What is greed anyway?

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Is greed real?

Yesterday’s letter claimed that since the pandemic, price increases above general inflation have contributed significantly to large profit increases at some of the biggest food suppliers. Some readers (though certainly not all) saw this as proof that greed is real and bad.

The story is a bit complicated, though. Yesterday’s (tentative) conclusions were drawn by looking at historical revenue and profit data at a small set of very large food retailers and manufacturers. I have (unscientifically) attributed the very strong increases in income growth post-pandemic, relative to the pre-pandemic period, to price increases – because that is the obvious explanation.

But it is actually possible to look directly at the price increases because some companies disclose them. One company that does is Mondelez, which makes Oreos and various other cookies and crackers. And of the eight very large food suppliers we looked at yesterday, Mondelez saw the biggest increase in revenue growth after the pandemic.

Here are the volume and price/product mix contributions to Mondelez’s revenue growth since 2016:

You can see unit sales spiked in the lockdown year of 2020 when we were all indoors snacking on Oreos and playing Xbox. Since then, volumes are flat down. But in 2022 and 2023, prices increased by 11.5% and 9.5% respectively. That seems like a lot!

It needs context, though. First, Mondelez was not alone, at least in 2022. CPI inflation for home food was 11.5% in 2022 and 5% in 2023.

And those price increases should be seen alongside Mondelez’s spending. Here is a chart of total revenue and costs (cost of goods sold plus selling, general and administrative). These are global results and not just the US, but the pattern of high prices and low volumes is generally the same across Mondelez’s other regions:

Costs have risen with (price driven) revenues. While Mondelez’s operating margins have expanded, it hasn’t been by much or very consistently. They were 15.8% in 2019, peaked at 17.4% in 2021 and were 16.6% last year. The main driver of high profits – at Mondelez and most other food companies – was not higher profit margins, but higher revenues at similar margins. In this sense, it is true that Mondelez and other food companies have only “passed on” the increases in input costs.

But maybe food companies have an obligation to keep prices low, therefore compressing their profit margins, in times of inflation? Failure to do so is raising prices? It seems wrong. At the same time, however, Mondelez’s profits are growing faster — and faster than inflation — since the pandemic, and it’s clear that the main driver of this is higher prices. Is it the difference between ordinary corporate behavior and profit growth?

Here the questions become philosophical rather than financial. Rather than engage in these debates today, I would just note that the market has not concluded that Mondelez and other branded food companies have become permanently more profitable as a result of post-pandemic inflation. If they had, their performance would have been better than this over the past five years:

War and markets

Unhedged believes that geopolitics almost always matter less to markets than most people expect. Elections, wars and pandemics are often important, but usually less important than forecasters think. And in any case, the market effects of geopolitical turbulence are very difficult to predict. There is very little, if any, geopolitical alpha to be had.

One way to test this thesis is to consider a stock market that is more or less always in the middle of intense geopolitical currents.

Enter Israel. Its stock market is larger, in terms of market capitalization, than those of the larger Turkish economy and the similarly sized economy of the United Arab Emirates. The Tel Aviv 125 index is concentrated in infotech (22 percent), banking (21 percent), energy (14 percent) and real estate (14 percent).

Shares are mostly held by national institutions such as pension funds and banks. Foreign investors such as Vanguard and Fidelity hold Israeli stocks in their extensive developed market funds and portfolios, but the foreign investor universe is otherwise small. Retail investors are not major players because Israelis are often heavily invested in fixed income. From Amir Leybovitch of Sigma Clarity:

The savings rate in Israel is very high. There is a mandatory amount of retirement savings automatically taken out of every Israeli’s salary that goes to institutional investors. Institutional investors receive a very large cash flow each month that they have to invest and buy almost any fixed income (product) available in the market.

When looking at the performance of the TA-125 in past wars, a trend emerges. At the start of war, there is often a dip as the market prepares for what could be a long conflict, followed by a quick recovery. Here is the index during the 2006 war with Lebanon:

There were two declines during the last major Israel-Hamas conflict in 2014, one just as it began, and one more prolonged as the conflict continued. In both cases, a rebound followed (although the index fell again in the post-war months):

These cases pretty well confirm the Unhedged bias: markets, again, are proving to be quite resilient in the face of political strife. And the pattern repeated itself after the October 7 attacks and the start of the current Israel-Hamas war:

This market shift was deeper and its recovery slower than past conflicts. This could be due to the severity of the initial attacks or investors who predicted that a protracted war would follow – a prediction that would have proved correct. The long-term outlook for the conflict is completely opaque. However, the market has held up surprisingly well so far.

But this resistance is probably due to wartime economic changes and the structure of the stock market, not to the prospects of the war itself. The biggest companies in TA-125, including Teva Pharmaceuticals and technology company Nice Ltd, get almost all of their demand from overseas. Israeli domestic consumers, who often do their discretionary spending abroad, spend more at home. And interest rates are high while the economy is hot – ideal for the banks that make up a fifth of the index.

The bond market had a bigger impact. The increase in military spending was not sufficiently compensated in the domestic budget, which led several rating agencies to downgrade Israel’s debt. Credit default swap yields and prices rose.

War is cruel and unpredictable. The war on the ground is being waged in Gaza, where the economic and societal impacts are far worse than those experienced in Israel today. If the war were to spread to Israel, it could crush the Israeli economy and shut down the stock market. Even if the war drags on in anything like its current form, Israeli consumers can cut back on spending. The increasingly contentious political and fiscal situation could cause a proper crisis in Israel’s sovereign bond market. The divestment movement, currently confined to college campuses, could spread. But for now, the Unhedged view stands.

(Reiter and Armstrong)

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