Market Edges: #Patience

"When you have afforded yourself and your family’s hard-earned capital the long-term Full Investing Cycle gift of #patience, these 3-6 week Counter @Hedgeye TREND moves are so silly."
-CEO Keith McCullough, Early Look, 2/21/2023

• Client Talking Points: Our Macro team breaks down long China, the precarious nature of sticky CPI versus negative real wage growth and the rock-and-a-hard-place for central bank policymakers.
• Chart of the Week: U.S. Macro analyst Christian Drake describes a worrisome scenario for U.S. consumers: rising credit card debt, higher debt costs and falling wage growth.
• Sector Spotlight: Our Industrials team is hosting their 1Q 2023 Mid-Quarter Themes Update. Here's a preview.
• What the Media Missed: Macro and Financials analyst Josh Steiner explains the Macro implications of the 2-year Treasury, Capital One/Synchrony/JPMorgan data, and Mortgage Purchase App data series.
• Around the World: A think piece from Demography analyst Neil Howe on "the global succession crisis."

It remains all RoC ATHs and Cost-of-Living Hard Places as credit card balance growth accelerated in the latest 4Q22 data released this morning. 

If you harbor a closet phobia of visuals depicting large growth numbers or angstful hues of red … the chart below shows growth in the balance of credit card debt accelerating to multi-decade highs while the cost of that debt similarly summits fresh multi-decade RoC highs …. while the savings rate plumbs multi-decade lows and the consecutive monthly streak of negative real income growth hit 22-months in the latest January data.  

Surrendering to the sirenic soft-landing call is compelling for the unaware but the macro mosaic wrt the underlying dynamics of the consumption economy is now littered with different variants of the chart below.   

Again,  Macro resilience on display domestically? Yes.  Progressive hollowing out under that surface strength?  Also Yes. 

…. Just a quick update on a ‘chart favorite’ from the 4Q22/1Q23 themes deck.

Aging business owners in Japan are struggling to find successors. While this issue may be particularly severe in the world’s oldest nation, it’s a growing problem for businesses around the globe. (The New York Times)

Neil Howe: In Japan, hundreds of thousands of business owners are on the verge of retirement. The single biggest cohort of business owners is 69-year-olds. Many of these companies have operated for decades, if not centuries, with ownership often passed down within families. Many are also vital to local industries. Yet an estimated 630K will close down by 2025 because there is no successor to take the reins.

The difficulty of finding a successor is particularly acute in Japan given that its population is rapidly aging and shrinking. Companies located in small towns and cities have a hard time attracting employees, let alone eager would-be owners. But a shortage of young people is not the only challenge. Business owners from Asia to North America to Europe are also facing a generational values shift: Millennials are increasingly opting for different careers and are not interested in taking over the family business. As a result, business owners are increasingly faced with one of two options: sell to a third party, or close. Both come at a serious cost to the economy and risk leaving consumers with fewer options and higher prices.  

The lack of a successor is a problem affecting all kinds of small and mid-sized businesses: car dealerships, insurance agencies, doctors’ offices, convenience stores, law firms. Global surveys show that most business owners are not confident about their succession plans--if they even have them at all. In a 2018 survey of 276K Japanese companies, 66% of them said that they had no successor to take over the business.

Those who had chosen a successor most commonly said that a family member would be taking over (36%), but this share has been steadily declining. Conversely, the share changing ownership via internal promotions, outside hires, or other reasons like a company merger has been climbing.

Similarly, in a 2019 survey by Step Research that polled business owners from 33 countries, 70% said that they did not have a succession plan. Only 37% said there was a high likelihood that their next CEO would be a family member. In some countries, especially Japan and other East Asian nations, the problem is numbers-driven. There are simply fewer young adults who are viable successors. But an even bigger issue across the board is lack of interest. Surveys of family businesses in China have shown that around 6 in 10 children of business owners are not interested in succeeding their parents.

Running a company requires long hours, hard decisions, and lots of stress. Millennials are seeking more work-life balance and don’t want to sell their souls to their jobs. (See “Goodbye, Dr. Welby.”) And those who do become entrepreneurs tend to want to pursue their own dreams, which are often in newer fields like IT and are located in cities. Many family businesses are in old-economy industries in smaller towns. Even larger, well-established firms are struggling to raise kids in the business tradition. Because they focus on giving their children the best education, they often end up raising super-credentialed doctors or lawyers (who want to work in big firms) rather than experienced leaders who "know the ropes" of managing an entire company.

Surveys show that young business owners are less emotionally attached to their work than older owners. In the Step Research survey, Silent and Boomer CEOs were more likely than Gen-X and Millennial CEOs to believe that their next leader will come from their family. Most Millennial CEOs also said they plan to retire before age 60, while most Boomer CEOs plan to work past 70.

If no one steps up, these businesses will close when the current leadership retires. One might wonder: Is this necessarily a bad thing? Maybe this means that the next generation is more economically mobile. Or perhaps more efficient businesses will replace them.

But successful family businesses play a vital role in the market economy. They keep the big chains honest and ensure competitive vitality across hundreds of industries. Long-established small businesses also demonstrate a persistent productivity advantage over large businesses, in part because generational continuity allows them to plan over the long term more effectively. What’s more, they serve a civic function. Not only do small business owners spend money locally, they are more likely to be engaged members of their communities.

The other option--selling to a third party--generates instant cash but also longer-term economic costs. Private-equity firms that are better known for multibillion-dollar deals, including the Carlyle Group (CG) and Bain Capital (BCSF), are increasingly turning their attention to rolling up small businesses in specific industries. (Recent acquisitions include a bean sprout company and a family-run restaurant chain.) These deals often come at the expense of the consumer welfare and productivity growth, since they are often followed by higher prices, poorer service, and ramped-up market concentration. (See “Shhh! The Markets Are Concentrating.”)

Another tailwind behind PE buyouts is that the fact that they allow companies to avoid hefty tax bills. According to a 2019 government report, more than 84% of mid-sized firms in South Korea don’t intend on passing the business to the next generation, largely because the country has one of the highest inheritance taxes in the world (up to 50%). The tax is levied on the total value of the estate, but of course much of that wealth is tied up in the company and is not actually accessible as cash, so families are often left scrambling to pay for it. In 2021, South Korea's inheritance tax made headlines when the children of late Samsung chairman Lee Kun-hee were hit with a $10.7B bill. 

Looking ahead, is there any chance that this situation could ease? IMO, yes. We may find more late-wave Millennials embracing the idea of becoming successors for two reasons. A growing share of young people are close to their families, and many are discovering how difficult it is to outearn their parents. Closer bonds combined with economic precarity makes the family business look like a safe harbor.