This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekday

Good morning. Here at Unhedged we get a fair amount of mail from readers who think we are wrong. It doesn’t often come from the chief executive of a company we’ve written about. Yesterday, though, Dara Khosrowshahi of Uber wrote to defend the company’s buyback policy, which we’ve criticised recently. It’s a substantive comment, and we’ve included it below. If other CEOs out there (other than John Ridding) have complaints, send them to: and

Euphoria calling 

Just about every flavour of equity — not just big cap US tech — is rallying hard, as we pointed out yesterday. Then, we put a vaguely positive spin on this fact. This is a broad bull market, which should make it more stable than a narrow one (though the evidence for a link between breadth and index performance is equivocal). 

In the name of journalistic balance, however, Unhedged feels obliged to give the dark side of the story too: that we are approaching euphoria. When everyone is feeling good about everything already, disappointment is the only place left for markets to go. And it does look like everyone is feeling pretty dang good. Here is the American Association of Individual Investors survey’s bull-bear spread — that is, the percentage of respondents saying they are bullish minus the percentage saying they are bearish. It has smashed through to the top decile of historical optimism:

Line chart of AAII bull-bear spread, % showing Happy happy

For those of you who think the opinions of retail investors are not a great indicator, Citi’s Levkovich indicator bundles AAII with a bunch of market-based sentiment indicators (short interest, margin debt, put/call ratios and so on). It gives the same reading — not a wild extreme, but at the very high end of sanity:

Adding to the worries, stocks in recent months have gone from pricey to plain expensive. Below is the trailing P/E ratio on the S&P 500:  

Line chart of S&P 500 trailing price/earning ratio showing Just plain expensive now

There are other signs of dizziness out there. Some individual stocks have gone bananas. Bryce Elder over at Alphaville has recently dissected one example, Super Micro Computer. Another mark is the speed at which the market has abandoned one narrative about why gains are likely — “rates will fall and valuations will rise!” — and embraced another — “AI will create growth everywhere!”. The smartest bulls will point to steady earnings growth and macro data. But still, it is striking that stocks have steamed upwards this year despite long yields rising from 3.8 per cent to 4.3 per cent, and the number of rate cuts expected by year’s end falling from seven to four. The falling-rates-equals-higher-stocks story was a fun toy the market threw away when something shinier came along.

So there is a bit of euphoria in the air, then. But what can investors do with this piece of information? Maybe nothing. Valuation, as everyone knows, provides no guidance to future returns except over very long holding periods. Sentiment has been a slightly better guide, at least recently. Look at the AAII chart up top. Going back to 2010, there have been four peaks as high as today: May 2021, March 2018, January 2015 and January 2011. In each case, S&P 500 price return over the ensuing year was about flat. But at any of those points, was market momentum as strong as it is now?

What we have, then, is a general signal that the chances of a market accident are somewhat elevated (but we can’t time that accident at all) and that returns in the next few years might struggle to match those of the past few. It’s probably best just to stay invested for now and see if the signs of euphoria intensify. Investing is hard.

What about the velocity of money?

Monday’s letter drew on a recent Dallas Fed paper to explore the link between the money supply and inflation. In short, we think the link looks weak (though asset price inflation may be a different story). 

But a boatload of readers wrote in to say: what about velocity? A classic idea in economics is the “quantity theory of money”, which describes the relationship between inflation, output and money. A key variable is the “velocity of money”, which captures how often cash changes hands. The shorthand equation is PY = MV, or:

Price level * Real output = Money supply * Velocity of money

This is the same as:

Nominal output = Money supply * Velocity of money

So, yes, velocity of money — how often money in circulation is spent — is related to prices, along with the amount of money. But these formulas are accounting identities, not causal relationships. Monetarism, on the other hand, is a causal claim: it holds, roughly, that the quantity of money affects purchasing power and the economy. In the 1970s one particularly strong strain of monetarism took hold. It held that the velocity of money was stable, so all that really mattered to purchasing power, and all that central bankers had to worry about, was the quantity of money.

The belief was that velocity is regulated by a limited appetite to hold cash. If velocity fell, people would end up holding more money. Eventually, they would tire of holding cumbersome, zero-interest cash, and put it to use. Velocity would rise again. And in the 1960s and 1970s, several measures of velocity did indeed look stable. But the relationship broke down. After the 1980s, velocity became remarkably volatile.

The quantitative easing era destabilised velocity even further. The 2008 crisis response, with its aggressive bond-buying and money-printing, prompted predictions of hyperinflation. What happened instead was a velocity collapse alongside weak inflation and growth:

Line chart of After the financial crisis, money exploded and velocity collapsed (Q1 2007 = 100) showing M2 the moon

The lesson of that period: lower velocity can offset even an enormous increase in the money supply.

What changed? As we discussed in Monday’s letter, the Federal Reserve began paying interest on commercial bank reserves, which had previously yielded nothing. In the pre-2008 world of “reserve scarcity”, the Fed influenced credit conditions by tweaking the (low) supply of reserves in the overnight federal funds market. Banks needed scarce overnight cash, but it was also an interest-free hot potato. So a small decrease in reserve quantities could send banks scrambling for cash, and push the federal funds rate up. Today, in the “ample reserves” world, cash is everywhere, nor is it cumbersome to hold. The Fed will pay your bank or money market fund 5.4 per cent to sit on it.

This means that velocity and money supply now mostly reflect Fed balance sheet policy. If the Fed is expanding the balance sheet, the money supply rises and velocity falls, because the excess money largely sits around. If the Fed is shrinking its balance sheet, money declines and velocity perks back up. That has been precisely the pandemic experience, as the chart below shows (note that the initial velocity collapse happened in a high-growth, high-inflation period, unlike in 2008):

Line chart of After the pandemic, money soared and velocity fell, but both trends have now reversed (Q1 2020 = 100) showing MV? More like QT

The punchline for investors, especially those steeped in the 1970s monetarist consensus, is that money isn’t what it used to be. Looking at the money supply and the velocity of money doesn’t render a reliable outlook for inflation because the Fed drives both. (Ethan Wu)

Dara Khosrowshahi of Uber responds

We’ve argued that Uber’s plan to steadily buy back shares is a bad idea: one should only buy back shares in a price-dependent way, and Uber is growing so fast that it must have higher-returning internal investments. We’ve also noted our objections to Uber’s practice of excluding stock compensation from adjusted earnings. It’s the stock comp that leads to share count creep, which in turn incentivises stock repurchases, even when they are uneconomic.

Uber chief executive Dara Khosrowshahi sees things differently, and took the time to lay out why in an email, which with his permission we reproduce (very lightly edited) below. We don’t agree with all of it, but we are curious to hear where readers land:

“On buybacks being price dependent: I agree with your (and Mr Buffett’s) sentiment. Mr Buffett is one of the world’s greatest investors — estimating fair value is what he does. Most companies and most CEOs are not investors. Of course we allocate capital, but that capital allocation is mostly operational. I am quite confident in my team’s ability to identify high-return technical projects versus the alternatives, but if you ask me whether PepsiCo or Coca-Cola is the better investment? Well, that’s not my area of expertise. I’ve also observed that non-professional-investor CEOs tend to be quite poor at buyback timing. They are typically overconfident when their stock has positive momentum (‘of course my stock price is going to rise!’) and scared/under-confident when their stock loses momentum — and in that instance they tend to hoard cash unnecessarily.

I also believe Uber’s best days are ahead: we have a large, utility-like business that is still in the early days of penetrating its market.

This has led us to conclude that a consistent buyback programme is the right answer for Uber. We are taking the humble investment route of dollar-cost-averaging over what we hope will be multiple years. Of course, this does not preclude us from taking a more aggressive stance on capital returns if our stock were to dislocate in the coming years. It is also worth emphasising that the value creation from a buyback programme doesn’t happen in 1, 2, or even 3 years — but by doing so in a systematic and predictable manner as we continue to scale profitably. 

You brought up another question regarding Uber’s ability to invest more into our business. Of course we can invest more . . . [but] there are generally two types of investments we can make: variable cost (marketing, incentives, etc) and fixed cost (sales heads, engineers, etc.). It is true that we can invest more to hire engineers to build new features that could return 20%+ ROI. However, engineers are a fixed cost that we have to commit to over the next 5+ years. Conversely, if a stock market investment doesn’t work out, you can just sell it.

As Uber’s CEO, I have to bet that my engineering pod cannot only return 20%+ next year, but also earn a similar 20%+ each and every year afterwards. Ship one great project, identify another, ship again, rinse and repeat. If my engineering pod fails to return its cost of capital, I can’t sell it — I’d have to lay them off. That comes with a financial cost but more importantly a human and organisational cost. It has been my experience that providing a stable, challenging but consistent work environment is hugely beneficial to our team. They can be focused on work rather than networking for their next job in case there is a lay-off. While many other tech companies overhired during the pandemic and had to subsequently fire many of those same employees, we have been disciplined about our growth and focused on building great products versus endless restructuring.”

One good read

One problem with US politics: losing elections is too pleasant.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.

Recommended newsletters for you

Swamp Notes — Expert insight on the intersection of money and power in US politics. Sign up here

Due Diligence — Top stories from the world of corporate finance. Sign up here

Source link