Last week, we reported that the economy exited 2023 on a strong note: Q4 2023 GDP increased +5.8% year-over-year on a nominal basis. Coupled with the strong holiday season, strong stock market, monetary tightening done and easing ahead suggested that 2024 would again be a strong year for the economy, consumer spending, and a better year for housing. And so, why the high number of announced corporate layoffs that the WSJ report on daily?
We think that there are four primary contributors.
- First, with stock prices and valuations elevated, management teams know that to justify and continue the upward momentum, they need to produce higher margins and return-of-invested-capital (ROIC), and better-than-expected earnings. Efficiency and automation that boost productivity and eliminate tasks and layers allow for that, reducing the number of employees needed. Generative AI is a technology that enables that.
- AI is now part of nearly every C-level conversation and companies are charging fast to not be passed by competitors. The growth of the cloud business for Amazon, Google, and Microsoft is at a +$40B annualized run rate. If half of this is cloud customers testing and deploying new AI capabilities, that’s $20B in expense that needs to be offset by “efficiencies” elsewhere.
- Certain companies are still adjusting to smaller market sizes than they planned for when hiring during the pandemic. The so-called “reality set in.” We’d include the electric vehicle (EV) market in this bucket where the market adoption has been slower than planned for. We’d expect the latest rounds of layoffs to be the final ones. Said differently, whether Wayfair, Chewy, Stellantis, GM, hire or lay off again is dependent upon their ability to take market share in a higher cost of capital world.
- As a result of structural change to industries (TV networks, for example) and unit economics, companies need to make offsets elsewhere. For example, in response to labor contract negotiations, UPS and the automakers made large increases in compensation for drivers and plant workers. Layoffs that fall into this bucket are more of a one-time adjustment.
Case in point on contributor #2: During its most recent earnings update, UPS announced that they would be letting go of 12K management jobs, 14% of the non-driver/servicepeople, to save $1B in expenses. UPS CEO Carol Tome noted, “[T]echnology has changed just so much in the past year, when you think about the advent of generative AI and the applications inside of our business, we're just getting started and I'm really excited about what the future will mean in terms of driving productivity and as well as improving the customer experience.” UPS CFO Brian Newman also added, “As volume returns to the system, we don't expect these jobs to come back. It's changing the effective way that we operate.”
We can also see the early effects of AI in the results of Google, Meta, and Amazon, beyond their cloud businesses. All three are early movers and implementers of generative AI for their core business. For example, all generate massive data, which is necessary train generative AI systems (first-party data is free, third-party data is very expensive); for example, 3.1B people use at least one of Meta’s apps each day. All three are delivering faster revenue growth in their core advertising businesses and all are seeing nice lifts in their productivity/efficiency/profitability. For example, Meta’s “Family of Apps” segment produced $21.2B in revenue and 53.9% operating income margins in Q4 2023, up from $10.7B and 34% in the prior year. For 2024, the segment is expected to produce $83B in revenue and 53% in operating income margins.
All three companies are leaning hard toward AI for others. This week, Meta CEO Mark Zuckerberg noted, “Everyone who uses our services will have a world-class AI assistant to help get things done, every creator will have an AI that their community can engage with, every business will have an AI that their customers can interact with to buy goods and get support, and every developer will have a state-of-the-art open-source model to build with. I also think that everyone will want a new category of computing devices that let you frictionlessly interact with AIs that can see what you see and hear what you hear, like smart glasses. And one thing that became clear to me in the last year is that this next generation of services requires building full general intelligence. Previously, I thought that because many of the tools were social-, commerce- or maybe media-oriented that it might be possible to deliver these products by solving only a subset of AI's challenges. But now it's clear that we're going to need our models to be able to reason, plan, code, remember and many other cognitive abilities in order to provide the best versions of the services that we envision.” Scale up these ambitions of Meta, to include those of Google, Amazon, Apple, Microsoft, Walmart, and others is billions of dollars to the tune $100B annually in the next couple of years by leading technologists on one technology like generative AI is quite rare.
In Placer’s latest TL;DR post on LinkedIn, we discussed that one of the biggest lessons of 2023 was that the unprecedented keeps happening, including 2020, 2021, 2022, and 2023. We are now seeing the signs of “unprecedented".
Zuckerberg also commented on efficiency and doing more with less, “Obviously, we're in a place now where the business is performing well. And I think the obvious question would be, okay, well, given that, should we invest a lot more in things? And the biggest thing that's holding me back from doing that is that at this point, I feel like I've really come around to thinking that we operate better as a leaner company. So even though...there's always questions about like adding a few people here or there to do something. And I guess I just have more of an appreciation about how all of that adds up and in the near term, maybe makes you go a little bit faster. But over the long term, the discipline to kind of hold things to a more streamlined level actually improves the overall company performance. So I'm really focused on that. In 2024...in terms of new headcount that we added to the plan, it's relatively minimal compared to what we would have done historically.” (We’d expect this characterization of Meta’s approach to staffing to generate discussions in the boardrooms across America. We’d expect Meta’s strong stock performance to be referenced by proponents of efficiency. In conclusion, we’d watch this story closely as this too is a possible “unprecedented.”
This week also brought a Federal Reserve FOMC meeting and Fed Chair Jerome Powell's press conference. The Committee kept its benchmark interest rate unchanged, and Powell said officials still have concerns about getting inflation sustainably down to their 2% target, making a rate cut as soon as their next meeting in March unlikely. As we’ve been writing the past few months, inflation is going in the right direction (deceleration), but not fast and hard enough. A definitive “down” in food inflation is what they are watching. We are getting close to that, but more capitulation by packaged food producers is needed. We still expect that soon, the producers are just more stubborn than was foreseen. The net-net of the decision and comments, in terms of market expectations, was a meaningful moderation in expectations for more than four interest rate cuts this year.
Powell also noted, “The economy has made good progress toward our dual mandate objectives. Inflation has eased from its highs without a significant increase in unemployment. That’s very good news. But inflation is still too high, ongoing progress in bringing it down is not assured, and the path forward is uncertain. I want to assure the American people that we are fully committed to returning inflation to our 2 percent goal. Restoring price stability is essential to achieve a sustained period of strong labor market conditions that benefit all...Our strong actions have moved our policy rate well into restrictive territory, and we’ve been seeing the effects on economic activity and inflation. As labor market tightness has eased and progress on inflation has continued, the risks to achieving our employment and inflation goals are moving into better balance...My colleagues and I are acutely aware that high inflation imposes significant hardship, as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation. We’re highly attentive to the risks that high inflation poses to both sides of our mandate, and we’re strongly committed to returning inflation to our 2% objective.”
In response to a question on why consumer confidence is unusually depressed, Powell said, “We’ve asked ourselves why that is and one obvious answer—we don’t pretend to have perfect wisdom on this, but one obvious answer is that the price level is high. Prices went up much more than 2% per year for a couple of years and people are going to the store and they’re paying much more for the basics of life than they were two and three years ago, and they’re not happy about it. And it’s fine that inflation is coming down but the prices they’re paying are still high. So that is what—that has to be some part of why people are unhappy and they’re right to be unhappy. You know, this is why we need to keep price stability. It’s why we need to do our jobs so that people don’t have to deal with things like this.”
In response to a question on “when” will the committee have confidence that they have hit the 2% objective, Powell said, “So what are we looking for to get greater confidence? Let me say that we have confidence. We’re looking for greater confidence that inflation is moving sustainably down to 2%. Implicitly, we do have confidence and it has been increasing, but we want to get greater conference. What do we want to see? We want to see more good data. It’s not that we’re looking for better data; it’s that we’re looking at a continuation of the good data that we’ve been seeing.” And in response to a similar question, Powell said, “We’re not looking for inflation to tap the 2% base once. We’re looking for it to settle out over time at 2%.”
What does the sum of this mean for consumer confidence and spending in the first half of 2024? For a baseline and level, we use the average of 2018 and 2019, and November 2023’s level. Our measurement of “retail sales” is General Merchandise, Apparel and Accessories, Furniture and Other Sales (GAFO), which is the collection of discretionary retail categories which excludes gasoline, auto, grocery, etc. Recall that last January, GAFO was very strong (+7%) as retailers flushed inventories to get clean before the end of their fiscal years, thus setting up January 2024 with an impossible comparison. The remainder of 2023’s months was an average of +0.7% growth year-over-year. Last week, we wrote about the weather’s havoc on January and the “payback period” that is likely in January/February resulting from December’s surge. January and February are also “shoulder periods”, and shoulder periods which have been softer than usual in 2023; there is little reason for that not to continue in 2024. The layoff and AI news may also make consumers more cautious in the early months of 2024. GAFO for January could be down mid- to high-single-digits. However, when we get into March, the noise will have settled those and spring will have sprung, sending shoppers into the stores and centers.
March and May of 2023 were also softer months, setting up 2024 to outperform in these months. April has some base-period pandemic effects (April 2020 was when retail took a beating), making it more challenging to model the month; thus, its a TBD. June 2023 was a better month, but we’d also expect the momentum to be solid in 2024 given the arrival of Summer. Adding the momentum, per our outlook, is lower grocery prices, the first of the 1st FOMC committee interest rate cut (early May), and more stability in employment (i.e., months past 2024’s early layoff wave). Our early preview of 2024 also pointed to improving trends for housing and home-related categories as we move through 2024, which we refreshed on last week. That’s more of a second half of 2023 tailwind. There may also be of element of “celebrate while you can spending” by consumers ahead of the fall and the peak of the election cycle. In sum, we expect the first half of 2024 to start soft and then stabilize before setting up the second half for a stronger pace, which has soft compares until November/December.
There is also a reflexive feedback element should our GAFO outlook be as soft as we expect in the first half of 2024, which is that retailers and brands would further cut prices and increase promotional events to gain share-of-wallet with consumers. That downward pressure on goods prices, plus the slack demand, would embolden the Fed’s confidence that they had licked inflation, which in turn, would draw forward the eventual interest rate cuts and deepen them. That in turn, would further catalyze consumption of big-ticket and home-related items, as well as housing, and set the second half of 2023 for stronger personal consumption expenditures and economic growth.
