm payrolls report was released earlier in the day. “It will be measured in years.”

“However long it takes, we’re going to be there. We’re not going to prematurely withdraw the support that we think the economy needs,” he added.

The statement aligns with comments from Powell and other Fed officials over the past week or so.

And it leaves investors with the continuing problem of where to put their money if they are to have any hope of a return. Financial repression (which is one way of looking at what is going on) is like that.

Back to Authers:

If we divide up the global stock market a little more, we see that the phenomenal recovery of the S&P 500 in the last six months is almost entirely an artifact of the great performance of the so-called FANG stocks. The NYSE Fang+ index, for all that internet platform companies are supposed to benefit from Covid-related shutdowns, is plainly in need of a correction. Meanwhile, the rest of the world has performed almost exactly in line with the S&P 500 excluding tech stocks — and both are yet to get back to where they started the year. These indexes aren’t in need of a correction, and haven’t been corrected.

Looking at other underlying trends during the Covid recovery, perhaps the most important has been that growth stocks have consistently beaten value stocks. This should be no surprise as growth is perceived to be in short supply, and so investors will pay a premium for those companies that can demonstrate it (most notably the FANGs). Looking at the Russell value and growth indexes drawn from the top 1,000 stocks in the U.S., we see a number of false dawns for value over the last year, while growth has continued to triumph. Growth has underperformed value over the last few days, but not by enough to correct anything.

Others have focused on the big bet on tech by Japan’s Softbank.

From the Financial Times (September 6):

SoftBank is sitting on trading gains of about $4bn after founder Masayoshi Son drove aggressive bets on equity derivatives that helped propel the US stock market to record highs, said people with direct knowledge of the matter.

The high-risk strategy has been built up over the past few months, these people said, with the Japanese conglomerate spending about $4bn on options premiums focused on tech stocks over that time.

Would that have been enough to drive the latest leg of the tech surge? I’m not convinced, but I did enjoy this quote (via Bloomberg):

“Son (Softbank’s CEO) is a speculator — not this visionary everyone claims he is,” said Amir Anvarzadeh, a market strategist at Asymmetric Advisors in Singapore who has been covering SoftBank since it went public in 1994. “This is yet another proof of that, as he is never too far from the action when a bubble is formed.”

Back at home, meanwhile, I keep worrying about what the election might bring (chaos seems a reasonable bet) and, for that matter, what a Biden win might mean. I cannot imagine that his plans to increase corporate taxes would be greeted with much enthusiasm by the market. Nor would his proposals to tax capital gains at ordinary income-tax rates for those earning more than a $1 million, a notion already familiar (but without the $1 million buffer) to taxpayers in New York State and New York City, which takes another slice too (again treating capital gains as ordinary income).

Anyone who believes that the push to remove the divide between income and capital gains will stop (for long) at those earning $1 million is very trusting indeed.

As The Wall Street Journal notes, Biden is also proposing this additional twist of the knife:

Currently, someone who dies with appreciated assets isn’t liable for income taxes on the difference between what they originally cost and what they were worth at death. Instead, heirs only pay taxes on gains that occur after the original owner’s death and only then if they sell the assets.

Under Mr. Biden’s proposal, capital-gains taxes would apply at death as if the asset were sold. This is separate from estate taxation.

Consider someone who bought stock for $1 million in 2010 and dies in 2021, when the stock is worth $3 million. Under current law, that person would owe no capital-gains taxes on a final income-tax return, and heirs would only owe taxes on gains above the $3 million value after they were to sell the assets. Under Mr. Biden’s plan, the $2 million gain would be treated as income when the person dies, triggering a nearly $800,000 tax bill even if there were no sale.

That plan reduces the incentive for people to hold assets to wait for that zero tax rate. If investors know they will have to pay a 39.6% tax now or when they die, there is less of a reason to wait.

Not, I would think, a market positive.

— A.S.

Around the Web

The problems caused by ultra-low interest rates just keep piling up:

A $750 billion industry still struggling to bounce back from the last crisis is cracking under the Federal Reserve’s lower-for-longer mantra on U.S. interest rates.

Prime money-market funds — a long-time favorite for anyone seeking a cash-like investment with a little extra yield — are facing an existential challenge, just four years after a regulatory overhaul to restore confidence in the wake of the global financial crisis. Assets in these vehicles dropped 20% in just six weeks earlier this year, spurring talk of new reforms. But some of the industry’s leaders are opting for another solution: Shutting them down.

The combination of the pandemic, the longer-term switch away from brick and mortar, and, of course, a lockdown in New York City run by politicians with no serious understanding of the basics of risk/reward are having their effect.

The Great Blighted Way:

More than 300 storefronts along Broadway are vacant, a 78% increase from three years ago, a recent survey found, as the coronavirus pandemic puts added pressure on bricks-and-mortar businesses.

Manhattan Borough President Gale Brewer and her staff counted 335 street-level vacancies in late August, when they inventoried storefronts along the avenue that spans about 13 miles and 244 blocks between the Financial District and Inwood neighborhoods. A similar survey in 2017 found 188 vacancies.

“The rent is so high, particularly on Broadway in Manhattan, that it’s hard for the small shops to make a go of it,” Ms. Brewer said. “At this point, with the gates down and sometimes plywood on the storefront, you don’t know whether it’s going to be rented.”

Rents can go down, of course, but who, for now, is going to have the confidence to take out a new lease? Not too many, I suspect.

But, in a hint of better news for Gotham:

Two of the world’s top private equity firms have introduced coronavirus testing for staff and are paying for taxis to the office, as employees return to their desks after months of remote working.

The measures come as governments push for workers to return to offices to boost struggling city centre businesses and highlight the challenges new ways of working present to an industry that relies on relationships and face-to-face contact.

Industry leader Blackstone, with $564bn under management, has said it will pay for employees worldwide to commute by taxi.

It also requires staff to test negative for Covid-19 before returning to its New York headquarters. Testing will be voluntary at its smaller London office but all employees must register on an app that they have no symptoms before any return.

Advent International, the US-based firm that last year raised a $17.5bn fund, is providing home testing kits for UK staff every fortnight and has told them they will not be allowed into the London offices unless they have tested negative for Covid-19 within the past two weeks. They must also have avoided public transport during that time.

Random Walk

There are many reasons to dislike the Olympics — a pompous authoritarian spectacle that has metastasized far beyond its origins — but the cost they entail for their host cities and countries is high on the list (my emphasis added):

The IOC and organisers of the Tokyo 2020 games are wrestling with the logistics of holding a postponed Olympics, which the Oxford researchers calculate are already the most expensive summer games ever.

The Tokyo bid originally foresaw a $7.3bn price tag for the games, but Japan’s national auditor, which has highlighted how the government has folded certain costs into non-Olympic budgets, has said the final cost may be more than three times greater…

According to the researchers, the cost overrun for the Rio summer Olympics in 2016 was 352 per cent, while for London 2012 it was 76 per cent. The average cost overrun for both summer and winter games since 1960, they calculated, was 172 per cent…

To explain Olympic cost blowouts, the researchers said overruns did not, over time, undergo a “regression to the mean” — the statistical phenomenon that looks at the impact of repeat events on outcomes.

Instead, they experience a “regression to the tail”, with overruns for individual games so variable that possible outcomes for host nations stretch into infinity. “Deep disasters such as earthquakes, tsunamis, pandemics, and wars tend to follow this type of distribution,” said the authors.

“Such events are not just the unfortunate, happenstance incidents they appear to be, that are regrettable but will hopefully be avoided in the future, with more awareness and better luck. Instead, Olympic cost blowouts are systematic, ruled by a power law that will strike again and again, with more and more disastrous results.”

The IOC response is predictably feeble, some blather about the games’ “legacy,” which is often little more than some housing, underused sporting facilities or, in some cases, stadia that are rotting away.

And then there were the Athens Olympics of 2004, which made some sort of contribution to Greece’s spectacular collapse just a few years later.

CNBC (from 2010):

While many factors are behind the crippling debt crisis, the 2004 Summer Olympics in Athens has drawn particular attention. If not the sole reason for this nation’s financial mess, some point to the games as at least an illustration of what’s gone wrong in Greece. Their argument starts with more than a dozen Olympic venues — now vacant, fenced off and patrolled by private security guards.

Stella Alfieri, an outspoken anti-Games campaigner, says they marked the start of Greece’s irresponsible spending binge.

“I feel vindicated, but it’s tragic for the country …They exploited feelings of pride in the Greek people, and people profited from that,” said Alfieri, a former member of parliament from a small left-wing party. “Money was totally squandered in a thoughtless way.”

The 2004 Athens Olympics cost nearly $11 billion by current exchange rates, double the initial budget. And that figure that does not include major infrastructure projects rushed to completion at inflated costs. In the months before the games, construction crews worked around the clock, using floodlights to keep the work going at night. In addition, the tab for security alone was more than $1.2 billion.

Six years later, more than half of Athens’ Olympic sites are barely used or empty.

Some legacy.

Los Angeles is set to host the Olympics in 2028. Why?

— A.S.

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