This week's interesting finds

We’re hiring! 

Specifically, we want to add a Product Manager to our Investment Analytics team in our Toronto office. 

We're always looking for talented people who can help us achieve our goals and we understand that extraordinary human ability is a scarce resource in high demand. If you think you've got some and are interested in our company, please send your resume to: WeAreGrowing@edgepointwealth.com 

This week in charts 

Manufacturing 

Growth

Mexico

Housing

Energy

Interest rates

Hedge Fund ‘Pod Shop’ Strategy Imitated by Pensions, Endowments 

University of Texas Investment Management Co. and the State of Wisconsin Investment Board — with a combined $230 billion of assets — are among institutions investing in hedge funds in a way that mimics how multimanagers use individual pods of traders to wager on a variety of strategies. 

Each hedge fund essentially becomes a kind of pod. By using customized sleeves, known as separately managed accounts — or SMAs — institutional investors can tailor their trading exposures, save on execution costs and impose their own risk limits. 

Rather than pooling their cash alongside other investors, the institutional clients request that a hedge fund trade theirs separately, allowing them to control leverage and own the underlying assets. That also gives them insight into the exact trades the hedge fund makes — unusual in a world where money-making methods are kept secret. With that knowledge, they can then replicate winning bets elsewhere in their portfolios. 

Comparing Trades

Firms like Dockside and Innocap help allocators invest in hedge funds through managed accounts and negotiate terms. The allocator picks the funds they want as their so-called pods and can compare trades made by the various vehicles. 

Innocap has more than 30 allocators investing in hundreds of hedge funds, while Dockside has six clients so far. 

Wisconsin’s $156 billion pension fund is invested in 10 managers through Dockside, mostly stock-pickers, and may grow that to as many as 20 by year-end. 

The concept isn’t entirely new. 

The Canada Pension Plan Investment Board and Duke University’s endowment have been running internal hedge fund SMA programs for years. Building out the infrastructure to do so is costly and time-consuming. 

Some firms, such as BoothBay Fund Management, New Holland Capital and Crestline Investors, offer clients exposure to hedge funds through SMAs. They determine which funds to invest in on the allocators’ behalf, risk limits and how to adjust exposures. In these instances, pensions and endowments have less control than with Innocap and Dockside. 

Institutions aren’t necessarily seeking to replace or compete with their investments in the multistrat giants, which have hundreds of trading teams and are far more complex. 

Traditionally, smaller hedge funds were open to creating the more onerous SMAs in order to boost assets. But Innocap has noticed that some of the industry’s larger hedge funds, those running billions of dollars, have been more receptive in recent years. In a challenging fundraising environment, access to any capital is prized, along with being able to share that a prominent institutional investor is a client. 

SMAs gained favor after the 2008 financial crisis and the Bernard Madoff Ponzi scheme, as investors sought more transparency and the ability to own the assets. Now they’re in even more demand. 

The amount of cash hedge funds manage in such pools has jumped by almost 50% over four years, reaching $226 billion at the end of 2022, according to a Goldman Sachs Group Inc. report last June. It’s most popular among the biggest institutional investors — those with more than $10 billion of assets — such as pensions, endowments and sovereign wealth funds. 

Of those considering SMAs, 60% plan to use a third-party platform, while 13% intend to build their own operations in-house, according to a fourth-quarter Morgan Stanley investor survey. The remainder plan to do both. 

Rising interest rates prompted the Wisconsin pension to act. 

It typically borrows capital to make hedge fund investments, but that became too expensive. Using Dockside’s prime brokerage relationships means it can turn a smaller stake into more exposure. Plus, efficiencies such as offsetting buy and sell orders of the same asset across various funds could also trim the expense of executing trades. 

China’s EV Price War Is Just Getting Started

With a historic round of price cuts this month, Tesla, Li Auto and a host of others have extended China’s monthslong electric-vehicle price war into a new quarter. Some say the fight is just getting started. 

EV makers in the world’s biggest market for electric and hybrid vehicles have been cutting prices en masse since last year, when slowing sales and rising competition from upstarts forced a rethink of the playing field. This month, prices were cut or incentives offered on more than 40 EV models, amounting to some of the largest reductions in China auto market history. 

CCB International analyst Qu Ke said he expects growing and intensified competition into the third quarter, given the current oversupply and soft consumer sentiment in China. Nomura analyst Joel Ying said the current level of competition could last for two to three years before the market enters a new, stabilized stage, potentially trimming the field to a handful of survivors. 

Drivers in the short term include a new batch of models launching this week at the Beijing Auto Show and coming government subsidies for trade-ins that have companies competing to capture an expected uptick in demand. Tesla’s fresh announcement that it plans to roll out cheaper models early next year could add to the pressure. 

One likely outcome of prices in free fall is that the popularity of alternative-energy vehicles will continue to rise, cementing their place atop China’s auto market. In the first two weeks of April, retail sales of EVs and plug-in hybrids overtook those of traditional vehicles for the first time, according to China Passenger Car Association data. The International Energy Agency this week estimated that 60% of EVs sold in China are already cheaper than combustion-engine cars. Elsewhere, it expects price parity only by about 2030. 

Another outcome is that the smallest players are at greater risk of going under. Lower prices will likely drive some industry consolidation, said Vincent Sun, a Morningstar equity analyst, citing recent exits of weaker players. 

Qu of CCB said he expects more startup original equipment manufacturers to go bankrupt in the next two to four years. 

Margins are also likely to suffer, although on that front the more established players have more room to give. Only three EV makers in China were profitable in 2023: Tesla, BYD and Li Auto. The latter two had enviable gross profit margins of 20% and 22.2%, respectively, while Tesla’s global gross profit margin was 18.2%. 

Others, including NIO and XPeng, have growing sales but are spending billions of dollars to catch up to rivals. 

XPeng and NIO still have ample liquidity to support their ambitions and potentially withstand withering prices. XPeng said it had the equivalent of $2.92 billion in cash and cash equivalents as of 2023, up 45% from a year earlier, while NIO’s rose 66% to the equivalent of $4.55 billion. 

EV makers will have some natural room for price cuts in an environment of declining input costs, such as lower lithium battery prices, and on greater efficiencies, coming via economies of scale and trimmed operating costs, analysts said. 

This week’s fun finds 

She definitely paid attention…

On her last day at EdgePoint, intern Aakanksha showed us everything she learned about our culture by designing sugar cookies based on each department. We thought they were pretty accurate (and delicious).

EdgePoint Corporate League Winter Champions

We’re excited to share the news that our EdgePoint basketball team has won the championship title in the BWT Winter Corporate Basketball League after a heart-stopping triple overtime victory. 

The game began with high energy, Mike Lo was outstanding, hitting three consecutive jumpers to set the tone early. 

In the second quarter, our team demonstrated resilience and discipline. Steven Lo's critical three-pointer from the corner, coupled with Alex's impactful performance off the bench—securing rebounds and adding a physical edge —helped us prepare for the tough half ahead. 

After halftime, Bryan Long led our defense and grabbed crucial rebounds, keeping us in the game. 

The fourth quarter turned into a defensive showdown, led by Jin, who boosted our energy and set the defensive tone. Both teams focused intensely on defense as the game neared its end and eventually leading to overtime. The intensity didn't drop in overtime; Bryan Long's buzzer-beating layup in the second overtime pushed us into TRIPLE OVERTIME!

In the final stretch of triple overtime, our determination was unmistakable, allowing EdgePoint to secure the win. 

This championship is more than just a victory; it's a reflection of our team's spirit, perseverance, and teamwork.

This week's interesting finds

First quarter commentaries are now live! 

This quarter, George Droulias discusses the three key levers that we believe drive a business’ worth, while Frank Mullen talks about the importance of remaining disciplined when managing credit in the face of market exuberance. 

This week in charts 

China 

Gold 

Capital Expenditures (CapEx)

Employment 

Private equity

LBO loans 

A $10 Billion Copper Mine Is Now Sitting Idle in the Jungle 

When the group of mining executives arrived at Panama’s regal Palacio de las Garzas, they were ushered past the ornate, wood-paneled ceremonial rooms and straight to the private office of the president. 

This was December 2016, before the upswell of anti-mining protests that would throw the country into chaos, and the team from First Quantum Minerals Ltd. were greeted as old friends. After all, they were building the country’s most important project since the Panama Canal had been opened a century earlier. 

But as they compared notes on the progress of their Cobre Panama copper mine, the president issued a warning. 

First Quantum had lucked into an unusually sweet deal in Panama, he said. Sooner or later, the company would have to agree on new terms with the government and pay more taxes. What was left unsaid: it would be better to do it sooner, under a business-friendly government like his, than to gamble on Panamanian politics. 

The stakes were high. The mine was set to be the centerpiece of Panama’s economy, generating between 4% and 5% of its gross domestic product and employing one in every 50 workers in the country. For First Quantum, which had borrowed heavily to construct a mine in the dense Panamanian jungle, it simply had to succeed. 

Philip Pascall was unmoved. A swashbuckling Zimbabwean who had built First Quantum from scratch by making bold bets that few others had the stomach for, he brushed aside the president’s warning and quickly moved the conversation away from tax. 

It was a gamble that would prove disastrous. Today, the $10 billion mine is sitting idle, shuttered by nationwide protests over a new tax deal signed in October. First Quantum’s share price has plunged by roughly half, and the company is being circled by predatory rivals. 

This account of how First Quantum's flagship investment fell apart is based on interviews with more than a dozen people involved in the project over a decade. 

It is in part a tale of First Quantum’s hubris, as the company’s bosses sought to build the mine fast and keep costs low, despite unsettled tax disputes and legal issues. Pascall dismissed private warnings not only from Panama’s government but also from his own advisors that the tax deal put his company in a vulnerable position. 

But it is also a story that resonates far beyond the walls of First Quantum’s offices and the borders of Panama, highlighting a dilemma at the heart of the global transition away from fossil fuels. While governments are pushing to secure the raw materials to build electric vehicles, solar panels and high-voltage cables required for the energy transition, few of their citizens want the mines needed to produce them. 

The fate of Cobre Panama is one of the central questions facing the miners, traders and hedge fund managers who have gathered in Santiago in Chile for the copper industry’s annual Cesco Week event. 

“If I was a copper mining company looking at Latin America, would I want to sink a 50-year operation into one of these countries where there is this rising risk?” said Gracelin Baskaran, a research director and senior fellow for the Energy Security and Climate Change Program at the Center for Strategic and International Studies. 

“If the sector is risk-averse, they don’t invest. And if they don’t invest, we don’t have what we need for an energy transition.” 

Charismatic Leader 

Trailblazing projects like Cobre Panama have long been a hallmark of First Quantum’s business. Headquartered in Canada, the company was founded in 1996 by Philip Pascall and his brother Matt. 

The brothers developed copper mines in countries like Zambia and the Democratic Republic of the Congo, regions with low investment grades where few of its competitors dared to venture. While mines can often take decades to build, the Pascalls cultivated a reputation for getting their projects done ahead of schedule. 

In a rare interview in 2013, Philip Pascall described the ethos of his firm to The Australian: “We dare where others don’t, we try new things out, learn from our experiences and have earned a reputation for delivering not only to budget, but before schedule in an industry prone to overrunning both.” 

Their boldness was rewarded in the 2000s, as demand from China supercharged the price of copper. By the early 2010s, First Quantum had become a multibillion-dollar success story. With cash to spend and growing ambitions, Philip set his sights on a deposit in Panama, a country until then little touched by the mining industry. 

The firm launched a $5.5 billion takeover of the deposit’s owner, Inmet Mining Corp., that quickly turned hostile after the smaller firm twice rejected First Quantum’s approaches. 

The end result was a $10 billion mining complex larger than the size of San Francisco, isolated in Panama’s tropical rainforest, and capable of producing more than 350,000 tons of copper in a year — enough to build about five million electric vehicles. In an industry where many of the largest deposits have been depleting for decades, it was a rare example of a major new mine. 

And the timing seemed fortuitous. China’s industrialization was being supplanted as the major driver of projected copper demand by a new juggernaut — the energy transition. The electric vehicles, charging stations and high-voltage cables needed to electrify the world’s transportation will all require lots of copper. Mining executives started talking about the gap between the amount of copper that would be needed to reach net zero and the anticipated supply from the world’s existing mines. The world would need dozens of new copper mines, they said. 

First Ore 

First Quantum’s success had much to do with its leader, Philip Pascall, and rapport he forged with Juan Carlos Varela, Panama’s president from 2014 to 2019. The two men would dine together, with Philip sometimes supplying wine from his brother’s vineyard in Cape Town. 

Varela was eager to see Cobre Panama built. He kept a piece of the first ore rock mined from Cobre Panama in his office. The night before the mine opened in 2019, he joined First Quantum staffers at a luxury resort on Panama’s southern coast to dine on sushi and toast the project’s completion. 

Still, the honeymoon wouldn’t last. Even before Varela left office in 2019, Cobre Panama faced increasing scrutiny. The project’s tax requirements were enshrined in an outdated contract struck in 1997 — a time of record-low copper prices — long before the deposit’s value was fully realized. The details of the contract, which First Quantum inherited from the concession’s previous owners, required the miner to pay a 2% royalty rate on minerals revenue — a sweet deal for a metals producer. 

Pascall had ignored Varela’s admonitions about the tax deal. In the years before Cobre Panama opened, both Varela and a former Supreme Court justice and board member for the mine’s local subsidiary had pressed Pascall to start arranging a contract that would satisfy the country’s higher tax demands. Insiders at the company said First Quantum’s leadership never acquiesced to Varela’s demands, but Varela didn’t force the issue either, instead allowing First Quantum to proceed with a lenient tax arrangement. 

The tax benefits became hard to ignore once the mine opened. In 2019, Cobre Panama’s first full year of operation, the mine's royalty payments to Panama were a sixth of what First Quantum paid to Zambia for its Kansanshi mine. (In that period, though, Zambia's tax rate was notably high for foreign mining firms). 

The disparities were enough to draw the ire of a new government. When Varela’s business-friendly administration was replaced by the centre-left party of Laurentino Cortizo, the new administration moved to secure a better tax deal for the country. 

Cortizo didn’t maintain the same friendly relations with First Quantum. He had steered Panama through a cataclysmic recession caused by the Covid pandemic, that saw employment fall drastically and inflation spike while container ships sat idle in the Panama Canal. Now he needed to refill the government’s coffers, and First Quantum, the country’s biggest investor, became an obvious target. 

The government pushed for significantly higher royalties as well as a minimum annual flat tax of $375 million. When the company pushed back, Panama threatened to shutter the mine altogether. 

“They were tough negotiations,” said Robert Harding, First Quantum’s chairman. “We were trying to protect our interests and they were trying to protect theirs.” 

After long delays and standoffs and over four years of negotiations, the government and company reached a tentative agreement in March last year. First Quantum acquiesced to the bulk of Panama’s demands in exchange for a 20-year extension on the mine’s operating contract. 

Hostility Brews 

To the outside world, it looked like the crisis had been averted. Months passed in relative calm, and the mine kept churning out huge amounts of copper. 

Yet on the ground, hostility was brewing. Panama was already seething with discontent over inflation, high unemployment and corruption, and there was long-standing resentment over Cobre Panama’s environmental impact and its contribution to the economy. With a national election looming, the mine became a focal point for all the country’s ills. 

In October, when Panama’s congress approved the new contract with First Quantum in what should have been a formality, the decision fueled an uprising of protests that paralyzed large swathes of the country. 

One of the driving forces behind the opposition was a powerful and confrontational construction union called Suntracs, which has a history of clashing with companies operating in Panama. The group had sought early on to take part in the mine’s construction, and Suntracs members subsequently stormed the gates of the mine and assaulted employees at least three times between 2015 and 2018. Now Suntracs played a key role in stirring up protests and pushing labor issues to the forefront. 

Across the country, protesters blockaded highways and rallied in the cities. Local boats, some of them operated by Suntracs, blocked access to Cobre Panama's coastal port for weeks, preventing First Quantum and its suppliers’ ships from docking. 

As the civil unrest raged, First Quantum had largely lost touch with the government’s decision making, according to employees who spoke with Bloomberg News. The close-knit relationship Philip had once maintained with Varela was virtually absent between Cortizo and Philip’s son Tristan, who had taken over from his father as CEO after overseeing Cobre Panama's construction as the project's general manager. 

When Cortizo called for a national referendum on the mine’s operating contract in October — a short-lived idea meant to calm mass demonstrations — Tristan Pascall and First Quantum’s other top executives were provided no advance notice. The soft-spoken executive largely conducted damage-control from the company’s London office, eventually visiting Panama briefly in late November following Cortizo’s call to shutter the mine. But Panama’s course was set. The mine produced its last ton of copper in November and has been sitting idle ever since. 

Cautionary Tale

For the wider mining industry, the story of First Quantum in Panama has become a cautionary tale. 

“It’s just a reminder that it’s so, so important that there’s mutual trust, and that what we’re doing is in the interest of all constituents,” said Jakob Stausholm, Chief Executive Officer of Rio Tinto, whose predecessor was ousted after the company irreparably damaged an ancient Indigenous heritage site in Australia. “You cannot run the risk of turning a blind eye to that side of the business.” 

In Panama, First Quantum has embarked on a media blitz ahead of presidential elections in May, hoping that it can gain enough popular support to persuade the next government to allow the mine to restart. The company says it’s spending $15 million to $20 million per month to preserve the site, and has committed to reforesting more than 11,000 hectares of Panama’s rainforest — double the area impacted by mining. 

Yet some analysts have predicted the shutdown could last a year or longer, while a question mark hangs over who will ultimately own the mine. The project has attracted interest from the likes of Barrick Gold Corp., a much larger mining firm that boasts a history of dealmaking in challenging jurisdictions. 

Cobre Panama’s closure was one of the key catalysts behind a global shortage of copper ore currently gripping the industry, which in turn has drawn bullish investors into the market and helped pushed metal prices to the highest point in nearly two years. The mine accounted for roughly 1.5% of the world’s supply of copper. 

And the closure of Cobre Panama has intensified warnings from the mining industry that future supplies of metals like copper may not be sufficient to meet the needs of the energy transition. The International Energy Agency has predicted that by 2030, mines in production or currently under construction will only meet half of global demand for battery metals like lithium and cobalt. Copper mines, meanwhile, are projected to meet 80% of global demand in that same time frame. 

The operation is “only one example of the geopolitical climate within which today’s copper and other commodity mining operations exist,” said Andrew Kireta Jr., president and CEO of the Copper Development Association, a US-based industry group. 

“If we proceed with a business-as-usual approach, these supply constraints and others will impact the US’s ability to meet the projected steep demand acceleration for copper to build out clean energy infrastructure and transition to electric vehicles.” 

US FTC preparing to sue to block $8.5 bln takeover of Capri by Tapestry, NYT Dealbook reports

The deal, which would bring together top luxury labels such as Tapestry's Kate Spade, Stuart Weitzman and Capri's Jimmy Choo and Versace, received regulatory clearance from the European Union and Japan on Monday. 

The FTC's five commissioners are expected to meet this week to discuss the case, a move that could precede a formal vote on whether to file a lawsuit, according to the report. 

The merger aimed to create a U.S. fashion powerhouse to compete better with bigger European rivals amid a slowdown in luxury spending. 

This week’s fun finds 

Our internal hot sauce challenge club received a hot tip this week to test The End. Flatline hot sauce followed by Stingin’ Hotter Honey, Red Lava edition. The End left everyone thinking “What did we ever do to you?” 

Before

After

Reviews: 

• “Why is it black?”
• “It tastes like burning rubber smells”
• "Are you crying?"

This week's interesting finds

This week in charts 

European spreads 

US Treasury 10-year yield

Construction equipment 

Automotive

Asset allocation 

Inflation 

Pharmaceuticals 

China Tells Telecom Carriers to Phase Out Foreign Chips in Blow to Intel, AMD 

SINGAPORE—China’s push to replace foreign technology is now focused on cutting American chip makers out of the country’s telecommunications systems. 

Officials earlier this year directed the nation’s largest telecom carriers to phase out foreign processors that are core to their networks by 2027, a move that would hit American chip giants Intel and Advanced Micro Devices, people familiar with the matter said. , people familiar with the matter said. 

The deadline given by China’s Ministry of Industry and Information Technology aims to accelerate efforts by Beijing to halt the use of such core chips in its telecom infrastructure. The regulator ordered state-owned mobile operators to inspect their networks for the prevalence of non-Chinese semiconductors and draft timelines to replace them, the people said. 

In the past, efforts to get the industry to wean itself off foreign semiconductors have been hindered by the lack of good domestically made chips. Chinese telecom carriers’ procurements show they are switching more to domestic alternatives, a move made possible in part because local chips’ quality has improved and their performance has become more stable, the people said. 

Such an effort will hit Intel and AMD the hardest, they said. The two chip makers have in recent years provided the bulk of the core processors used in networking equipment in China and the world. 

Shares of Intel dropped 3.6% to $36.27 in early trading Friday while AMD fell 4.2% to $163.27. 

Beijing’s desire to wean China off American chips where there are homemade alternatives is the latest installment of a U.S.-China technology war that is splintering the global landscape for network equipment, semiconductors and the internet. American lawmakers have banned Chinese telecom equipment over national-security concerns and have restricted U.S. chip companies including AMD and Nvidia from selling their high-end artificial-intelligence chips to China. 

Chinese authorities have in turn been pushing for years to remove foreign suppliers from critical supply chains, seeking to source products from grains to semiconductors locally as national-security concerns rise. Similar orders requiring Chinese state-linked entities to shift their buying to local tech alternatives have resulted in U.S. software and hardware firms including Microsoft and Dell Technologies gradually losing their grip on the market, The Wall Street Journal has reported. 

China has also published procurement guidelines discouraging government agencies and state-owned companies from purchasing laptops and desktop computers containing Intel and AMD chips. Requirements released in March give the Chinese entities eight options for central processing units, or CPUs, they can choose from. AMD and Intel were listed as the last two options, behind six homegrown CPUs. 

Computers with the Chinese chips installed are preapproved for state buyers. Those powered by Intel and AMD chips require a security evaluation with a government agency, which hasn’t certified any foreign CPUs to date. Making chips for PCs is a significant source of sales for the two companies. 

China Mobile and China Telecom are also key customers of both chip makers in China, buying thousands of servers for their data centers in the country’s mushrooming cloud-computing market. These servers are also critical to telecommunications equipment working with base stations and storing mobile subscribers’ data, often viewed as the “brains” of the network. 

The two chip giants have the lion’s share of the overall global market for CPUs used in servers, according to data from industry researcher TrendForce. In 2024, Intel will likely hold 71% of the market, while AMD will have 23%, TrendForce estimates. The researcher doesn’t break out China data. 

China’s localization policies could diminish Intel and AMD’s sales in the country, one of the most important markets for semiconductor firms. China is Intel’s largest market, accounting for 27% of the company’s revenue last year, Intel said in its latest annual report in January. The U.S. is its second-largest market. Its customers also include global electronics makers that manufacture in China. 

In the report, Intel highlighted the geopolitical risk it faced from elevated U.S.-China tensions and China’s localization push. “We could face increased competition as a result of China’s programs to promote a domestic semiconductor industry and supply chains,” the report said. 

Geopolitics already cloud the outlook for Intel and AMD’s China operations. Intel said in January that $3.2 billion, or 6% of its revenue in 2023, was dependent on U.S. government export control authorization, an amount the company expected may increase in future years. 

China contributed 15% of AMD’s revenue last year, according to the company’s annual report. That was down from 22% in 2022 after AMD was restricted by U.S. authorities from selling its high-end AI chips to China. 

China will form the bulk of demand for wireless communications equipment over the next few years, said Earl Lum, the founder of telecommunications consulting firm EJL Wireless Research. The country is seeking to move from 5G to even faster network speeds, and global telecom operators outside of China are slowing down their purchases, he said. 

Local CPU substitutes have made large strides in recent years, with companies including Huawei Technologies’ HiSilicon and Hygon Information Technology, as well as entities including the National University of Defense Technology, gaining ground. 

Chinese chips aren’t always considered as good, people familiar with the matter said, but they have been winning over Chinese telecom customers. 

When China Telecom bought some 4,000 artificial-intelligence servers last October, 53% were powered by Intel’s CPUs. The rest used Huawei’s Kunpeng processors, according to a tender document. In some earlier tenders seeking to buy servers, Intel made up a much higher proportion. 

Companies Reconsider Research Spending With Tax Deal Held Up in Senate 

Large U.S. companies are pressing lawmakers to revive expired tax breaks for research and development spending, as a political stalemate keeps some finance executives wrestling with those investments. 

Lawmakers hoped April’s tax filing deadline would spur action, but with a bill proposing the change stalled in the Senate, expectations are waning for a deal soon. 

The political wrangling comes as large public companies say the law as it stands is costing them hundreds of millions or billions of dollars, while some owners of small and medium-size businesses say they wonder if their firms will survive. 

The tax change went into effect in 2022. Under a provision in the 2017 Tax Cuts and Jobs Act designed to generate revenue to help pay for cutting the corporate tax rate, companies must deduct research costs over five years for domestic research costs and over 15 years for those incurred abroad, rather than immediately. 

Companies of all sizes have been urging lawmakers to reverse the law. The House passed a bipartisan bill in January to restore immediate domestic research deductions retroactively from 2022, but Republicans have held up the bill in the Senate over details of child-credit changes, their inability to amend the bill and the prospect of a better deal if the GOP wins a Senate majority in November’s election. 

Hyster-Yale, which in its last fiscal year booked revenue of $4.1 billion, spends around $100 million a year on R&D, and the law change that went into effect in 2022 increased its tax bill by about $25 million a year. “So that’s $25 million less that I have to invest back into my business, whether it’s R&D, whether it’s plants and equipment, hiring new people,” Minder said. 

Like many others, Hyster-Yale’s executives expected the law would be repealed. That hope is fading, and what’s more, the repeal in the current bill runs only through 2025, so it’s a stopgap, said Minder, also his company’s treasurer. 

“In the lack of certainty from D.C., we have to make certainty for ourselves,” said Minder, adding companies that invest heavily in research, like Hyster-Yale, may need to reconsider how much to allocate for R&D and where that money is spent. The company spends around 80% of its research budget in the U.S. and the remainder elsewhere, according to the CFO. 

“We have people here in the U.S., we have facilities, processes, R&D here, and we much prefer to keep it that way,” Minder said. “But even if we get this temporary measure, we have to have a plan B. Do we have to act on it? No, but we can’t be in this spot again come 2025.” 

Other companies likewise are considering future R&D outside the U.S., where incentives can be more favorable, said Rohit Kumar, a former Senate GOP leadership aide who now is a co-leader of the national tax practice at accounting firm PricewaterhouseCoopers. It also means companies have “dramatically” slowed research spending since the law took effect, he said, pointing to U.S. Bureau of Economic Analysis data showing R&D spending declined last year after growing 6.6% on average over the previous five years. 

“It’s sort of natural that if Congress makes something more expensive to do, companies will do less of it,” Kumar said, adding the situation worsens with each estimated tax payment date. Companies make estimated tax payments to cover liabilities throughout the year, with the next date for large companies on April 15. “Every payment date that we go through where we don’t address this, you take more R&D money out of the economy,” he said. 

Steve Valenzuela, CFO at Alarm.com, is frustrated by the holdup in the Senate. Roughly 30% of the technology provider’s revenue, which last year was $881.7 million, goes to R&D, he said. The law change increased Alarm.com’s 2023 tax bill by around $43 million. 

Valenzuela said Alarm.com can cover the increase, but the company would prefer to invest those dollars into its business. He also said the change in the law has him thinking about whether to spend more in other areas of the business such as sales and marketing. 

For Jack Henry & Associates CFO Mimi Carsley, the longer the bill sits in the Senate, the less likely it becomes law this year. Carsley is preparing the financial technology company’s tax payment this month along with a plan for the full tax year as though the law remains unchanged. 

R&D is central to Jack Henry’s business, and while the law isn’t likely to affect current spending, it may prompt reduced investment in other areas and increase the rate of return required for new projects, a measure known as hurdle rates, according to Carsley. 

“Even in the largest companies, you’ve had the combination of higher interest rates plus this extra hit from a cash perspective,” she said. Jack Henry’s tax bill rose between $70 million to $80 million in its last fiscal year because of the change. “Hurdle rates will have to go up for projects as a result.” 

This week’s fun finds 

Pringles and Crocs Just Dropped a Limited-Edition Shoe Collection, and Yes, There Are Lots of Mustaches Involved 

Crocs is on an absolute roll with its food-focused partnerships, and its latest collab announcement will surely make chip fans happy. 

On Thursday, the shoe company announced an all-new set of kicks with Pringles. And no, it's not just slapping mustaches on everything, but rather, it's making footwear that's actually useful to everyone who can't go a single step without their chips.

This week's interesting finds

This week in charts 

Education

 

Trades

Housing 

Property valuation changes 

Ratios

Household debt 

Bankruptcy

Unemployment 

Policy rate decisions 

What Makes Housing So Expensive? 

Buying a home is by far the largest purchase most of us will make, and paying the rent or mortgage will be our largest monthly expense. In the post-pandemic home-buying boom, the median sale price of a new home peaked at almost $500,000 dollars, just under seven times the median household annual income that year (though it has since fallen). Most new homebuyers will pay around 30% of their income on their mortgage, and the median renter in the bottom quintile of income spends 60% of their income on rent. 

People concerned about building more housing are right to pay attention to zoning and land use rules: over 100 million Americans live in places where most of the cost of residential property comes from the land itself. But they should not neglect the physical costs of building homes, which are overall more important. Unfortunately, as we’ll see, reducing these physical costs is far from straightforward. 

We can divide the costs of a new home into roughly three buckets: “hard costs” (physically constructing the home), “soft costs” (design, administration, marketing, and other non-physical construction costs), and the costs of land. Per the NAHB, on average hard costs are about 56% of the total costs, soft costs (including builder profits) are about 25%, and land costs are about 18%. 

The cost of housing comes from a variety of sources. In most cases, for both new construction and existing housing, the largest line item is the cost of constructing the home itself. For new construction this is on average 80% of the cost of a home (including hard and soft costs), while for existing construction it's still in the neighborhood of 60-70%. 

It’s only in dense urban areas that the cost of land begins to dominate the cost of new housing, driven by regulatory and zoning restrictions that limit how much housing can be built in a given area. Another way of looking at it is that in the areas that we need housing the most, zoning and regulatory factors are responsible for the lion’s share of housing costs. 

U.S. Home Sales Jumped 9.5% in February 

Home sales rose in February from the month prior, marking the first time in more than two years that sales increased for two consecutive months. 

Sales of existing homes, the majority of purchases, surged 9.5% to a seasonally adjusted annual rate of 4.38 million, the National Association of Realtors said Thursday. 

Economists surveyed by The Wall Street Journal had estimated sales of previously owned homes to fall 1.3% in February. 

The momentum in sales over the last two months comes just ahead of the spring selling season and follows one of the most sluggish periods for the housing market in recent history. 

Home sales in 2023 fell to the lowest levels in nearly 30 years. Since 2022, higher mortgage rates, high home prices and limited inventory have stifled sales, which were still down 3.3% from a year earlier in February. 

But mortgage rates that have dropped since last fall and a now-rising inventory of homes for sale are giving some buyers more choices. 

“Additional housing supply is helping to satisfy market demand,” said Lawrence Yun, NAR’s chief economist. 

The most expensive homes saw the biggest increases in sales. Homes sold for more than $1 million shot up 37% in February, compared with the same month a year ago. Sales of homes priced from $750,000 to $1 million rose 23%. 

Thirty-year fixed mortgage rates have been trending down following a recent peak of 7.79% in October. The rate averaged 6.87% for the week ended March 21, according to Freddie Mac. 

Home buyers in February also benefited from a more than 10% increase in the number of homes available for sale, compared with the same month a year ago, NAR said. 

Demand, however, appears to be outstripping supply, leading to rising prices that will inevitably push some buyers out of the market. The national median existing-home price rose 5.7% in February from a year earlier to $384,500. That was a record high price for the month of February, NAR said. All four regions of the country analyzed by NAR saw price increases. 

“Homeowners are in a happy situation with the rise in prices,” said Yun on a Thursday press call. “But home buyers are frustrated.” 

Prices rose most in the Northeast, even though sales dropped more there than any other region, a development NAR attributed to still-lagging inventory. 

Home buyers already feeling priced out shouldn’t expect affordability to greatly improve this year, said Charlie Dougherty, a director and senior economist at Wells Fargo. 

“At the end of the day, you’re still looking at home prices that have risen 45% since January 2020 and incomes that haven’t risen as much,” he said. “The sales rebound is unlikely to be all that energetic.”

There are some signs that sellers are adjusting their expectations or capitulating more often on price. A smaller share of homes sold in February went for more than asking price, compared with a year ago, NAR said. And nearly 14.6% of homes listed for sale in February had seen a price cut, an increase from the same month last year, according to a report from Realtor.com. 

Christine Quinn dropped the price of her mother’s house in Fairhope, Ala., more than once before selling it last month for $580,000. “The season was not a great time to sell,” she said. “I’m relieved that we’ve sold it.” 

In Denver, Matthew Hingst bought a one-bedroom apartment in February for 1.7% below the listing price. The seller also gave him $3,000 to make small repairs. “I feel like the buyer has a lot more power to be able to ask for things,” Hingst said. 

The height of the sales market typically comes in the spring and economists said results during those months will hinge in part on whether buyers can get more relief from mortgage rates. Federal Reserve officials have said they expect to cut the federal-funds rate at least three times this year. Those cuts could precede lower borrowing costs for home buyers. 

Also still unclear is how NAR’s $418 million agreement to settle claims that the industry kept agent commissions artificially high will affect home sales. Rules about how agents are compensated are scheduled to change in July. 

Yun said real-estate agents have raised the possibility that the new rules might squeeze first-time buyers, who might have to come up with money to pay an agent if sellers choose not to cover the cost. First-time buyers accounted for 26% of home purchases in NAR’s latest survey, matching the lowest figures ever measured for that cohort of purchasers, Yun said. 

This week’s fun finds 

Newest member of the Analytics and ESG team, Jack Bruton served up some Detroit-style pizza for his moai on Friday. The wait was worthwhile - it came with 25 lbs. of wings and his friend’s award-winning hot sauce. Well done! 

2024 Total Solar Eclipse 

On April 8, 2024, a total solar eclipse will cross North America, passing over Mexico, the United States, and Canada. A total solar eclipse happens when the Moon passes between the Sun and Earth, completely blocking the face of the Sun. The sky will darken as if it were dawn or dusk. 

If you’re looking for something fun to do this weekend, check out how to make a pinhole camera. 

You don't need fancy glasses or equipment to enjoy one of the sky's most awesome shows: a solar eclipse. With a few simple supplies, you can make a pinhole camera that lets you watch a solar eclipse safely and easily from anywhere. 

All you need is: 

• 2 pieces of white card stock 
• Aluminum foil 
• Tape 
• Pin, paper clip or pencil