How many lattes is a CEO worth? #NewsMarket

Good Morning. Yesterday Home Depot cut its sales guidance, blaming a cautious consumer. The company’s shares — much to Unhedged’s surprise — still ended the day up. Whatever fear was in the market last week seems to have left. Let us hope that this morning’s inflation report does not bring it back. Email us: [email protected] and [email protected].

Today at noon UK time and 7am eastern time Rob will be joining FT experts from New York, London and Tokyo for an FT subscriber event about the recent surge in market volatility. It will be good fun! Sign up at ft.com/marketswebinar.

Starbucks’ new boss

After replacing its CEO Laxman Narasimhan with Chipotle CEO Brian Niccol, Starbucks gained $21bn in market cap (an increase of 24 per cent) and Chipotle lost $5.7bn, all in a day. Can replacing one man with another possibly create that much value?

By our rough maths, that is the amount of additional value of Starbucks selling a billion extra venti lattes a year into perpetuity (that assumes $6 per venti at a 15 per cent net margin and a price/earning multiple of 21, for those who are following at home).

We’re sceptical. Unhedged has tended to take the Warren Buffett view of executives: good management is important, but the quality of the business is much more important (“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”).

There are examples of transformational leadership changes — Microsoft swapping Steve Ballmer for Satya Nadella, or Apple ousting Gil Amelio for Steve Jobs. And Niccol had real success at Chipotle after taking the helm in 2018. This from Jeffrey Sonnenfeld at the Yale School of Management:

Morale [at Chipotle] was low, communications were god awful, basically there was a loss of confidence by public health officials [before he came in]. About every constituency had lost confidence in the founder leadership . . . He dealt with a similar problem of food safety as CEO of Taco Bell, and was able to earn back trust and greatly improve communications, branding and expansion. The stock was up about 40 per cent the first year he got there.

Yet the problems at Starbucks of today are drastically different from those at Chipotle a few years ago. This is not a public health crisis. Starbucks is simply not meeting the moment. It is caught up in boycotts in the Middle East. And in China — its second-largest market — it has taken a beating from local competitors and a weakening Chinese consumer. Starbucks is also swatting away unionisation and struggling to cut long customer waiting times. In the US, the brand also seems to simply have lost its lustre, perhaps because its success has made it so ubiquitous.

The two businesses are also at radically different points in their life cycles. Starbucks is an international behemoth: nearly 40,000 stores in 85 countries. As of Q2, Chipotle has about 3,500 stores — the size of Starbucks in 2004.

Chipotle and Starbucks may also be on different sides of a consumer trend we recently mentioned. Fast-food chains such as McDonald’s have struggled, but pricier “fast casual” Chipotle has done well. It seems that poorer Americans are eating at home, while wealthier consumers are trading down to relatively high-end but still affordable brands such as Chipotle. Is Starbucks also stuck in the middle — with discriminating consumers going to hipster coffee shops while stretched consumers brew coffee at home?

And Niccol will not be just struggling against a picky consumer. Howard Schultz, the former CEO, played a big role in Narasimhan’s ousting. Schultz retains board observer rights and is the company’s largest independent shareholder, and has feuded with nearly all his successors. Narasimhan was only in the role for a year and a half. How many lattes would it be worth if Schultz retired properly?

(Reiter and Armstrong)

Is everything a carry trade now?

Much of the focus, here and elsewhere, during the recent market mini-crash was on the yen carry trade. Investors who borrow cheaply in yen and invest in currencies with higher returns are vulnerable to unexpected changes in the value of the yen, the investment currency, or the investment itself. And when changes hit, carry traders need to get out fast, because the trade’s funding side comes with risk limits.

But what if the focus should be on more than just the yen carry trade? What if the whole market has this structure? Kevin Coldiron, a former quant fund manager who now teaches at the University of California, thinks it does. He co-authored a book saying so, and recently applied his ideas to the mini-crash on his substack.

Coldiron argues that carry trades have several salient features. They are liquidity-providing, meaning they move money from where it is abundant to where it is scarce. They are always bets on the world staying the same, or rates and other prices staying within their usual ranges; in other words, they are short volatility. And when there is a sharp jump in volatility, carry traders have no choice but to sell to raise cash, which can then create more volatility and more selling, and ultimately a crash.

All true. The controversial part of Coldiron’s thesis is that the S&P 500 has become a huge global carry trade. The S&P is the most heavily traded global risk asset, and an immense ecosystem of derivatives and other leveraged trading vehicles have grown up around it: index futures, zero-day options, Vix options, leveraged exchange traded funds, and so on. The S&P risk ecosystem is so interwoven with other risk assets that “S&P 500 volatility is . . . a proxy for volatility of risk assets everywhere”.

Unexpected moves in the index itself can prompt fire sales in the derivatives ecosystem, and those fire sales can move the index in turn, whether through hedging or the simple need to raise cash. Any risk asset held in portfolios exposed to the S&P (that is, almost all portfolios) might start to move as well. Everything is a carry trade because everyone is short S&P volatility.

(Yes, every trade has two sides, so everyone is also long volatility, too. But it’s the short volatility side of the trade that has the risk limits, so that’s the side that blows things up.)

One objection is that markets have always been vulnerable to leveraged speculation, and have always been defined by steady trends broken up by bouts of acute volatility. Coldiron’s response response is that it is a matter of degree. He argued that things became much worse in 1998 when the Federal Reserve organised an industry bailout of Long-Term Capital Management (a fund which Coldiron describes as running a huge book of short volatility trades). Once it was clear the Fed would act to prevent volatility trades from exploding, their popularity grew. And the Central bank continues to suppress volatility, most recently with its corporate bond backstop in 2020.

Another objection: the S&P 500 has not been that volatile, really, since 2008. The latest crisis abated in a week, leaving little apparent damage. If the market is a huge carry trade, where’s the huge crash?

One good read

Colour war captains and summer camp prestige.

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