State Of The States

Uncle Sam manages his money worse than Michael Scott manages his branch. But, thankfully, his nieces and nephews do a much better job. Find out why states are raking it in and why we should consider reallocating responsibility to the more local level.

October 10, 2024

Silver banana goes to…

In this issue of the peel:

  • Jerome Powell is the Chairman of the Board of the Fed, but yesterday, we were the Chairman of the Bored after reading through the newly released Fed Minutes. We didn’t learn much, but it’s crucial to dive into the inner workings of the Fed’s decisions. Find out what’s behind them below.

  • More nerd companies that make me angry because I don’t understand them are popping off, largely thanks to Nvidia. Meanwhile, your grandparents are giving your inheritance to Norwegian Cruise Lines. Plus, Monsanto is still causing problems for Bayer, and the DOJ wants to break up Google. 

  • Uncle Sam manages his money worse than Michael Scott manages his branch. But, thankfully, his nieces and nephews do a much better job. Find out why states are raking it in and why we should consider reallocating responsibility to the more local level.

Market Snapshot

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Macro Monkey Says

We’re Gonna Need A Minute

Important decisions deserve scrutiny.

Whether it’s considering where to go to college, what to major in, or if you should get a keg of Busch or Natty this weekend, crucial calls like this can determine the fate of your life, society, and even that party you’re throwing.

That’s why it’s important to look this stuff over, even if the decision is something as trivial and insignificant as the direction of the U.S. economy.

Obviously, that’s no Busch vs. Natty debate, but I guess we can look this over too. Let’s get into it.

What Happened?

Yesterday, our economic overlords released the latest Fed Minutes from the Eccles Building in our beautifully gentrified capital city of Washington, D.C.

The purpose of the Fed Minutes is to dive deep into the sick, twisted minds of Federal Reserve officials—our economic overlords—and find out the reasoning behind monetary policy decisions.

As a reminder, the above image shows the path of interest rates since that damn virus showed up back in early 2020.

After a decade of ZIRP, a 3-year attempt to raise rates off the floor from 2016 to 2019, throwing them right back to zero, then launching the fastest rate hiking cycle in history, leading to a 50bp cut last month, interest rates have been volatile, to say the least.

Now, the question going forward centers on how much—if any—loosening of monetary policy is needed to maintain the Goldilocks zone our economy is in without retriggering the beast of inflation.

In September, that was an easy question for FOMC participants, the policy-setting arm of the Fed, to make. They knew they were cutting rates, but there was a big dispute over how much.

According to the Minutes, slightly less than half of the FOMC’s 19 members began the conversation looking for a 25bp cut due to concerns over the implied signal that the Fed would send to markets by starting with a “jumbo” rate cut.

But, in the end, only one FOMC member—Michelle Bowman, a Fed Governor—voted against the 50bp cut in favor of a 25bp cut. 

Given that activity in the housing market has been slower than using Excel with a mouse, unemployment’s slow rise since January 2023, weakness in manufacturing, and a few other restrictive factors, it was predetermined that a cut was coming in September.

The only decision to make was how much. Here, the question came down to “Which risk has a higher probability of causing near-term problems to the U.S. economy: inflation going higher again or the unemployment rate continuing to rise?”

Bowman thought her fellow overlords were getting too cocky on the battle against inflation, believing that retriggering rapid price growth was the bigger issue. By the end of the discussion, everyone else saw unemployment as the greater threat.

The other factor to consider was the signal a 50bp cut sends. 

Usually, the Fed only rips a 50bp “jumbo” cut if they think we’re heading into a recession, so there was concern over how markets would react if they thought the Fed thought that the U.S. was heading for a recession. You still with me?

Anyway, the Fed sought to diminish these fears in Fed Chair JPow’s post-meeting press conference, where he pinky-promised the decision was made because of how down bad inflation has become.

However, there are other ways to loosen policy besides just cutting rates.

The Fed’s balance sheet effectively serves as a liquidity management tool that helps implement interest rate policy and manage liquidity.

When the Fed buys assets, increasing its balance sheet, it’s adding liquidity primarily to Treasury and mortgage-backed securities markets, thus loosening policy and spurring activity in these asset classes.

Right now, the Fed is neither buying nor selling assets but letting existing assets mature without replacing them. This is called a “balance sheet runoff.”

When the Fed lets assets runoff, it’s neither increasing nor decreasing liquidity. The goal is to “normalize” the size of the Fed’s balance sheet in the aftermath of a plethora of quantitative easing in the wake of the GFC and pandemic.

If they wanted to, the Fed could ever-so-slightly loosen policy by stopping the runoff and buying assets to replace maturing securities. 

But, JPow and the FOMC gang (besides Michelle Bowman) think they can simultaneously cut rates and reduce the size of the balance sheet without f*cking things up to use the technical term. Fingers crossed, they’re right.

The Takeaway?

We really don’t learn much new information from the Fed minutes, but it does help us understand why the Fed makes its decisions.

Markets barely reacted to the release for exactly that reason.

Now, all eyes are on earnings szn beginning today, next week’s CPI print, the next PCE release on Halloween, the October jobs report, and how these could factor into the Fed’s next decision on November 7th.

Career Corner

Question

Hi mentors, I saw this interview question online and was wondering how you would go about answering it. "Which valuation method is the best?" Thank you!

Answer

Go through the pros and cons of each (briefly, or stick to the one most relevant) and then use that to explain why you think the pros of X make it the best in Y situation (or overall, depending on the exact interview prompt)

Head Mentor, WSO Academy

What's Ripe

Astera Labs (ALAB) 15.60%

  • The bull market in meat riding continues as an announcement from Astera Labs sent shares booming thanks to their close friendship with AI kingmaker Nvidia.

  • This nerd company making products I don’t understand announced new products I still don’t understand, including a portfolio of new fabric switches, which help manage AI data flow for computing systems.

  • Nvidia’s SVP of GPU Engineering said the new switches “support NVIDIA accelerated AI infrastructure deployments across a wide variety of AI and HPC workloads.”

Norwegian Cruise Line Holdings (NCLH) 10.91%

  • Anyone waiting on an inheritance from their grandparents is gonna have to put that to bed. They’re spending it all on cruises, and Norwegian is loving it.

  • Shares ripped on Wednesday after a slew of upgrades for the cruise line driven by a bullish sentiment on the company’s strategic shift and expansion plans.

  • Norweigan will add 13 ships to its fleet by 2036, offer dynamic pricing options, and whatever the hell “open jaw itineraries” are. Citi sees almost 50% upside with a $30/sh price target.

What's Rotten

Bayer AG (BAYRY) 6.89%

  • I’m no consultant, but I’m pretty sure that not giving your customers cancer is usually ideal. Hang on, let me pay McKinsey $5mn so we can figure it out.

  • While we wait for our answer, Bayer is headed back to the courtroom after a Washington judge said they’d review yet another case against Bayer’s Monsanto unit.

  • Bayer bought Monsanto in 2018, apparently unaware they were the Harvey Weinstein of agricultural firms. It’s been embroiled in nonstop legal battles since.

Alphabet (GOOG) 1.59%

  • Given that I’m typing this on a Google Doc and using Google Search for research so most of you can read this in your Google inbox, I can’t imagine why the DOJ would call Google a monopoly!

  • But they did. And a federal court agreed, leading the DOJ to announce they’re actively considering a breakup of Alphabet as a remedy for antitrust violations.

  • This will get dragged out for years in appeals courts, but it could be the first time a government-mandated breakup has been issued in the U.S. since AT&T in 1982.

  • The other L Alphabet took was a loss in their lawsuit against Epic Games, requiring Android to allow other app stores to compete with the Play Store.

Thought Banana

State Of The States

We know that Uncle Sam has a tough time managing his money.

This guy has nearly $36tn in debt and adds somewhere between $1-$2tn to that pile in any given year. In fact, he just added another $1.8tn at the end of fiscal year 2024.

But, his nieces and nephews—for the most part—are doing a helluva lot better. Let’s dive in.

What’s Happening?

While the federal government spends money like a recently divorced single dad having a mid-life crisis, states are much more responsible.

The vast majority of states run budget surpluses, meaning they collect more revenue than they spend on services, as I’m sure that’s a foreign concept to most Americans.

And in FY’2022, the number of states running a budget deficit hit a record low.

As we can see, the average state runs a budget surplus of 103.6%. Only 6 states—Connecticut, Hawaii, Illinois, Massachusetts, New Jersey, and New York—ran deficits throughout the 15-year period studied. Only two ran deficits in FY’2022.

Meanwhile, Utah is out here flexing a 136% budget surplus, the highest in the nation. Kentucky, Florida, Texas, New Mexico, and Montana follow closely behind, with Montana as the only state to never run a deficit through the 15-year period.

There are a few big factors at play. States with high GDPs, low but growing populations, and low pension liabilities tend to manage their finances better than Mr. Montgomery in The Simpsons.

Then, there are others. For example, California manages its finances worse than its average Instagram-flexing resident, running a $97.5bn surplus in 2022 but carrying a $275bn unfunded pension liability, both the largest in the nation.

Other factors that help states manage their budgets include:

  • High Access to Natural Resources (Texas, Montana)

  • Low/No Income Tax (Florida, Alaska)

  • High-Quality Infrastructure (Utah, Georgia)

  • Diversified Economies (Washington, North Carolina)

  • High Foreign Direct Investment (South Carolina, Delaware)

  • Balanced Budget Constitutional Requirements (Wyoming, West Virginia) 

The Takeaway?

Uncle Sam could learn a lot from these states.

If we want to help him out, legislatures at the state and federal levels consider ways to potentially change the way some social benefits are provided. 

For example, if states were responsible for their own public healthcare, we could save Uncle Sam $1.6tn in Medicaid/Medicare expenses in 2024, closing the deficit by nearly 90%.

Obviously, it wouldn’t be that easy, but the question of scale is crucial when it comes to social services. 

At the state level, there tends to be a higher degree of trust, while services could be tailored and made easier to understand without having to address all 340mn of us at once.

Like Nassim Taleb said, “With my family, I’m a communist. With my close friends, I’m a socialist. At the state level of politics, I’m a Democrat. At higher levels, I’m a Republican, and at the federal levels, I’m a Libertarian.”

Maybe it’s time to clear up Uncle Sam’s plate and let states and municipalities eat a little more.

The Big Question: What other steps could the U.S. take to ease the financial burden at the federal level?

Banana Brain Teaser

Previous

List S consists of the positive integers that are multiples of 9 and are less than 100. What is the median of the integers in S?

Answer: 54

Today

There are 5 sales agents in a certain real estate office. One month, Andy sold twice as many properties as Ellen, Bob sold 3 more than Ellen, Cary sold twice as many as Bob, and Dora sold as many as Bob and Ellen together. Who sold the most properties that month?

Send your guesses to [email protected]

❝

Blessed are the young, for they shall inherit the national debt.

Herbert Hoover

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Happy Investing,
David, Vyom, Ankit & Patrick