From December thirtieth, two thousand twenty-four to December thirty-first, two thousand twenty-four
I. Foundation
resistance to change and hence greater dependability for the results shown in the past.
Inflation catch-up in macro data: consumer prices and input costs
Actual wage growth is not as concerning as the headline data suggests.
Historically, union wage growth is typically a lagging indicator of labor-market conditions, because union contracts are adjusted less frequently, and therefore reflecting inflation peaks for longer.As the chart at the lower right shows, over the past three years, wage growth for union workers consistently lagged that of nonunion workers, only beginning to catch up in the past few quarters.
Figure: A lag between union and nonunion wages
With measures of labor-market tightness continuing to decline or remaining stable, some wage growth reflects lagged catch-up compensation and does not indicate that the labor market is heating up again.Lagged union-wage pressures temporarily put upward pressure on prices in labor-intensive categories, thereby delaying the return of core PCE inflation to target.
Many stories about price inflation can be explained using similar logic:
The components of current inflation with the largest increases may look overheated, but they are actually the result of lagged catch-up effects, not a renewed pickup in the labor market or accelerating demand. This phenomenon is most evident in housing, health care, auto insurance, and other regulated prices.
In these areas, market prices or input costs rose sharply over the past few years, but their growth has slowed recently, while consumer prices are in a catch-up phase. As the gap between prices and costs gradually narrows, price increases will gradually slow.
Take housing as an example: official shelter-inflation measures will catch up with higher market prices:
Figure: Official shelter-inflation measures lag market-price measures
The chart on the left shows that since the first quarter of 2020, rents for new tenants have risen 24%, while the official shelter-price index has risen only 22%.Market prices—that is, rents paid by new tenants—often adjust faster than rents paid by existing tenants, while the official shelter-inflation measure includes rents for both new tenants and renewals.
The latter usually adjusts more slowly, because leases are renewed less frequently, and landlords do not want to lose tenants by raising rents too quickly. In some cases, regulations also limit rent increases.
The data need time to reflect the gradual adjustment in the rental market and the fading of catch-up price increases.
In health care, consumer prices also catch up with higher input costs.Health care prices usually adjust more slowly, mainly because contract terms are longer, especially in the hospital sector.
The chart at the lower left shows that since the first quarter of 2020, health-care service costs have risen 15%, reflecting higher supply and labor costs (for example, hospital wages rose 13% during 2021-2022), while consumer prices have risen only 11%:
Figure: Contract terms in health care cause consumer prices to catch up with input costs later
Similarly, in the auto-insurance sector, consumer prices are also catching up with higher input costs.
The chart at the lower left shows that since the first quarter of 2020, auto-insurance costs have risen 51%, while consumer prices have risen 43%:
Figure: The auto-insurance sector also has to coordinate prices with regulators, creating an inflation catch-up effect
These cost increases have a long lag because auto insurers need to negotiate price adjustments with state regulators based on recent costs and profitability.
Accordingly, When analyzing macro inflation, the portions involving inflation catch-up can be excluded when assessing forward-looking trends and turning points., when the parts of the inflation basket are not materially affected by lagged catch-up effects, when their price growth slows to the upper end of the previous cycle’s range, the disinflation trend can be expected to stabilize,
At this point, as prices catch up, catch-up inflation is nearing its end.
Chart: Catch-up inflation naturally ends as prices catch up
Officially measured rents have now fully caught up with market prices, and owners’ equivalent rent has also nearly caught up with market rents for new tenants, continuing to converge toward the low growth rates of the past two years. Catch-up in regulated categories such as auto insurance also appears to be nearing its end.
Chart: Wage growth has tended to fall below 4%, and catch-up wage growth for union members has ended; they often sign multiyear contracts, and those contracts are now nearing expiration.
Further reading:
GS：Continued Catch-Up Means the Latest Wage and Inflation Readings Are Lagging Indicators
GS：Shelter Inflation: A Longer Lag for OER
GS：Car Insurance: Another Case of Catch-Up Inflation
GS：10 Questions for 2025
2024.12.30
Why is auto insurance’s contribution to PCE far lower than its contribution to CPI?
Auto insurance contributes far less to PCE than to CPI There are two main reasons. First, the PCE index captures changes in insurance premiums after subtracting “normal losses” paid to consumers, while the CPI index captures premiums alone.Therefore, auto insurance accounts for about 3.7% of core CPI, but only 0.6% of core PCE.
Auto insurance contributes far less to PCE than to CPI, for two main reasons.
First, The PCE index reflects changes in insurance premiums after subtracting “normal losses” paid to consumers, while the CPI index reflects premiums alone. Therefore, Auto insurance accounts for about 3.7% of core CPI, but only 0.6% of core PCE.
Example:Suppose a consumer pays 1000 dollars a year for auto insurance, and the insurer pays the consumer 600 dollars a year:
1) CPI directly counts 1000 dollars as the cost of insurance.
2) PCE counts only 400 dollars (that is, premiums minus claims), because the remaining 600 dollars are compensation paid by the insurer to fulfill the contract, not the cost of insurance services.
PCE focuses on the net cost of insurance services by subtracting “normal losses,” making it a more precise measure of insurance prices. CPI is more direct: it reflects the full premiums paid by consumers and therefore gives a clearer picture of the expenditure pressure consumers feel.This difference means that auto insurance has different weights and price-change patterns in PCE and CPI.
Second, the PCE index measures auto insurance prices using PPI, while CPI uses insurance premium data directly.
In PPI, prices are reset only when sampled policies expire and are renewed, whereas CPI reprices half of its sample on a rotating basis every two months. The differences in the measurements of PPI and CPI stem mainly from differences in how often and how the samples are updated.PPI uses dynamic sample adjustments and renewal-based pricing, resulting in a longer lag but better representing actual changes in market premiums; CPI, by contrast, is based on a fixed sample, reflects price trends more promptly, but is less adaptable to changes in market structure.
[Effect of the policy renewal mechanism]
1) PPI reprices policies in the sample only when they are renewed. This means price changes are reflected only after renewal. If the renewal cycle is long (for example, a year or longer), price adjustments are delayed.
2) By contrast, CPI updates prices by resampling a portion of policies every two months, so price changes are captured more frequently and promptly.
3) Why occasional jumps occur: When a group of policies in the sample expires and renews at the same time, the price adjustments are reflected all at once in PPI, causing a noticeable “jump” in the price curve. Because CPI updates prices more frequently, its curve is smoother and such jumps occur less often.
Therefore, PPI’s measurements can show occasional jumps when policies are renewed, and sometimes lag behind CPI. In addition, PPI uses “direct replacement” adjustments, periodically updating the policies in its sample so they better represent companies’ premiums, whereas CPI has priced the same set of policies since 2004. As insurance costs have risen over the past few years, consumers may have adjusted the types of policies they buy and the coverage limits, which has also contributed to differences between the measurements of CPI and PPI.
Further reading:
GS：Car Insurance: Another Case of Catch-Up Inflation
Market Notes 240729: PCE and the Fed's inflation target; PCE is more relevant along the monetary policy path
2024.12.30
Inflation and the auto insurance industry’s profit cycle
The rise in auto insurance premiums mainly reflects a lagged catch-up with rising costs, due to pandemic-related supply-chain disruptions, used-car prices rose sharply, and those increases later drove up repair and maintenance costs. Medical and legal costs have also risen significantly over the past few years, reflecting more severe accidents and more litigation, which have increased medical costs per claim.
However, the effect of these cost increases on prices comes with a long lag, partly because auto insurers must negotiate rate increases with state regulators based on recent costs and profitability.
As shown below, In the fourth quarter of 2023, companies’ losses as a share of revenue were still about 8 percentage points above the 2019 level, in which case premiums will subsequently rise to catch up with costs:
Chart: In the fourth quarter of 23, auto insurers’ losses as a share of premiums collected were still about 8 percentage points above the 19 level
Costs rise faster than prices can be adjusted on the profit side, so earnings decline in the first half of an inflation cycle, while auto insurers’ earnings improve to some extent in the second half.
Further reading:
GS：Car Insurance: Another Case of Catch-Up Inflation
2024.12.31
An investment thesis and framework for the auto insurance industry written by Buffett in his twenties
The original text comes from Buffett’s article “The Security I Like Best,” published in 1951, The GEICO mentioned in the article marked the beginning of Buffett’s path to insurance cash cows; its chairman at the time was his teacher, Benjamin Graham.At the time, Davis, the financial vice president of GEICO, had intended to brush him off, but ended up talking with Buffett for more than four hours.
Full employment, sharply rising profits, and record dividends clearly do not go hand in hand with a sluggish stock market.
For the past 5 years, most industries have enjoyed this kind of prosperity, and a few minor fluctuations have done nothing to diminish this enormous wave.Yet the auto insurance industry did not share in this prosperity.After suffering huge losses in the period immediately following World War II, the automobile insurance industry finally improved in 1949. However, in 1950, casualty insurers were hit hard again, making it the insurance industry's second-worst year in 15 years.
The share prices of some casualty insurers (especially those with a large proportion of auto insurance) performed very poorly.In terms of profitability and assets, many of these stocks seem undervalued. The auto insurance industry itself tends to smooth cyclical fluctuations. Most car buyers consider auto insurance a necessity.Insurance contract rates are adjusted each year to reflect conditions at the time. Rate adjustments lag costs, creating a headwind during the inflationary period of 1945-1951, but if the economy enters a deflationary phase, it should be a favorable factor.
Other advantages of the industry include no inventory, collections, labor, or raw-material problems, as well as no risk of products becoming obsolete or related equipment being phased out.
GEICO was founded in the mid-30s and provides comprehensive automobile insurance services nationwide to eligible groups,
including:
1) federal, state, and municipal government employees; 2) active-duty and reserve commissioned officers, as well as noncommissioned officers in the top three pay grades; 3) veterans who were eligible for this benefit during their service; 4) former policyholders; 5) teachers and staff at primary, secondary, and higher-education institutions; 6) employees of government contractors working specifically in national defense; 7) the company’s shareholders.
The company has no agencies or branch offices, so policyholders can obtain a standard auto insurance policy at annual rates discounted by as much as 30%. The company handles claims nationwide through about 500 agents, and processes them very quickly.
“Growth companies”generally refers to those excluding price increases and easing competitive pressures, have still increased sales over the past few years companies.
Based on the performance below, GEICO is clearly a bona fide growth company:
Image source: Horizon Global Strategies
Of course, yesterday’s growth does not generate profits for today’s investors. For GEICO, however, we have reason to believe that there is still considerable room to grow. As of 1950, the company was registered in only 15 of the 50 states nationwide (including Washington, D.C., and Hawaii).At the beginning of 1950, the company had fewer than 3000 customers in New York State.
For prospective customers, the 25% discount on a 125-dollar policy in New York should seem more appealing than the 25% discount on 50 dollars of premiums in less-developed areas.As price competition becomes more important during recessions, the appeal of GEICO’s rates should enable it to take business from other comparable companies more effectively.
As insurance rates rise with prices, the gap of 25% in rates also becomes larger in absolute terms. The company is also under no pressure from agents to accept questionable applications or renew policies for high-risk policyholders. In some states with inadequate rate structures, the company may suspend marketing.
GEICO’s greatest appeal may lie in its profit margin.In 1949, the company's insurance profit as a share of premium income was 27.5%, while the average profit margin among the 135 casualty insurers surveyed by Best's was only 6.7%. In 1950, business conditions deteriorated, and the average profit margin calculated by Best's fell to 3%, while GEICO fell to 18%. GEICO does not operate in all casualty insurance lines. Although personal injury and property insurance are important business lines for GEICO, they have the lowest profit margins.
GEICO also has a substantial collision insurance business, which was a very profitable line in 1950. In the first half of 1951, almost all insurers lost money on casualty insurance, with personal injury and property insurance being the least profitable lines. GEICO’s margin fell to just above 9%, whereas Massachusetts Insurance Company lost 16%, New Amsterdam Casualty Company lost 8%, and Standard Casualty Company lost 9%.
Because GEICO was in a rapid growth phase, its cash dividends remained relatively low. From 1948 6 1 to 1951 11 10, stock dividends and stock splits (a 1-for-25 split) increased the number of shares outstanding from 3000 shares to 25 ten thousand shares. The company also issued warrants to subscribe for shares in an affiliated subsidiary.
Ever since 1948 Benjamin Graham’s investment fund acquired a large stake in GEICO and took it public, Graham has served as chairman of the board. Leon Goodwin is the company’s president, an outstanding executive who has guided GEICO since taking office. At the end of 1950, the 10 directors on the board collectively owned about one-third of GEICO’s outstanding shares. The company earned 3.92 dollars per share in 1950, and 4.71 dollars per share in 1949 (when total business volume was smaller). These figures exclude unearned premium reserves, which were substantial in both years. Profits in 1951 were lower than in 1950, but the across-the-board rate increases this summer will be reflected in 1952 earnings. From 1947 to 1950, the company’s investment income quadrupled, reflecting growth in its assets. At the current share price, At the current valuation, the company trades at 8 times earnings for 1950, a poor year for the industry, which seems to fully discount the company’s enormous growth potential.
2024.12.31
II. Insights
Our Viewpoints and ideas on market.
Artificial intelligence: A gap between the investment cycle and adoption rates
The AI investment cycle continues to run smoothly, and market interest in frontier technologies such as generative AI remains high, with clear signs of capital inflows and application potential gradually emerging across multiple industries.However, the adoption rate remains quite low, especially in traditional industries and small and medium-sized businesses, where adoption has not yet reached scale.
This phenomenon suggests that the transformational impact of AI on overall labor productivity（overall labor productivity）may take several years to emerge.
Chart: The artificial intelligence investment cycle is progressing smoothly
Chart: Adoption remains low, indicating that a major impact on overall labor productivity is still years away
Once the training began, researchers discovered a problem in the data: It wasn’t as diversified as they had thought, potentially limiting how much Orion would learn..The problem hadn’t been visible in smaller-scale efforts and only became apparent after the large training run had already started. OpenAI had spent too much time and money to start over...
The possible setback to expectations of a major leap forward in AI is also reflected in the forced shift from training to reasoning models:
In a recent TED talk, one of OpenAI’s senior research scientists played up the advantages of reasoning. “It turned out that having the bot think for just 20 seconds in a hand of poker got the same boost in performance as scaling up the model by 100,000x and training for 100,000 times longer,” said Noam Brown, the OpenAI scientist. "
Further reading:
GS：Global Economics Analyst-Top 10 Charts of 2024
WSJ：The Next Great Leap in AI Is Behind Schedule and Crazy Expensive
TED：AI won't plateau — if we give it time to think
（https://www.ted.com/talks/noam_brown_ai_won_t_plateau_if_we_give_it_time_to_think?subtitle=en）
2025.01.01
III. Market Pulse
Our latest Comments on the economic and market environment
Note: All content in this text is for reference only, does not constitute investment advice, and is not a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for decision-making.