How many lattes is a CEO worth?

Good morning. Yesterday, Home Depot cut its sales guidance, blaming a cautious consumer. The company’s shares – to Unhedged’s surprise – still ended the day. Whatever fear was in the market last week seems to be gone. Let’s hope this morning’s inflation report doesn’t bring it back. Email us: [email protected] and [email protected].

Today at noon UK time and 7am ET, Rob will join FT experts from New York, London and Tokyo for an event for FT subscribers on the recent spike in market volatility. It will be fun! Sign up to ft.com/marketswebinar.

The new boss of Starbucks

After replacing its CEO Laxman Narasimhan with Chipotle CEO Brian Niccol, Starbucks gained $21 billion in market capitalization (up 24%) and Chipotle lost $5.7 billion, all in one day. Can replacing one human with another create so much value?

By our rough calculations, this is the amount of additional value of Starbucks selling an additional billion venti lattes per year in perpetuity (which assumes $6 per venti at a net margin of 15% and a P/E multiple of 21, for those who are following home).

We are skeptical. Unhedged has tended to adopt the view of executives since Warren Buffett: good management is important, but the quality of the business is far more important (“When a management with a reputation for brilliance approaches a business with a reputation for bad economics, it is the reputation business that remains intact.”).

There are examples of transformational leadership changes — Microsoft replaced Steve Ballmer with Satya Nadella, or Apple replaced Gil Amelio with Steve Jobs. And Niccol has had real success at Chipotle since taking the helm in 2018. This from Jeffrey Sonnenfeld of the Yale School of Management:

Morale (at Chipotle) ​​was low, communications were terrible, there was basically a loss of confidence in public health officials (before he came in). Almost every constituency had lost faith in the founding leadership. . . He faced a similar food safety issue as Taco Bell’s CEO and was able to gain trust and greatly improve communications, branding and expansion. The stock is up about 40% in the first year it’s been there.

However, the problems at Starbucks today are drastically different from those at Chipotle a few years ago. This is not a public health crisis. Starbucks just doesn’t meet the moment. It is caught up in Middle Eastern boycotts. And in China – its second largest market – it has taken a beating from local competitors and a shrinking Chinese consumer. Starbucks is also eliminating unionization and working to reduce long customer wait times. In the US, the brand seems to have simply lost its luster, perhaps because its success has made it so ubiquitous.

The two businesses are also at radically different points in their life cycles. Starbucks is an international giant: almost 40,000 stores in 85 countries. In Q2, Chipotle has about 3,500 stores — the size of Starbucks in 2004.

Chipotle and Starbucks may also be on different sides of a consumer trend I mentioned recently. Fast-food chains like McDonald’s have struggled, but the more expensive “fast casual” Chipotle has done well. It turns out that poorer Americans are eating at home, while wealthier consumers are trading up to relatively upscale but still affordable brands like Chipotle. Is Starbucks also stuck in the middle — with discriminating consumers going to hipster coffee shops while laid-back consumers brew coffee at home?

And Niccol will not only fight with a demanding consumer. Howard Schultz, the former CEO, was instrumental in ousting Narasimhan. Schultz retains board observer rights and is the company’s largest independent shareholder, and has feuded with nearly all of his successors. Narasimhan was in the role for only a year and a half. How many lattes would Schultz be worth if he retired properly?

(Reiter and Armstrong)

Is everything a carry trade now?

Much of the attention, here and elsewhere, during the recent mini-crash in the market has been on yen trading. Investors who borrow cheaply in yen and invest in higher-yielding currencies are vulnerable to unexpected changes in the value of the yen, the investment currency, or the investment itself. And when changes occur, carry traders need to get out quickly because the financing side of the trade comes with risk limits.

But what if the focus should be on more than trading the yen? What if the entire market has this structure? Kevin Coldiron, a former quant fund manager who now teaches at the University of California, thinks so. He co-authored a book saying this and recently applied his ideas to the mini-accident on his substack.

Coldiron argues that carry trades have several important characteristics. They provide liquidity, that is, they move money from places where it is plentiful to places where it is scarce. They are always bets that the world remains unchanged, or that rates and other prices remain within their usual limits; in other words, they are short volatility. And when there is a sudden spike in volatility, carry traders have no choice but to sell to raise cash, which can create more volatility and more selling and ultimately a crash.

All true. The controversial part of Coldiron’s thesis is that the S&P 500 has become a huge global carrier. The S&P is the most heavily traded global risk asset, and a huge ecosystem of derivatives and other leveraged trading instruments has developed around it: index futures, zero-day options, Vix options, exchange-traded funds lever and so on. The S&P risk ecosystem is so intertwined with other risk assets that “the volatility of the S&P 500 is . . . a proxy for the volatility of risk assets everywhere”.

Unexpected moves in the index itself can cause fire sales in the derivatives ecosystem, and those fire sales can move the index in turn, either through hedging or the simple need to raise cash. Any risk assets held in S&P exposed portfolios (ie almost all portfolios) could start to move as well. It’s all a carry trade because everyone is short S&P volatility.

(Yes, every trade has two sides, so everyone has long volatility too. But it’s the short volatility side of the trade that has the risk limits, so that’s the part that blows things up.)

One objection is that markets have always been vulnerable to leveraged speculation and have always been defined by steady trends, interrupted by bouts of acute volatility. Coldiron’s answer is that it is a matter of degree. He argued that things got much worse in 1998, when the Federal Reserve staged an industry bailout for Long-Term Capital Management (a fund that Coldiron describes as running a huge book of short-volatility trades). Once it was clear that the Fed would act to prevent the explosion of volatility trades, their popularity soared. And the central bank continues to suppress volatility, most recently with its corporate bond protection aid in 2020.

Another objection: The S&P 500 hasn’t been this volatile, really, since 2008. The last crash petered out in a week, leaving little apparent damage. If the market is a giant carry exchange, where is the giant crash?

A good read

Color war captains and summer camp prestige.

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