Sunday, August 5, 2012

Is it Politically Correct to make a Profit?

What is the long-term outlook for the US wine business? Having been around the business for more than 30 years now, I can remember different phases in our industry's evolution and I'm constantly thinking about just what was happening to shifting demand and why, because those patterns can predict the direction we're heading next. I remember when there were 13 states that had reciprocal shipping laws and wineries shipped only to about 30 of them.  I remember when drinking was bad for you. In fact when SVB began in the wine business in the early 90s, we were just moving out of a time of a structural change that led to declining demand both in gallons consumed and per capita consumption as you can see in Figure 1 above.

I remember Bartles and Jaymes exploding onto the scene driving huge consumption and then dying back. I remember the years of mass imports and mass marketing for Blue Nun, Mateus, and Lancers Rose (They made really cool candle holders too). I remember the 1980's that had two moderate, or one long, recession depending on whom you believe. Those were the days when people actually thought wine did not contribute to a healthy lifestyle. I know..... it's hard to believe. Since then, scientists have decided wine consumption is as good for you as broccoli and we’ve had nearly 20 consecutive years of growth in consumption. Why? What's the reason for imports moving into the market and having success at one point? Whats the reason U.S. consumers started inhaling copious amounts of US wine and left the imports later?

Beyond the Judgement of Paris which reflected the serious growth in US wine quality, and the French Paradox which gave us all an excuse to drink again after it fell out of favor in the 80's, I'd suggest three main things propelled the growth in consumption of US wine. 1) Foreign wine stopped their assault in mass advertising in the 1990's.  2) the Boomers median age was 35 in the middle 90's; the lower band of an age when consumption of all things is at its peak and they discovered along with Madison Avenue, Mass Luxury. 3) Certainty for investors which led to the greatest period of growth in wealth this country has seen during the decade of the 1990's. The impact on the wine business was that the Wealth Effect took over, and those healthy and wealthy Boomers wanted a gracious lifestyle. They wanted fine living. So we saw continuous growth in shipments and higher prices as consumers traded up.

Today we are hitting increasing headwinds to expect a return to the kind of growth we saw in the wine business over the past 20 years. Moving past the part we can't control which is the aging Boomers, It really gets down to this: Certainty is needed for Investment. Wealth creation is needed for spending. Wealth creation is needed for pricing increase in fine wines. But wealth creation is being trodden under foot because of the degree of market uncertainty and the fact capitalism has fallen out of favor. If you're an investor, certainty is everything. Where is that uncertainty coming from? Start with the Street itself.

Just this past week, Bill Gross posted in his Blog the "Cult of Equity" was dying. The short treatment is he thinks future returns in the S&P are going to be far less than what we've experienced historically. Bill Gross is the Co-Founder of PIMCO Advisors who have close to $2 Trillion under management. Bill's bias is toward bond trading but when he speaks, people listen. His op-ed was loud and clear and generated a fair amount of rebuttal from those who make their money on equities. Case in point is the research done by one such fellow on Bill Gross' stock calls in the above chart. Reading this, its hard to know why anyone would listen to Gross. The countervailing view is the S&P is range bound but almost an historic bargain, the Fed continues to issue supportive statements as they did on Wednesday, home values have bottomed and the US economy is recovering. But Gross's views, and similar self-interested opinions like that create a level of fear uncertainty and doubt in markets.

The ECB and Fed actions are really what is driving most investment moves these days. I remember the days when stock moves were based on fundamentals or technical analysis. Imagine that. Today? Its nuanced messages out of Bernanke and Mario Draghi that have investors guessing about QE3 and survival of the EU. What happened to the good old days when businesses created products, service and the framework for business to operate? Today markets move based on if Ben will extend Operation Twist or if the Germans will support the ECB's need to control the landscape for Satellite Country Banks, outside of their own country's Governments control. Since nobody can predict the moves by either Central Bank, the investor sees uncertainty and prices that into the market, killing wealth creation.

Then there are those actions that have taken place in Washington. Tops on my list of those creating market uncertainty is the political gamesmanship that pit Wall Street versus Main Street, and the continuing saga fanning the flames of class warfare between the Millionaires and Billionaires versus the rest of the U.S. populace. On the one hand, President Obama and the left talks at the business world and asks for their cooperation to create jobs, and in the next breath throws the entire lot under the bus to gain favor with the middle class vote. We need a healthy business climate to see recovery and yet the foundation for which our system of commerce has been based is falling into disfavor; self-induced in part by obscene greed in the ivory towers, but at the same time politicized in Washington as never before.

An article in the WSJ last week spelled it out pretty well: Why Capitalism has an image problem. I liked the authors summation:
If it is necessary to remind the middle class and working class that the rich are not their enemies, it is equally necessary to remind the most successful among us that their obligations are not to be measured in terms of their tax bills. Their principled stewardship can nurture and restore our heritage of liberty. Their indifference to that heritage can destroy it.
The kind of self-dealing and cronyism that creates distrust among the masses will never build back investor confidence, drive wealth creation and then spur demand for consumption of any goods, let alone wine.

Second on my list of Washington idiocy is the finger-pointing in Congress that places more emphasis at assigning blame to the other party and keeping the opposition from gaining credit, versus doing anything that can actually help the economy. The old politics that allowed compromise has turned into tit-for-tat retaliation and I'll scratch your constituents and earmarks if you scratch mine. That disabling rift led the Republican controlled House to block a debt ceiling increase in November of 2011 that in past votes had only received token debate. This was political chicken - like two cars driving headlong toward each other, and the Republicans were willing to drive the momentum of the country's recovery into a wall in an attempt to gain the upper hand in the debate over our Nations debt and proper stewardship of our children's future. The outflow of that decision was the downgrade of the US Governments AAA rating. Now as we approach the next Fiscal Cliff, investors are pricing in uncertainty for something that was never in the past even a risk.

In Silicon Valley Banks 2011-2012 State of the Industry Report and again this year, we reiterated our belief that the US wine business was at the beginning of a long term growth pattern. We still believe that despite the grim view of the last few paragraphs. But if you were around in the 1990's to see that market and that kind of growth in pricing and demand witnessed, don't expect that same thing to happen this time around as we see the business recover. While Inventory is in balance and trending to shortage again, the producer's ability to increase price at this stage is limited because the investment environment is impaired, even with historic low interest rates. Its being limited by European Union dysfunction and unapologetic greed and self-interested statements from Wall Street. It's further limited by class warfare emanating out of the Obama Administration, and by a Republican party led by John Boehner who would rather play chicken with the debt ceiling in order to make a statement about run-away spending, rather than support the fragile recovery.

The wine business in the US is at one of those inflection points as we discussed last week in SVB on Wine. As a banker who sees the financial statements of hundreds of private wineries, I can tell you we are seeing outsized success in the financial recovery of the forward thinking wineries who see the landscape in front of us, and make clear business decisions based on that vision. The separation of the best performing and the next layer of performers has never been greater. There are wineries right now that are just hitting the cover off the ball and making record profits. That is encouraging for a business that just came out of an unprecedented demand shock. The sad part is their success today - in fact the financial success of almost any business  - seems to have fallen out of political favor. What does that mean for the future of American capatilism?

When will it be politically correct for business people to make a profit again? What do you think?


  1. I am not certain that you can answer your last question from a wine industry perspective alone and yet ultimately it does effect everyone in it.

    We need a champion...a leader who can tackle this divide that has split this country down the middle..yet I think both parties only offer us choices that continue to build greater distance between people.

    I always wonder.."what if they threw an election and no one came to vote"??? In my opinion, few of us vote for a candidate that we think is best but instead we vote for the lesser of two evils. Heck of a way to run a country.

    Until (somehow) we can choose a person who can truly lead us and (re)unite us nothing else is going to happen of substance...for a long time now we can been running on automatic pilot...probably the reason that Wall Street feels that they can do whatever they want..there is no real authority to keep them in check.

    Until there is confidence that "we" the people share the successes and failures of this country, that the people we elect are there in DC for our benefit (not theirs), that business is run by corporate cultures that is first indebted to the people that buy their products and/or services (not to shareholders and the rest be damned)we can complain, we can plot, we can plan but it is success by chance not design.

    I read your words that the best performers are knocking the cover off the ball (and believe you) but I reflect on many friends in Napa and Sonoma who relate to me that the past two months have not been good. Perhaps that is the seperation you wrote of...that the layer (or divide) between them has never been greater.

    Perhaps we will see a bit of darwinism develop...a natural selection where only the strongest survives but I also realize that behind those numbers that are discussed are human beings who may not survive the next go mant wine families will suffer devastating losses.

    We need someone, somewhere to stand up and unite "the people" again so that we stop looking at "what's in it for me" and start living and working as people who care about a little bit more than just today's pay check.

    1. Great comments Mark. There are still lingering issues in the business. We see something a little similar with the Municipalities that are just now fining BK like Stockton and Bakersfield(? a city in Southern Cal). Unless a troubled business changes the formula, it will struggle waiting for the environment to bail them out. We will see continuing changes in ownership; nothing in a major way in terms of wineries in serious trouble though. The business is doing well on average, but as I mentioned above, there is a real separation between those doing very well and those just doing.

  2. Good stuff, Rob. This comes up a lot for me in public presentations around the financial crises and their aftermaths worldwide. Many forget that wealth is built from profit, and that government revenue comes from "profit". For the wine industry, profit is survival fuel, as in any other industry.

  3. Thanks for the comments Rob. Flaunting wealth in the crash would have been like dancing on the graves of the millions out of work. And yet that closed down restaurant sales as consumers stayed out of the light. Today we have so much distrust of institutions - earned distrust in both corporate America and the Government, it impairs investment. The general belief is if you are wealthy, you came by it unfairly - you won at the expense of someone else. They lost.

    Family wineries used to carry a lifestyle image; the good life and luxury living. Today, taking that approach is at their own peril. Its an image that doesn't really work. What does work? Family owned, self-made businesses, family farms. But looking like you are making millions just isn't the right feel today. In fact it is politically incorrect to make a profit.

  4. Rob:

    I think this is a faulty premise:

    "The sad part is their success today - in fact the financial success of almost any business - seems to have fallen out of political favor."

    1. Thanks Tom for the comments. I'm curious what your counter is. Can you elaborate?

  5. I disagree Tom. I think there is a real concern for anyone who has been successful to spend money on "luxury" anything for fear of being branded a "one per-center" and that the success was gained on the backs of the downtrodden.
    You have to believe that anyone with political aspirations is hesitant to order a bottle of wine in a restaurant that costs more than $100.

    Nice work Rob.

    1. Eric -
      Occupy XXXX has taken on a new meaning, much as has "gate" before in the 70's... Watergate, payolagate, etc.. Its an outward expression of the political divide that exists and is growing between have's and have nots. There is a feeling that those who have wealth cheated to get it, and now the gravy train has left the station and "I didn't get mine." Consumers who had thought equity in a house was safe and would set their retirement woke to find themselves upside down through no fault of their own.

      But we all know today, anything that goes wrong has to have blame assigned today, and while Washington was square in the early sights of the disenchanted and disenfranchised, the blame was quickly shifted to Wall Street who would have reveived a part of the blame anyway. Those in government now seem absolved, but the lingering anger is still there pitting corporate America and the wealthy against the rest of us. Its the 1% vs the 99%. Its the millionaires and billionaires "not paying their fair share," nevermind the fact they are following tax law set up by Congress and the IRS to encourage different kinds of investments and with that comes a lower tax bill.

      It's also led to the anger over bailing out Wall Street, ignoring the fact the US got 100% of their principal returned and actually made a premium on their TARP investments. The consumer feels like they didn't get theirs and deserve a bail-out just like Wall Street.

      In my opinion there is a lot that has to happen to fix this divide, but ignoring that for a moment - what does that mean for wine? The message for winery owners is its OK to make a profit, but displaying success isn't politically correct.

    2. Eric:

      I've seen no indication that folks are unwilling to spend money on bottles of wine due to being branded a part of the 1%. Conspicuous consumption is doing just fine.

    3. Tom - Thanks for clarifying your view. A couple data points and other articles to offer support for the OP:
      1) Romney won't release taxes. Why? Because he made a lot of money and will get criticized as being in the 1% if he does. He might have legally paid less in taxes because of charitable contributions and other legal tax strategies, but releasing will give the opportunity for him to be further painted as a 1%'er.
      2) Financial Times today: "Backlash against the Rich has gone Global." citation: "....a new global trend: an international backlash against the wealthy that is reshaping politics from Europe to the US to China."
      3) What you don't hear about those greedy one-percenters. This from Forbes: "What’s not said enough about the 1 percenters is how difficult were their paths, but perhaps even more to the point, how much easier and better our paths will be for what they did ahead of us. Rather than bemoan their wealth, it’s time we start thanking them."

      There are of course a lot more headlines. But to your point about a false premise, I think you must mean while the stuff I'm speaking about might be true, its not impacting wine sales? ("Conspicuous consumption is doing just fine.")

    4. Rob:

      1. The wealthy running for office, including the presidency, have often been branded as out of touch. It's not as though Romney's wealth is unrevealed. It's pretty clear to everyone he's extremely wealthy...and yet, he is tied with Obama in the polls. He's not releasing tax returns because there is something in the returns that go beyond indicating he's wealthy. The released of the 2010 returns confirmed that.

      2. The "backlash" against wealth in America has led to a near identical party split that we've seen for the past 20 year in America, despite one of the wealthiest candidates we've ever seen.

      3. "Difficult paths"? Really? More difficult than working 12 hours a day doing manual labor? Today the 1%ers control more than 50% of all the wealth in America. The change began occurring with the continued tax breaks beginning with the Reagan administration. But the big deal was determining that investment income ought to be given a special tax rate different than the guy who earns money working.

      I don't think there is a backlash against wealth. I think there is a backlash against the perception that priority is given to the wealthy, the perception that the wealthy have near total control of the political and economic system and the perception of an unwillingness of politicians to do anything about this.

      Me? I just want consumers to enjoy the wines they want, wealthy, middle class or poor.

    5. Thanks for the thoughtful response Tom. I appreciate you adding your voice to the discussion.

    6. I found this interesting story from CNBC reflecting one of the social issues I see here:

      "The wealthy aren't just building financial moats, they're also building psychological moats. The Occupy movement, media coverage of inequality and the Obama campaign's "you didn't build it" attacks have all made the wealthy fearful of any outward signs of success.

      The survey showed that only 31 percent of today's One Percenters "like it when others recognize me as wealthy." That's a huge drop from 2010, when 53 percent liked the recognition. This jibes with another recent poll that showed One Percenters don't see themselves (and don't want to be seen) as One Percenters.

      The wealthy, in other words, are embarrassed to be wealthy."

  6. I also disagree with the premise that profits are out of political favor or somehow "not politically correct". What has never been accepted are profits at the raw expense of others. Wall Street's questionable activities over the past 8+ years are out of political favor. Those of us making a profit the old fashioned way have never lost favor(making something, employing people, adding and giving back to the local and regional economy).
    Wall Street would say they are the realists, and put money to work with brutal efficiency. That using only money to make money is one of the oldest and purest form of business. This may be true, but they must respect the fact that they are and always will be a small minority, powerful, but still a minority.

    1. I'd like you to be correct Mike. My instinct is otherwise, but I would like to think that its OK to celebrate a company that is making millions, without someone else decrying their success as nothing but winning at the expense of others.

      But I whole-heartedly agree with your Wall-Street POV and will go one further to add Executive Compensation to the list of abuses. CEO's can earn such a big slug of cash now, in a single year they can have their retirement covered and then focus on using shareholder investments to drive quater-to-quarter growth and take higher levels of risk. That's not good for the system. How do we get around that? I think claw-back provisions on Executive Bonuses should be standard. That might better calibrate that piece of what I see as adding risk to our system of capital.

  7. I don't know Mike. Seems to me that "1 per-center" tag is pretty easy to throw about and is. Practically everyone is "rich" to someone.
    Before long it will be only the car you drive or the house you live in to get you on the list of Madame DeFarge.


  8. Someone much wiser than I said that in the short term the stock market is a voting machine. In the long run it is a weighing scale - true value will eventually come out. Most of the press looks at the recent past and forecasts that the future will be like that. In the late 1990's we had forecasts of Dow 36,000. In mid 2008 we had forecasts of oil at more than $250-300 a barrel. If risk capital is only rewarded at the same rate as a bond that has first call on the the capital of a business - no one will invest in the business. Rates of return will eventually be 3-5% more than bond rates or the investors will sit on the sidelines until they do.

  9. Tone-
    Thanks for weighing in. I'm guessing that the US equity markets will be a comparatively good place to be for the next few years, if for no other reason than we are ahead of the rest of the world in recovering from the market crash. That said, I wouldn't want to predict a rate of return over then next decade. I think this is closer to the environment of the 60's when residing in any asset class didn't get you as much as traders who made it in and out of different classes.

    Pointing out the social issues that are plaguing the country isn't fun, but they aren't divorced from the investing environment which is why I point it out. We need a country that respects the work required to attain wealth. But we also need some moral changes in the financial community that balances out opportunity a little better to see the best outcome in a capitalist country.

  10. I am looking to you for an opine on whether lending to the wine biz is profitable now or going forward? Big agglomerates of brands or single-name owner-operated? Tuff questions to ask you, but you are on the inside.

    As for me, I don't see much growth in the U.S. econ. if Ibama gets re-elected. What would he do that would encourage people?

    1. MAW - Yes, its still a profitable business at least for us. We take very little in loan losses due to our focus and our ancillary consulting that helps our clients odds of success. You are correct about the roll-up of brands. Its something we pointed out maybe a decade ago; being stuck in the middle - too big for custom work and too small to get distributor attention - is a bad thing. One of the solutions is the roll up and its not a bad thing to see.

      Growth? Its going to be muted. Wall Street isn't a fan of the current President for obvious reasons and at least for the short term, most prognosticators believe Romney will be a better President for Wall Street..... and yet, that is the Catch 22 from the perspective of the middle class.

  11. Rob - First, I want to thank you for taking on an issue like this and be willing to thoughtfully engage in the back-and-forth of the discussion. Going back to your statement that capitalism seems to be going out of favor, I find this concerning for more than just the wine industry or the economy in general. As capitalism goes, so does economic freedom, and as economic freedom goes, so does freedom in general. This entire issue has to do with envy, which was originally considered two separate deadly sins due to the truly negative influence it has on people. The same people camping out in NY last year, were more than happy to be visited by Kanye West and Jay-Z, who both make more than your average CEO and employ very few people and produce very little. Even our so-called populist president is not serving Two Buck Chuck at the White House. People are too focused on wealthy men in suits instead of their neighbor who purchased a house he knew he could never afford. What is important is punishing those who break the rules and rewarding those who are successful who do not. Instead of letting corrupt congressmen rewrite the rules, i.e. Dodd/Frank, we should go after those who knowingly broke the law.

    As far as how this all relates to wine and investing in the industry, France has been decapitating the rich for 200 years and yet their wine industry is still populated by millionaires and billionaires who still manage to make a profit in a nation threatening to increase the top marginal rate to 75%. Some of our most influential founders were wine enthusiasts and their collective vision helped create the amazing domestic wine industry we enjoy now. I think investment in the U.S. wine industry will stay strong, but it will be based on value, not as trophy estates, cult wineries, or celebrity labels.

    As a final comment, when opting for socialism over capitalism, let's remember that Marx felt that socialism was just the transient stage before communism where inequality was still present based on merit. If you are no longer interested in capitalism, just remember, it won't be long before your own hard work is no longer rewarded.

    Michael M.

    1. Wow. Very powerful writing MM.

      We are in a strange place when as a capitalist society, 69% don't want to be recognized as being wealthy. Now I'm the first to point out wealth has a social cost of bringing others up. Too many miss that important part of social rent. That is the moral responsibility of the wealthy and keeps socialism - forced wealth transfer, from taking hold. But when that large of a percentage are not proud of their place in life, what can we expect next in a capitalist society? The risk is a breaking down of the rewards in the system itself.

      In my opinion, the debate is a healthy one because capitalism at its worst is selfishness and greed. Greed is not good and the greed we've seen on Wall Street and in the corporate towers is unbalanced at best and cancerous at worst. I agree with Obama's sentiment that if you have wealth, you didn't earn that yourself. That's lunacy to think you could live on the moon and with nobody around, create anything that is long lived.

      In the same way, if you don't have wealth, its not somebody's fault. It takes effort, hard work and sacrifice to make a better life. It takes luck to be in the 1% (or a rich relative).

      You aren't owed a happy life because you grew up in the US. Our Declaration of Independence doesn't guarantee happiness. It says we should be free to life, liberty and the PURSUIT of happiness. It takes effort to pursue happiness. A culture that promotes a balance that rewards effort and encourages social responsibility at the same time for those fortunate to have found success is the ideal. That hopefully happens in a socially responsible way without forced wealth transfers that at its worst, is destructive in a capitalistic society. Forced wealth transfers shrinks the pie and discourages effort.

      Its a wake up call but its not a complaint about the country. We are still living in the best country on earth. But we can all be better to support the capitalist value and the opportunities that system creates for the individual. The debate that raises awareness of the risks of straying from those principles is worthwhile.


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