12 February 2018

Bad Vibrations

The recent fibrillations of Mr. Market have been the grist for countless pundits. Rather than attempt to precis all of them, I'll just note this one from Jeff Sommer
"What we have seen in the last week or two is minuscule compared with the amount of real risk that is coming in the months and years ahead," said Salil Mehta, an independent statistician with deep experience in troubled markets and their consequences. He was the director of research and analytics for the federal Pension Benefit Guaranty Corporation and for the Treasury's Troubled Asset Relief Program, which was set up to help stabilize the financial system in the 2008 crisis.

Is that a grand oops? Perhaps so. What Mr. Sommer, and his correspondents, miss (and such media pundits do so frequently) is that Mr. Market can only go on a Jabba The Hut binge if he's fed lots of moolah, increasingly. Where does the moolah come from? As well, so far as stocks are concerned, it's the opportunity cost (and imputed risk aversion) of Treasuries. But opportunity cost is a two-say street. Many/most pundits take as an article of faith that "government borrowing steals from private investment". That's never been true, of course. There are, fundamentally, three things to be done with idle moolah. You can stuff your mattress. You can buy Treasuries. You can buy corporate instruments. From left to right, increasing (universally assumed) risk. If you want to make more moolah, you go corporate. If you want safety, you go gummint. And so it went after the Great Recession. Why? If you read up the recent piece on Fab 8, you can see that returns on corporate instruments is limited by science/engineering progress. Ever more Bongo Bucks to spit out chips. The only way that can generate financial returns is if there's an expanding market for those chips. Remember that the 300mm wafer was dead meat more than a decade ago? Still around.
If the foundry can keep its wafers-per-hour production rate on 450mm wafers close to its 300mm wafer production rate, it can produce vastly more chips per hour. This helps reduce costs, provided that the semiconductor economy is healthy and the foundry utilization rate is high.

Hasn't happened. So, Treasuries and private physical investment are competitors, but the former is driven by psychology (mostly) while the the latter is driven by physics (mostly). The added risk, as the Extreme Tech piece tells us, is that cheaper unit fixed cost leads to capital returns if, and only if, output can be sold at high enough price. As we've seen in the Treasuries market, all that moolah chasing a, more or less, fixed supply drove up prices; and down imputed return. Now that more and more corporates find themselves in the tech cul-de-sac of the asymptote of progress, returns there still have risk, but lower intrinsic return. Unless, naturally, floor sweeping wage earners do earn enough to want and pay for the iPhone X. Good luck with that.

And, by the way, here's another quote from the Fab 8 story:
Growing up is realizing that fabs are sophisticated sinkholes of ever-increasing capital expenditure in the eternal quest to outsmart physics, so much so that where there used to be dozens of foundries and IDMs jostling at the cutting edge, there are now just four: TSMC, Intel, Samsung, and GlobalFoundries. Of them, only TSMC and GlobalFoundries are pure-play foundries, only taking orders from fabless chip designers rather than fabbing their own designs.

Don't screw with Mother Nature.

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