Slow and Steady

By?Weronika Pycek,?Shawn O'Malley, and Matthew Gutierrez· May 31, 2023

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?? More evidence of a resilient economy was delivered Wednesday. The number of U.S. job openings unexpectedly rose in April, increasing for the first time since December and adding to optimism that the economy is more resilient than feared.

The economy is hanging in quite well, though some see the latest job news as a reason to believe the Federal Reserve could hike interest rates once again at its meeting in two weeks???

Check out our Chart of the Day below for the jobs data visualized.

Amid all the data and debt ceiling negotiations, the S&P 500 has remained largely unchanged over the last month, six months, and year.

—?Matthew

Here’s the rundown:

Today, we'll discuss two items in the news:

• Korea’s quest to join the financial big leagues
• China’s sluggish domestic demand
• Plus, our main story on the fascinating business of Costco wholesale

All this, and more, in just?5 minutes to read.

POP QUIZ

The hot dog and soda combo (only $1.50!) at Costco is a staple among its loyal fans. How many combos did Costco sell during the 2021 fiscal year? (Scroll to the bottom to find out!)

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IN THE NEWS

???? Korea Vies to Join Financial Big Leagues (Bloomberg)

Home to more conglomerates than?Hong Kong, with a?GDP?not much smaller than?Canada’s, and a longer life expectancy than?New Zealand,?South Korea?is pushing to no longer be classified as an?emerging market?by the financial indexing giant?MSCI.

MSCI designs stock indexes?that investment funds use as their benchmark, influencing how?billions?of dollars are allocated worldwide.

• For example, many people use passive index funds in their retirement accounts tracking MSCI’s indexes. Which indexes countries and their public companies are included in, and the weights they carry in those indexes, can impact?financial inflows?and?investors’ returns.
• Ultimately, there are?no clear rules?on distinguishing a developed market from an emerging one — a growing sticking point in international finance.

Ahead of MSCI’s annual review in?June, the country is pushing financial reforms, with?South Korea’s President?emphasizing his priority to fix “outdated regulations” and better protect minority shareholders.

Why it matters:

Inclusion of Asia’s?fourth-largest economy?in MSCI’s list of?23?developed countries would be an important signal to investors about the maturity of South Korea’s capital markets, and?Goldman Sachs?estimates more than?$50 billion?could flow to the country as a result.

It could also be a considerable step toward eliminating the so-called “Korea discount” — a chronic markdown in market valuations for Korean stocks compared to global peers.

• That comes partly from the nation’s reputation for?family-run conglomerates?with?poor corporate governance. In a developed market index, South Korean companies would be held to a higher standard.

Not everyone is eager for the potential change. One portfolio manager commented, “If Korea gets upgraded to developed markets status, it’ll become a?smaller fish in a bigger pond, with fewer Korean stocks likely contributing to MSCI indexes.”

• While about?$1.8 trillion tracks the MSCI emerging markets index, about?$3.5 trillion?follows its developed markets gauge.

???? China's Factory Activity Falls to a Five-Month Low?(Reuters)

China's factory activity?shrank?more rapidly than anticipated in May due to?weakening demand, intensifying the pressure on policymakers to address the country’s faltering post-Covid economic rebound.

China's official manufacturing purchasing managers' index (PMI) dropped to a?five-month low?of?48.8?(below?50?indicates contraction instead of expansion).

• In?May, China’s service sector witnessed its?slowest expansion in four months, and the?National Bureau of Statistics?highlighted a contractionary shift in factory output,?accompanied by a decline in new orders for the second consecutive month.
• "The?sluggish domestic demand?could weigh on China's?sustainable growth?if there are no efficient and effective policy moves to engineer a broad-based recovery," said?JLL’s chief economist.

Analysts at?Nomura?and?Barclays?have now reduced their?2023?GDP growth forecasts?for the country.

• Nomura added, “unlike previous cycles, we see?no easy fix?this time around as, in our view, the real barrier to sustaining the growth recovery is a lack of confidence.”

Why it matters:

As the world's?second-largest?economy emerges from three years of comparatively strict pandemic lockdowns, the economic reopening that investors were so excited about seems to be hitting a roadblock.

• From the end of?October?to late?January?of this year, an?ETF?of Chinese stocks (ticker:?MCHI) rose some?59%?on reopening hopes, only to?fall?more than?23.8%?in the time since, with the country’s economic bounce back largely failing to meet expectations.

• As?Reuters?puts it, “Last month, imports contracted sharply, factory gate prices fell, property investment slumped, industrial profits plunged, and factory output and retail sales both missed forecasts.”

This comes as JPMorgan CEO?Jamie Dimon?warned that “uncertainty” about the Chinese government’s policies risks has hurt investor confidence, particularly as tensions with the U.S. have escalated.

• Dimon also called China’s youth unemployment figures “scary,” which reached?20%?in?May.

MORE HEADLINES?

?? Congress expected to?vote?on debt ceiling Wednesday evening

?? Twitter may only be worth 1/3 its?pre-Musk value, according to Fidelity

?? Tech leaders?warn?AI poses an existential risk for humanity on par with nuclear war

CHART OF THE DAY

THE FASCINATING STORY OF COSTCO

Airplane hangar beginnings

Costco opened in 1976 in a converted airplane hangar on Morena Boulevard in San Diego, a humble beginning for a global company that now posts a market cap of over $220 billion.

The store, then called Price Club, focused on serving only small businesses. They started it after raising $2.5 million from friends and family.

Shortly after a $750,000 loss the first year, it opened up to serve non-business members, too, and growth began to take off.

In 1983, the first Costco warehouse opened in Seattle. Customers immediately loved the traits that have defined the company: Consistent, low prices on quality bulk food and household items.

Costco became the first company ever to grow from zero to $3 billion in sales in under six years. By 1993, the company, then PriceCostco, had 206 locations generating $16 billion in annual sales.

Co-founder James Sinegal always advocated for low prices: “It doesn’t do Costco any good if nobody can afford to buy anything.”

Hire and pay well

Costco has always strived to keep costs down and pass the savings on to members.

Initially, the business was limited to business leaders who needed supplies and wholesale office items. But Sinegal and fellow co-founder Jeff Brotman opened the company to consumers, with a paid membership required for entry. Its loyal membership base is the biggest distinguishing factor between it and other brands such as Walmart, Target, and large grocery stores.

Because the pricing is relatively inexpensive, Costco’s profits depend on its roughly 125 million members paying about $60 annually. Costco doesn’t spend money advertising its stores, yet it has a retention rate of roughly 90%. (Average member household income is nearly $100,000.)

It also pays its workers above the federal minimum wage and competitors.

“When employees are happy, they are your very best ambassadors,” Sinegal has said. “When you hire good people, and you provide good jobs and good wages and a career, good things are going to happen.”

Legendary investor Charlie Munger adores the company for its leadership, membership model, strong supplier relationships, and steady cash flow.

“I love everything about Costco,” Munger, 99, has said. “I’m a total addict, and I’m never going to sell a share.”

Defining attributes

According to Costco’s website and annual reports, the company focuses on a few areas:

• Quality:?Costco warehouses carry roughly 4,000 SKUs, or stock-keeping units, which retailers use to track inventory. That’s well below the average of 30,000 at most supermarkets.
• Costco focuses on filling its large warehouses with quality products based on price and features. For example, rather than offering several brands of the same product, Costco might offer only one type.
• Entrepreneurial spirit:?True to Sinegal’s vision, Costco usually promotes from within.
• Employees are trained rigorously and instructed to be exceedingly helpful, as they aren’t merely customers but paying, loyal members. Costco offers attractive rewards programs to entice members to continue shopping in stores and online for everything from egg cartoons and fresh fish to backyard furniture and grills.
• ‘Do the right thing’:?That’s a Costco slogan that isn’t necessarily thrown around publicly but feeds into what makes the business tick. It’s about the employees going above and beyond for members, offering affordable prices even if they could charge more, and having clean, organized stores at all times.
• One example: Once, Costco realized they had marketed and sold a shirt as 100% silk, but it wasn’t true. They contacted each customer who bought the shirt and refunded them.
• Long-term orientation:?Some of the best businesses and market leaders emphasize how they zoom out without much concern for short-term stock price or business performance.
• At Costco, it’s all about the long-term. “You just can’t get too focused on worrying about what’s going to happen in the next quarter,” Sinegal once said. “You have to worry about where the business is headed long-term.”

Key takeaways

Costco makes a small percentage of its profits from its merchandise, whereas most profit comes from its membership dues. Only members can shop at Costco. In other words, it makes a profit without even selling an item.

While other retailers may worry that a decline in same-store sales will collapse profits, Costco is generally more steady year-to-year because of its consistent revenue stream of memberships.

“I go to Costco every weekend,” Jimmy Kimmel once said. “ It’s my favorite part of the week.”

Dive deeper

Check out this?neat breakdown?of Costco’s treasure-hunt shopping strategy.

TRIVIA ANSWER

Despite concerns about inflation increasing food costs, Costco’s iconic hot dog combo remains just $1.50, the same price it was in the 1980s. The company sold?122 million?combos during fiscal year 2021.

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