Schumpeter: The Santa Clause
A festive memo from one of America’s leading chief executives to his lieutenants.
DEAR Team, I trust you are looking forward to your vacations and that the spirit of love and generosity infuses your family gatherings. I also hope that this spirit will be left next to the Christmas tree when you return to work at this incredible company on January 2nd. Because 2018 is going to be the year when America Inc loses its head after a decade of iron financial self-control. And I am not going to make that mistake. Let me drop some festive wisdom: when everyone else is throwing money around like Santa, it is best to behave like Scrooge.
During my workout at 5.10am this morning my trainer played U2. I love Bono for his personal advice on charitable giving, but he is also a perceptive lyricist. “It’s a beautiful day” captures the mood in business. Third-quarter results blew the roof off. Earnings per share for the S&P 500 are 23% above the last peak in 2007. The world economy is rocking. At this week’s digital town halls our sales teams in Houston and Guangzhou reported record industrial orders. President Macron—whom I first met in 2008 when he was a junior spreadsheet guy at Rothschild—tells me that even the Europeans are doing high fives.
The triple adrenaline shot of a stockmarket boom, synchronised global growth and a worldwide passion for technology is both exciting and dangerous for corporations. Let’s not kid ourselves. People will get sloppy about allocating capital. My worst blunders were in the boom years of 1998 to 2001, when we caught the internet bug too early, and between 2006 and 2008 when we invested too much in energy. Every boss is tempted to splurge right now, cheered on by politicians, economists and investors.
I waded through Washington last week. The tax bill will boost our profits by 9%. After I got mad at Mitch McConnell, he reinserted a helpful clause that will save us money in Cayman. Our firm will pay only a small levy to repatriate cash held offshore and will benefit from accelerated depreciation. Like most companies, we’ve also noticed a better attitude from our regulators: unlike the Obama years, I get my calls returned. There is a price, though. Many Republicans are sincere—they believe in “trickle down” economics and expect us to invest more. A few even expect us to revive the rustbelt. When I saw the president he gave me his hardest sell yet on building a new plant in Iowa. Ivanka had to turn on Fox News to distract him.
The intellectual climate has turned pro-investment. Most economists claim firms are chronically underspending. I know that 67.384% of that is BS. Our job is not to flip-flop according to their models but to deploy capital over economic and technology cycles. Gross corporate investment, at 12.4% of GDP, is in line with the 50-year average, and we have invested a steady share of sales. Still, they are right that many big firms have the resources to let their hair down and let capex rise in line with record profits.
Investors are pivoting, too. The same Wall Street analysts that used to say the “L” in long-term stands for “loser”, and begged us to buy back more shares two years ago, now hint we should seek to grow. For the first time in years the shares of firms that invest heavily are no longer underperforming, according to Morgan Stanley. Buy-backs are out of style: just $128bn was spent on them last quarter, 20% less than in the same quarter in 2015.
Twenty years ago CEOs would have looked at all this and asked “how much” more they should invest. But to understand investment today you have to do a deep dive and answer four other questions: who, what, where and when? Our firm used to be America’s third-biggest investor, just behind ExxonMobil. But “who” invests has changed: Alphabet has taken our place (including research and development). Tech firms are competing with incumbents and using their dirt-cheap cost of capital to invest on their behalf. They account for 24% of investment by S&P 500 firms. My buddy Satya Nadella at Microsoft says if we shift our IT centres to his cloud division, we’ll save $700m of investment a year. If I can trust Microsoft not to steal our data, he’s got a deal.
“What” we invest in has changed, too. Like most firms, a quarter of our budget goes on intangibles, including software. When I grew up AI was an acronym used in animal husbandry, but I know our firm needs to make mid-size bets on new technologies like artificial intelligence. Tech cuts both ways, though: I’m nervous about building factories that may quickly become obsolete.
As for “where”, it’s simple: everywhere. We’re fairly typical for a big American firm, with 40% of our sales and investment abroad. Given that emerging markets will outpace America, that may rise. Other countries are being protectionist, too. President Xi’s people are clear that if we want full access to China’s domestic market, we have to invest more there. We have to pay to play.
Lastly, “when” should our firm invest more? Now, in the 101st month of a recovery? The longest-ever expansion, in 1991-2001, lasted 120 months. I have got to admit, it’s a tough call.
A turkey shoot in 2020
Here is my prediction. Expect a surge in corporate investment in 2018, with nominal spending rising by up to 10%, equalling the boom in 2006. There’s just too much pent-up energy. But it will be more skewed towards intangible assets than in the past, and while it will help the economy, it won’t revive the rustbelt.
As for our firm. I get it, I know our investment committee is besieged. We need a new campus in Austin, our software is buggy and fleet management wants Teslas. But leadership is about prioritisation, not saying “yes” to everyone. If you doubt it, repeat two words after me: Jeff Immelt. The former boss of General Electric was so soft on capital allocation the firm has turned to jelly.
So here’s the deal. Santa isn’t coming to this company. We’ll wait as our rivals’ budgets swell and the tech boom turns into a bubble. When recession strikes in 2019 our balance-sheet will be pristine and we’ll expand when others are weak. In Christmas 2020 this incredible firm will enjoy the biggest stocking ever.