Good morning. We enjoyed meeting Unhedged readers at Tuesday’s FT Alphaville pub quiz in New York, where a team from GIC, the Singaporean sovereign wealth fund, brought home gold. We would’ve bombed the quiz ourselves. Questions included: “To the nearest thousand dollars, what is the highest value of pizza that Domino’s Pizza’s chief executive may have received as part of his compensation last year?” Email us: robert.armstrong@ft.com and ethan.wu@ft.com.
CPI: stuck
If three data points make a trend, then US inflation looks stuck at 3 per cent. That’s the message of yesterday’s March consumer price index, the third stubbornly hot inflation report in a row. The three-month average of core CPI is running north of 4 per cent, and the longer term averages aren’t far behind:
It’s not quite as bad as the chart above suggests, because personal consumption expenditure inflation, which the Federal Reserve targets, is running nearly 1 percentage point lower than CPI. But the recent trend is clear and inflation concern is due.
The market reaction on Wednesday was big. Stocks fell, futures markets further lowered rate cut expectations, and yields surged across the curve, led by the two-year which was up 23bp. The two-year is still below 2023 highs but has risen nearly 75bp this year. It all reflects the view that the Fed will keep rates higher for longer, and may not cut at all in 2024.
The reaction is justified by the composition of the March CPI data. Core services inflation rose an annualised 6 per cent, and unlike in the past two reports, there were no big anomalies to blame. Arguing CPI looks hot because of a start-of-the-year “January effect” price adjustment only works for so long. Used car prices, which rose in February and lifted overall goods prices, fell 1 per cent in March; goods deflation also resumed. Airfares and hotel prices, two volatile categories which can throw off the data, were both well behaved.
Instead, inflation came in strong in services categories that have looked persistently hot for a while: shelter, medical care and auto services. Shelter inflation again bucked longtime predictions that it’ll fall to match the more benign trend shown by new lease data from the likes of Zillow. Medical care was driven by strongly rising prices for hospital services (up 1.2 per cent in March), likely reflecting big recent wage increases at major hospital systems.
Meanwhile, car insurance and auto repair shot up 2 per cent and 3 per cent, respectively, in March. These two categories make up 7 per cent of core services inflation and have rather scary-looking longer-term charts:
There is still a case for optimism. Though the labour market has broadly normalised already, wage growth has ground down more slowly. The latest data suggest 4 per cent to 5 per cent wage growth, compared to a pre-pandemic 3 per cent to 4 per cent. That could mean it’s only a matter of time until slowing wage growth lessens price pressure on, say, hospital or car repair inflation. Shelter inflation could also fall further, as analysts have long predicted. No one knows the “right” lag time to expect between the Zillow rent and CPI rent data; it could simply be longer than anticipated. Three months of sticky inflation is worrying, but could prove a bump in the road.
On balance, we think this CPI report is a blow to fast-disinflation optimism, and creates significant uncertainty around rate-cut timing. So it makes sense markets flinched yesterday. The bigger question for investors: how much did the recent rally depend on imminent rate cuts to begin with? (Ethan Wu)
Apple lawsuits: different this time?
I have been covering tech companies on and off for a couple of decades, and all through that time intelligent and well-informed people have been telling me, periodically, that some lawsuit or other is going to do serious damage to the super-profitable business model of some Big Tech company. Microsoft is the prime example here, but there is also Oracle vs Google, Motorola vs Qualcomm, assorted efforts to restrain Google’s ad business, and so on. It is only a minor exaggeration to say that none of this has ended up mattering one tiny little bit. Microsoft, which has had more legal targets painted on its back than anyone, is the highest-valued corporation in the world.
So it is hard for me not to shrug off the US Department of Justice’s lawsuit against Apple, which alleges the iPhone maker is a monopolist. This kind of thing has never mattered before. Why should it now?
Dan Ives, an analyst at Wedbush who has a buy rating on Apple, says “it is different this time because the pressure is building globally and the DoJ has struck when the iron is hot”. He says the litigation is, on a risk scale of 1-10, an eight, whereas other tech litigation in recent decades was a two or three. While he thinks the chances of the justice department forcing an overhaul of the company’s business model are low — less than 20 per cent — this would have a big financial impact.
The war on Apple is indeed multi-front. In Europe, the competition authorities have fined the company €1.8bn for suppressing competition from rival music streaming services on its platform. That’s a sum Apple will fish out from the couch cushions, but is a taste of the fines and remedies that could come with the EU investigation of Apple’s and Google’s app stores under the Digital Markets Act. Meanwhile in the US, the legal fight with Epic Games won’t go away. The Fortnite game maker says Apple has violated a judge’s order to allow app developers to steer customers to transaction platforms outside of the app store. And the justice department’s antitrust lawsuit against Google’s search business threatens the payments Google makes to Apple to be the default search engine on the iPhone — a large, pure-margin chunk of revenue.
All the legal challenges focus on a single, two-sided issue: Apple’s ability to trap consumers within its iPhone ecosystem, and to extract payments from rivals who want to get at those consumers. This basic issue applied to music streaming, transaction steering, watch-phone pairing, digital wallets, and so-called “superapps”.
Nick Rodelli of CFRA Research, who specialises in legal questions, thinks the DoJ has a three-in-four chance of winning the case and the victory surviving Supreme Court review. This outcome might take as little as three years, he says. This puts Apple’s services revenue, which accounts for about a third of operating profit, at risk. His central case is a 10 per cent hit to earnings per share — a lot, for a company that is not growing earnings particularly quickly any more.
A more benign while still realistic view comes from Gene Munster of Deepwater Asset Management. He too sees a significant chance of the DoJ successfully enforcing remedies on Apple in many of the areas it is targeting — watches, wallets, superapps, and so on. But he thinks increased openness may not lead to that much consumer switching. “Just because it is easier to switch doesn’t mean people will.” People trust Apple as a brand, he says, because the products work well. “It keeps coming back to who has the good products,” he says. The biggest worry, in his view, is therefore the loss of the Google money.
This view chimes with Unhedged’s strong belief about the immense laziness of most people in most domains. Investors need to think about the following equation. Estimate how much better a rival product is than Apple’s, in terms of price or (subjective) quality. Subtract the (subjective) cost of switching. If the result is negative, Apple should be OK. And remember, people loathe switching their digital and financial infrastructure, even if it doesn’t take that long.
To simplify even more, the key question about Apple is still not about the legality of its business model. It’s about the quality of its products. Are they still better, or at least not much worse?
One good read
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