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The Consumer is Weak… But You’d Never Know

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The Consumer is Weak… But You’d Never Know

If Retail sales are a proxy for consumer spending, then it’s being overstated.

Not by a little… but by a lot.

Retail Sales figures are mistakenly including a thick slice of non-retail corporate business.

You see, non-store online retail sales (aka Amazon) began to accelerate in July. Meanwhile, big-box (aka Nordstrom and Macy’s) store sales fell.

The casual reader would assume that this was just another step in the cannabilization of brick-and-mortar stores.  From one pocket to the other.

But something much different is taking place. Retail sales include Amazon.

Instead of swapping one sales channel for the other… they’re mixing apples-and-oranges.

Consider Amazon’s cloud services business (Amazon Web Services or AWS.)

Thanks to achieving the highest level of federal security clearance, AWS has picked up over 2,300 government agencies using its cloud services. Amazon’s AWS business is increasing its share of the government’s $70 billion annual budget for IT spending.

On top of that, there is the basic business use of the AWS offerings.

Business is booming:


Amazon’s AWS sales (monthly avg.)

2013:  $260 million

2014:  $390 million

2015:  $650 million

2016 (Q1): $900 million

Amazon is on track to do about $12 billion in annual cloud services – $5 billion more than last year.

That is likely being included in Retail sales, although it is essentially government and business spending.

Now factor in Microsoft’s cloud service sales (approximately $3 billion per year).

You can see Amazon and Microsoft are distorting the retail sales figures.

Retail vs Nonstore

Simply remove non-store sales from retail spending and the annual growth in spending falls from 2.5% to 1%.

However, it’s impossible to really isolate out how much cloud services contribute to non-store retail sales. The Census Bureau only goes by a company’s reporting. So if the Census Bureau includes Amazon in the survey, they’re surely including its AWS revenues. (Its probably safe to say Amazon is included considering its the biggest contributor to U.S. non-store retail. And today, all retailers now have a strong online presence while mobile shopping is no longer a novelty number.)

Based on this adjustment, the already mild consumer spending growth is barely positive.

To net it out, the addition of Amazon and Microsoft’s cloud services overstates the consumer spending numbers… by billions of dollars.

Lots of retailers cater to both business and consumers: Costco, Office Depot, and so on.

But very few have added ~$5 billion in annual revenue that is essentially corporate spending on IT.

With U.S. gross domestic product (GDP) and retail spending already anemic, any interest rate increase or uptick in inflation will significantly hurt consumer spending. 

KEY POINT: The consumer is weaker than reported. They’re not spending as much as perceived. Once consumer spending contracts (which we see it’s beginning to), businesses will forego investments. And even cut jobs. We’re close to that inflection point. A main reason it hasn’t happened already is because retail sales include “cloud services.”


Andrew Zatlin

Editor of Moneyball Economics

Picking Winners in a Semiconductor World

By | economics, economy, Uncategorized | No Comments

We know full well by now that the global economy of the 21st century can be effectively summed up by the prowess of the semiconductor and smartphone markets. Semiconductors are the modern equivalent of oil or steel.

With that in mind, we can begin to pick out who the winners and losers of the near future will be:

  • iPhone sales make 3Q macro economic data look weak but will push up 4Q
  • China, as an iPhone manufacturer, will benefit
  • Semiconductor sales show more German and overall EU weakness
  • US is still chugging along but signs of slower growth are appearing

Regional Economic Distress and the Smartphone Economy

The smartphone frenzy unleashed by the iPhone 6 will boost China and Taiwan in 4Q on a macro level. In fact, the anticipation contributed to 3Q economic softness as sales of older models dipped. Markets may feel a bit reassured if they see some uptick from China.

Given that (1) German Industrial Production is contracting, (2) Sony reported a $2B profit loss and (3) Samsung announced plans to build a $15B semiconductor plant; you can start to see who is and who isn’t a player in the digital economy.

It’s a good time to be a semiconductor maker. Sales are entering the longest period of growth since 2010, and are on target to hit the longest streak since the dotcom boom. Smartphone imports into the US will breach $100B.

Semiconductor Billings

However Germany and Japan (Sony) won’t benefit because they are non-players in the 21st century digital economy. Conversely, Korea (Samsung) is a dominant player in the smartphone world.

Rewarding the Smartphone Players

If you want to predict the future of the global economy, pick out the major players:

  • US Designs: Most of the hardware and software is designed by US companies. Qualcomm, nVidia, Google and Apple to name a few.
  • Taiwan Manufactures: Almost 50% of smartphone semiconductors come from Taiwanese companies such as TSMC and UMC.
  • China Assembles: Apple could not sell 10M iPhone 6’s in one week without the formidable assembly strength of Chinese companies.

The impact can be quite impressive. Tiny Vietnam exported $38B in electronics last year (source: International Trade Council). They rank as the 12th largest export country. The reason? Samsung assembles in Vietnam. Just a few years ago they were best known for exporting sneakers.

The key point in all of this is that the iPhone 6 will boost China’s macro, which should reassure the markets a bit. However conditions are ripe for widespread currency intervention, leading to a strong dollar.

EU Suffering From a China Slowdown

The SouthBay Shipping Index has contracted for the first time in a year. Back in April, SouthBay began sounding the alarm that the EU would see a recession sometime in 4Q 2014 or 1Q 2015.

The primary signal was the SouthBay EU Shipping Index, which leads the EU economy by ~6 months. (The EU economy relies on goods shipments and the Index measures specific data that is especially sensitive to early shifts in demand for goods.)

The Index first began to slow in 2Q and then it tipped over.

EU Shipping

Auto production is getting hit. Semiconductors reflect the same slowdown trend.

Germany is a big consumer of semiconductors, especially in cars where semiconductor penetration continues to grow thanks to ever more safety and entertainment features.

Germany also depends on Chinese auto sales. Per the China Association of Automobile Manufacturers, China auto sales have been slowing from 14% Y/Y in May to 10% in July and 8.5% in August. With 24% of the Chinese auto market, Germany is suffering.

Semiconductor Europe

Not to mention the US auto market has peaked. Factor in the Russia/Ukraine geopolitical saga, and it’s time for monetary action again. Inflation? What Inflation? August inflation hit 0.4% (vs -0.3% in July). Europe is seeing the lowest annualized inflation since October 2009. With that in mind, a cheaper Euro is easily allowed.

China’s Much Needed iPhone 6 Boost

China’s exports are not doing very well. The country’s credit bubble is bursting and pulling down the domestic economy. Efforts to prop up the all-critical real estate market include lowering down payments and easier credit terms, but a slowdown is inevitable.

This makes exports more critical than ever.

As the chart below shows, Hong Kong exports are slowing down at a bad time.

Hong Kong Exports

Echoing the slower trend, US imports from China in August grew a mere 1.7% Y/Y.

That’s partly the law of big numbers. The US imports ~$450B from China, about 25% of total US imports (ex autos, petroleum). Squeezing another 5% would be the equivalent of adding Russia’s entire exports to the US.

US Imports

A slowdown has been in the cards for a while. In 2010 YTD, China’s exports to the US grew $45B Y/Y. In 2011, $26B. In 2014 it is down to just $13B Y/Y.

China is hugely dependent on smartphone exports and the iPhone 6 is driving recent export stagnation. This means China’s 2H macro story should improve.

From an export and industrial production perspective, not all smartphones are equal.

On one side is Samsung. A Samsung sale is good for Korea (where the chips are manufactured) and for Vietnam (where the phones get assembled).

On the other side is everyone else, including Apple. Chips get made in Taiwan and China, and products get assembled in China.

From a Chinese perspective, a Samsung win is a China loss. An Apple or Xiaomi win is a China win (Xiaomi is a Chinese maker of Qualcomm phones). Over the past year Samsung gained market share at Apple’s expense largely because Apple’s iPhone 5s was behind the curve in terms of features, functionality and price. More recently, Samsung has been knocked out of the Chinese market by lower priced Xiaomi, a local product.

Then there’s Apple. Apple sales typically stagnate before a new release, and then they jump. The iPhone 5s was a placeholder, a less innovative release, and the unit sales reflect disappointment.

The much awaited iPhone 6 set sales unit records of 4M in the first 24 hours and 10M unit in the first week.

iPhone Sales

Bullish expectations will be a welcome boost for Chinese manufacturers like Foxconn. The Apple release schedule effectively pushed out sales from 1H 2014 into 2H 2014. Suppliers report that Apple has ordered 68M units, a 27% Y/Y jump. It would double 3Q’s iPhone exports from China. An extra 35M units means $6B+ in Chinese exports. Add in some economic multipliers, and it will boost China’s GDP by at least 0.5%.

The impact of smartphones on China’s exports is seen here.

Impact of Smartphones on China

In August, US phone imports shrank (-3.6%) Y/Y and China imports stalled at 1.7%.

Smartphones are the third largest US import, after gas and cars. At least $110B+ of phones will be imported this year, mostly from China.

A slowdown in smartphones immediately translates into a slowdown in imports from China. Until another growth engine appears, China’s marginal growth depends on this market.

China is Positioned Well for 4Q

First, the latest macro data reflects the world before the iPhone launched in September. Expect China-US trade to rebound accordingly.

Second, China is taking the lead for low-end smartphones, and that’s where the growth is. Samsung just reported $3.8B in profit, down 60% from last year because they have lost the China market to Xiaomi.

Although we’re still just talking about a 0.5% boost to GDP. That’s nice, and it could make the markets think that China has recovered growth, but a cheaper yuan will do more.

Like Europe, inflation has moderated: 2% and well below Beijing’s desired 3.5%.

With China positioned well, US companies reaping some of the benefit and Janet Yellen firmly in place as the Fed leader, look for Central Bank coordination that allows for a stronger dollar.

Semiconductor Companies: Cautious Today, Hopeful Tomorrow

Semiconductor companies are a proxy for the private sector in general.

The Great Recession is alive and well in the minds of producers today. Fear of excess inventory dominates every investment decision.

Consider the Semiconductor Equipment Book-to-Bill ratio. For decades demand hurtled between shortage and excess, but for the last two years, the ratio has hugged the 1.05 level. Forward demand has remained cautious and risk-averse.

Semi Equipment

Producers have reason to be cautious. Based on silicon wafer consumption, chip unit production has been pretty flat Q/Q.

Silicon is to semiconductors as iron is to autos. Semiconductors are built like layer cakes, using silicon wafers as the bottom layer. 2Q wafer shipments surged in preparation for the September/October phone and tablet releases, but demand ex-smartphones is mild.

Silicon Wafer

Capital Intensity measures CAPEX divided by revenue. This metric has held steady at ~$20 because there is an oligopoly managing supply. Prices are high and stable, and producers don’t want to disrupt the situation.

Capital Intensity

This makes Samsung’s decision to build a $15B plant very interesting. It means that they see enough future demand to absorb massive new supply. In dollar terms, Samsung is expecting at least $150B+ in future demand growth at $10 Capital Intensity and $300B at current levels of semiconductor billing.

For context, total global semiconductor sales hit $305B last year. That’s a big commitment and the Matrix-like smartphone ecosystem is the main reason for the expectation.

The Internet of Things (IOT)

Every new consumer product goes through an evolution where the complexity gets hidden.

The first cars had unbelievable failure rates and the original chauffers were more garage mechanics than limo drivers. Over time, the complexity got hidden and ease of use increased. Goodbye manual transmissions, hello automatics.

The smartphone is a runaway hit because it eliminates the PC complexities. Focusing on ease of use, it turned the PC into a consumer device.

The IoT is about connecting everything to the Internet. It’s a grand plan. And the starting point is the smartphone because everyone already has one. It is essentially a computer in your pocket that can talk to big computers in the Cloud and small computers around you, all while you are on the go.

A lot of money is getting poured into the IoT. If you take every smartphone user and convince them to buy a network-connected pair of glasses and a watch, that’s a lot of silicon being sold.

The problem is that the devices don’t deliver to expectation. The Apple Watch can last a day without charging. People don’t want yet another gadget that could fail if it doesn’t get powered up daily. (It’s like some bad episode if Ultraman – will he make it to the Sun to power up just in time?) That’s just one example of the gap between what today’s hardware can support and what the consumer market needs.

The other problem is typical of Silicon Valley. There’s new technology in search of a need. Just because I can have shoes that monitor my daily walking, why should I? Well, apparently a few million people found a reason.

So investments are being pumped into new batteries and chips that consume power differently. Also into security since so many devices are interacting and listening in.

Enable the technology and eventually the applications will emerge.

What About 4Q?

4Q had the chance to be a massive event. Strong smartphone sales coupled with strong peripheral sales (wearable devices). Instead, suppliers have to make due with just smartphone sales. That means excess inventory in late 4Q.

Will wearable devices be more fizzle than sizzle? These are the early days. When Apple released the iPhone, it took years to break 10M units of sales.

Early this year, IDC forecast wearable device sales would hit 19.5M units in 2014. Recently, Canalys announced that YTD sales have been only 6M.

What’s missing might be the big product release. Apple pushed out their Watch release to February. HTC just announced the same. Google Glasses still are not widely available. More options will emerge over the next few months, but the shortfall is a problem for producers.

Also missing is a value proposition. What do you get for $300? Most smartwatch offerings boil down to reading text messages on your wrist. Lots of gadget-hungry people will buy the latest thing indiscriminately, especially for <$100. Yet expectations rise at a $300 price point. Samsung had to re-launch their product line-up because, to put it plainly, the products themselves sucked.

It’s really easy to create a wearable device. It’s a lot harder to find the killer application.

Apple is Winning, Others Are Losing

Apple suppliers are much happier than others.

  • Samsung phone sales are disappointing. They lost on the high-end (Apple) and on the low-end (Xiaomi).
  • Amazon Kindle Fire is disappointing as well. Amazon expected to sell a few million units. Instead, the market yawned. Prices have been cut from $200 to $99.

Samsung is now sitting on a mountain of excess capacity. Amazon’s suppliers have lots of excess chips as well.

Add to this excess the miss in wearable devices, and suppliers will face pricing pressure and inventory corrections in December and into 1Q 2015.

Yet strength remains apparent for China and Taiwan in 4Q macro, as they are the clear winners to emerge from the smartphone battle arena.