FOLLOW THE MONEY 10/15/26
In today’s “macro-world”, gone are the days when you could manage your business on a local level, relatively unconcerned with national and international parameters such as money supply or hyper-scaler capex and their possible long-term effect on productivity. The Fed’s 2% target, strongly touted by Ben Barnanke 15 years ago, which would have raised today’s price level by 33%, has been cosistently exceeded. The modestly higher 2.8% average CPI increase has raised price by an eye-catching 49%. The accompanying 33% reduction in purchasing power is disturbing and the loss of purchasing power is even higher, since the published CPI index is likely understating health care, education, housing, etc.
The debt of $40 trillion, and its $1 trillion plus annual interest cost is an obvious concern to both political parties but they continue to defer the necessary fiscal discipline. The Trump administration, falsely describing today’s economy as robust (and more) plans to grow out of the problem, with expanding productivity hopefully driven by AI Capex, thereby expanding GDP at a rate fast enough to dilute the debt burden. History has shown, however, that a Central Bank driven loose money policy has not produced improving productivity. To the contrary, central bank intervention, including the suppression of interest rates, has proven to be the fuel behind inflation of goods and services as well as the pricing of financial assets, in turn leading to economic distortions and misallocated resources. Historical numbers provided by David Stockman, Budget Director under Ronald Reagan, indicate that private sector productivity rose at 1.93% annually from the early 1950s to the early 1970s, without Central Bank intervention. From 1971, when inflation took off after Richard Nixon closed the gold window, until 1995, private productivity rose at just 0.65% annually. From 1995 to 2018, through the Greenspan, Bernanke & Yellen years, with massive money printing, zero percent interest rates, and the capex spending boom of the dotcom bubble, productivity grew at all of 0.98%.
The reality depicted above leads to a conclusion that future growth in productivity, even as a result of the trillion dollar plus AI capex boom will come nowhere close to bailing the US (and the world) out of the current debt crisis. It is too soon to know how effective new Fed Chairman, Kevin Warsh, will be. but highly credentialed Treasury Secretary, Scott Bessent, has done nothing so far, to build confidence. We described last month, correctly so far, our skepticism that his actions would help the Japanese Yen or lower long term interest rates. More important over time is the very low probability that his “3+3+3 in ‘28” mantra will come through. 3% growth is unlikely, especially if we deduct the current inclusion In “growth” from the AI capex boom. Also unlikely is the Debt to GDP ratio, now running about 5.8%, coming down to 3%, especially with the certainty of higher interest and defense spending. Perhaps most unlikely is the projected 3-million-barrel increase in domestic oil production, currently running only 13.8M bbl/day, barely up from 13.5M. Putting it all together, there is no magic bullet, including AI productivity, that will solve the problems that have been decades in the making and are too large at this point to cure without pain. This column is attempting to help minimize the predictable discomfort.
Warren Buffet famously suggested that “when the tide goes out, we see who is swimming naked”, and it seems to us that this is the fundamental case within restaurant land. Stock prices are down substantially and operating performance has varied widely, through Covid and beyond. Within the 60 or so restaurant/franchising companies that we follow closely. balance sheets have diverged, corporate priorities have been adjusted, and valuations reflect the differences. The best stocks have shown improving fundamentals supported by low levels of balance sheet indebtedness. Within that context, the following discussion deals with the allocation of balance sheet resources within our coverage universe. In particular, the wide use of stock buybacks, popularly described as “returning cash to shareholders” has too often been detrimental. Our website will provide. more fully than space here allows, how companies have too often paid up to 40 times trailing EBITDA to buy back stock. Investors generally encourage stock buybacks, but paying 40x trailing EBTDA, for example, amounts to only a 2.5% immediate cash on cash return on capital which could also have been used to build stores, pay dividends, make acquisitions, etc., Why then did Wingstop, spend $662M over four years, at 35-40x EBITDA at the time, building debt to almost 5x current EBITDA? Why did the Directors of Jack in the Box, Papa John’s and Dine Brands build debt to buy stock, while fundamentals and stock price deteriorated? “Returning cash to shareholders” is equally misleading as “non-cash compensation”. If cash buys back the stock that is then used to fund the “non-cash” options, then the option expense is very much a cash expense. More on this subject in future articles, but this seems like a good time to suggest that management of publicly owned companies (and their Boards) report more realistically to their owners.
Roger Lipton
