Noah's Arc 2024 Q1 Newsletter
Stagflation?
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Executive Summary:
I’m back to writing about the Economy.
While GLP-1 drugs from the last newsletter continue to have a blockbuster impact on Wall Street, I’m focusing on the opinions we’ve written that brought many of you to this newsletter.
Stagflation?
Inflation is down and on the surface the economy looks strong. I’ll talk about the beneath the surface risks we face. These are by no means predictions, but rather places where things could go wrong. I’ll also talk about the interesting approach the Federal Reserve is taking.
Personal Note- How Is Solo Operating Noah’s Arc?
I’ve now been running Noah’s Arc on my own for about 3 months and after tinkering with the research strategy & business model, I’m excited to say we’re profitable!
Stagflation?
Stagflation: persistent high inflation combined with high unemployment and stagnant demand in a country's economy.
At the start of 2023, everyone was worried (myself admittedly included) about how we could be in for a recession. Rising inflation and sharply higher interest rates seemed to be quickly slowing the economy.
However, 2023 turned out much better than expected….or did it?
When we think of economic growth, we often think of stats such as ones related to employment. Since, if everyone has a job, making good money and participating in our consumer led economy this should create strong economic growth right?
I agree.
The problem is that, I believe, the labor market looks weaker than it appears on the surface. Coupled with inflation that is staying stubbornly higher than the Federal Reserve's target rate of 2%, and we may get a mild case of stagflation.
Looking at the labor market, both wages growth and unemployment look a little skewed. While the official unemployment rate sits at 3.9%, this obscures a more common than expected phenomenon we’re seeing in this economic cycle: underemployment.
Underemployment is the measure of someone who wants to be employed more (typically full time) but is not able to due to lower staffing hours from an employer or from the fact they cannot find full employment.
What happened during COVID is that we saw a lot of employers lay off a large group of Americans right as the pandemic began, just for these same workers to be unavailable when it came time to ramp business up again. The result is now that the economy has slowed a little, many employers are opting to cut employee hours across many people vs. laying off whole individuals.
The result is that more people are now underemployed. The Wall Street Journal did a great piece on this last June. In essence, the average work week, after peaking at 35 hours per week in April of 2021 (as the economy accelerated after coming out of the pandemic) has now crept down to 34.3 hours per week as of February.
This doesn’t seem like much, but keep in mind that for many lower and middle income earners in the US, their annual income is based on an hourly rate times the number of hours worked (where white collar workers are typically salaried).
What we’re seeing with this is that employers are giving raises to some employees and then cutting their hours. This is why wage growth has continued to be healthy… it's measured as an hourly rate for consistency (since work weeks fluctuate). However, consumers do not spend based on their hourly rate, they spend based on the paycheck they receive every 2 weeks.
It may be (in part) for this reason, lower and middle income consumers in the US have now largely exhausted their pandemic savings. Prices keep going up for them (and so do their hourly wages) but in many cases their hours may be getting cut.
Overall, unemployment can be measured in a few ways. The most common unemployment rate we see is technically called the U3 rate (on a scale of U1-U6). U3 counts people looking for work over 15 weeks and people who have sought temporary employment. U6 (on the other hand) includes more people such as workers facing underemployment.
U3 (normal unemployment) stood at the 3.9% figure we mentioned for February. This bottomed at 3.4% in January 2023. U6 (which includes underemployed individuals) is at 7.3% after bottoming at 6.5% in December 2022.
While U6 is always inherently higher than U3, the increase here indicates that some groups of Americans are becoming underemployed vs. unemployed. This makes the official unemployment rate appear lower than what actually reflects the economic reality, while showing that wages are still strong (while working-hours are weakening).
This aligns with the increasing levels of consumer credit card debt (and delinquencies). Many people (partly due to hours worked and inflation) saw a lifestyle-drift post COVID.
This is why (partly) consumer spending has held up. People got used to previous spending habits even if their hours were cut and effective compensation went down.
In essence, we have weaker than what appears on the surface income growth but resilient consumer spending due (in part) to spending habit changes during COVID.
Combined with supply chain shocks and you have consumer price growth that has stayed stubbornly above the target range.
We previously wrote about the risk that non-core inflation could have in sneaking back into inflation readings down the road. Supply chain shocks like we are seeing today (bridge collapse blocking a major port in Baltimore this last week, Suez canal charters being rerouted due to the Israel-Hamas war (causing shipping rates to jump), and the Panama canal slowing traffic due to lower than expected water levels).
All of these affect shipping rates which lead into producer prices being higher, which cause consumer prices being stubborn and in some cases trending higher (and since consumers have a willingness to pay, producers get compensated for passing along price increases to their end customers). All of this pushes inflation.
In fact, by some measure, super core inflation (in part due to sub-volatile components) has recently been recording some of its highest readings since the peak of inflation in 2022.
We now have the risk of underemployment (a post COVID version of unemployment) and higher than expected inflation -albeit still lower than 2022 but higher than what is long run optimal for the economy. We have the risk of stagflation.
What’s interesting, however, is that the Federal Reserve is looking to cut rates even in spite of what could be inflationary pressures. Much of this is because the Federal Reserve now has their federal funds rate charging 5.5% -well above the inflation rate. Whether this rate cutting will kickstart inflation again (and officially cause stagflation) is anyone’s guess. I think it’s an under-appreciated risk however.
Personal Note- How Is Solo Operating Noah’s Arc?
I’ve now been running Noah’s Arc on my own for about 3 months and while I definitely enjoyed having a Co-Founder that understood what the current goals and pain points were, I will say being a solo-entrepreneur has been pretty nice. Plus Noah Jacobs and the team are making great headway with Ultima… I’d say the divide and conquer from the last newsletter is working well.
I’ve been focusing more on research and content creation as ways to build Noah's Arc. I’m a firm believer that companies that want to build a brand, audience (and more customers) need to have a strong content strategy that well serves their target audience. For me, it's convenient because I have found people are willing to pay for research I’m writing and it has meant that I can now get paid to write research on companies even if I do not invest in using fund capital. I’ve found the eventual investments being even more picky than last year, and I’m proud of the resulting winners I’ve found by redoing the research process.
With this, I’m excited to say for the first time Noah’s Arc is profitable now. The investment fund has made money for in total since inception (including so far this year), but the management company is now profitable too (it’s default alive as Y Combinator founder Paul Graham would say).
I’ll talk more about this new research strategy in the future, but for now that means I’ll continue to operate Noah’s Arc full time. Expect quarterly updates from me (as usual) going forward.
It’s now been 3 exact years since this newsletter was launched. Once again, I appreciate the feedback, wisdom and advice I have gotten from all of you who read this since this got started.
Hope everyone has a Happy Easter to those who celebrate it.
Best,
Noah