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McIntyre Partnerships 1Q20 Commentary: Long Chemours [Analysis]

McIntyre Partnerships 1Q20 Commentary: Long Chemours [Analysis]

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McIntyre Partnerships commentary for the first quarter ended March 31, 2020, discussing how the current crisis will likely impact Chemours (NYSE:CC)’s near-term earnings.

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Q1 2020 hedge fund letters, conferences and more

Performance Review - FY 2019

Through Q1 2020, McIntyre Partnerships returned approx. -56% gross and net. This compares to S&P 500, S&P 600, and Russell 2000 returns including dividends of -20%, -33%, and -31% respectively. The fund is heavily concentrated in Chemours Co (NYSE:CC), whose shares fell 51% in the quarter. The fund has recovered modestly in April.

I could say many things about our returns, but the reality is I decided to place the “big bet” in a “scary looking” cyclical and ran into a market crash equivalent to 1929 and 1987, with market indices down 35-45% and hundreds of stock down far worse than that. I cannot imagine a worse possible near-term market backdrop for my decision – the fund is at its highest potential volatility into the highest period of volatility since 2008. The current marks are what they are. A sudden market crash, for whatever reason, is always a possibility, and I have no real strategy to avoid the mark to market drawdowns that inevitably come with them.

Instead of pontificating on the markets, the focus of this letter is on why I believe CC is fundamentally a safe bet, despite the market reaction, and extremely cheap even in a protracted recession.

Portfolio Review - Exposures and Concentration

At quarter end, our exposures are 105% long, 30% short, and 70% net. Our five largest positions were 90% gross exposure. Our CC investment is exceptionally large and has a significant options component which makes our exposures less meaningful versus the market at present.

Our four largest positions are CC, TPHS, GTX, and Permanent Bank. We have no other investments of notable size.

Portfolio Review  - Existing Positions

Chemours (CC)

Pre-Covid Update

Prior to the current covid crisis, our CC investment was beginning to work. In mid-February, CC rallied sharply on strong Q4 earnings, and the company guided to 2020 FCF of >$2/share and took back share in the TiO2 market, which is central to my thesis. I felt the guidance was conservative, setting CC up for “beat and raise” earnings. In the two months since then, the TiO2 market has shown signs of a rebound with pricing and volume increasing – a good sign the 18 month destock, which was the largest in industry history, was behind us. Even with the global economy coming to a halt in mid-March, TiO2 volumes have remained reasonably strong with competitors and consultants reporting stable volumes in April. While the current crisis will likely impact near-term earnings, I believe my Chemours thesis has begun to play out and results will continue to improve as the economy recovers post-covid.

Simple Pitch

The simple pitch on why CC is safe even in a harsh recession is that its balance sheet and liquidity are very strong, and its operations have robust competitive advantages that drive profits even in a bad environment.

Long-Term Safety

Over the long-term, CC’s business is a necessary part of the economy. In a world of lockdowns, chemical production has been deemed an essential service and CC’s plants remain open. It is not a random coincidence that the business I chose to concentrate our fund in has been deemed essential. If we are to live in a world where we are not all sitting naked in fields, material science a.k.a. the chemical industry is an essential part of our civilization and cannot simply be turned off like a cruise ship or a restaurant. TiO2 is in the paint on your walls, the plastics in your cell phone, and rubber in your shoes. CC’s refrigerants enable the air conditioning we use to cool our homes and keep our produce fresh. CC’s products are fundamental building blocks of society.

Further, I do not believe CC’s businesses are at risk from any secular shifts. TiO2 and refrigerants have no feasible substitutes, i.e. a secular supply shift, and paint and air conditioning demand are not at risk from any long-term change, i.e. a secular demand shift such as the growth of software, shifting millennial buying patterns, etc. While the macroeconomic ebbs and flows can impact Chemours' near-term earnings, over the long run, CC’s products are essential, and demand will return.

When considering the fundamental safety of an investment entering a cyclical downturn, there are two critical and linked factors: the company’s financial strength and operating resilience. The company must have ample liquidity to withstand a shock and must generate strong pre-tax earnings even in a protracted, bad recession. On both metrics, I believe CC is strongly situated. Further, CC’s shares are cheap even in a protracted recession.

Financial Strength

In practical terms, companies go bankrupt when they cannot either cover their interest payments or roll over their debt. While other factors, such as breaking a covenant, can technically tip a company into bankruptcy, such occurrences are rare. It is thus imperative for a business to have cash available to pay operating and financial costs in the event of an economic shock.

To evaluate CC’s liquidity, I conduct a stress test and conclude CC has ample liquidity even in unrealistically extreme circumstances. CC has $1.6B in total liquidity, consisting of $1.1B of cash on balance sheet at present and an additional $500MM in revolver availability. This compares to interest expense of $200-$250MM, depending upon cash and revolver balances. There are no maturities due before 2023. The most restrictive covenant is 2.0x senior secured leverage ratio, which CC would not trip unless EBITDA falls 40% and could be renegotiated in such a case.

In my stress test, I take Factset’s estimates for consensus sales and EBITDA and assume a 50% drop in sales with a 50% decremental margin, and conclude CC has adequate liquidity to weather such a scenario until Q4 2021.

impact chemours

I want to reiterate how tremendously overly punitive I think this scenario is. This model implies a sustained 20-40% drop in TiO2 and refrigerant volumes, which given their essential nature in my opinion implies a 30-50% drop in global GDP. Further, the operating characteristics of CC’s business, particularly their substantial low-cost position in TiO2 and the specialty chemical margins of Opteon, imply a 50% decremental margin is excessive. I use what I consider a wildly pessimistic view to illustrate that, even in the event I am quite wrong on my operating assumptions, CC has ample liquidity to weather the storm.

Operating Resilience

CC’s two main operating businesses are Tio2 and Fluoroproducts. While both product lines are cyclical, CC’s strong competitive advantages drive operating profits even in recession. In TiO2, CC is the low-cost producer due to their scaled operations and a proprietary production process, which creates a sustainable competitive advantage and predictable profits even when TiO2 peers struggle and burn cash. In Fluoroproducts, CC’s patented Opteon brand is the key profit driver and shares a duopoly market with HON, implying strong margins even if volumes drop. These competitive advantages mean that while peak and mid-cycle earnings are cyclical and difficult to predict, CC’s operating profits in a downturn are far more predictable. Unlike many TiO2 peers such as TROX and KRO, CC can run with modest leverage and be confident in their ability to cover costs even in a sharp, sudden downturn like we are currently experiencing.

TiO2

Despite its cyclicality, I consider CC’s TiO2 business to be one of the most robust competitively advantaged businesses I have ever analyzed. TiO2 is a commodity. While there is a sharp quality difference between high-tech Western TiO2 manufacturers and low-tech Chinese manufacturers, Western companies’ TiO2 is effectively interchangeable and Western producers’ margins are broadly similar – except for Chemours. CC operates its plants at a massive scale versus peers and has a proprietary process allowing the company to use a variety of feedstocks not available to competitors, which drives a large cost per ton advantage versus competitors. Here is a chart of CC’s historical margins versus TiO2 peers:

impact chemours

CC has earned on average almost twice the EBITDA margin of competitors despite making functionally similar products. The benefits of this advantage are particularly acute in downturns. In 2008 and 2009, CC’s competitions saw margins and profits sharply contract. As capex typically runs 3% of sales in TiO2 production, most were struggling to breakeven and some filed for bankruptcy. However, CC generated a high-teens EBITDA margin even as competitors were burning cash.

In per unit math, CC’s low-cost position equates to a roughly $300/ton advantage versus peers, or $400/ton EBITDA including $100/ton in D&A/maintenance capex. CC has roughly 1.3MM tons of nameplate capacity which it can operate at a 90% utilization rate. This implies CC can earn $500MM in annual EBITDA in an environment in which literally every other Western TiO2 producer is forced into bankruptcy. In practical terms, given TiO2’s essential nature, TiO2 producers typically trough at cash burn for a quarter or two before capacity closes and some degree of profits returns, thus I consider $500-$600MM in TiO2 EBITDA to be a true trough condition.

CC’s ability to generate significant profits even in conditions where competitors are burning cash is at the core of why I believe CC is a safe investment. I consider this cash flow stream to be one of safest available in the market. While one-time issues, such as CC’s move to fixed volume contracts, a pandemic causing a sudden volume drop, a plant outage, etc. can impact Chemours' near-term TiO2 profits, the sustainable competitive advantage implies this EBITDA stream of at least $500-$600MM will return.

Opteon

Opteon is CC’s patented next generation refrigerant, which results in a 99% reduction in global warming potential versus legacy products and shares a duopoly market with HON’s Solstice product. Opteon is accounted for in CC’s Fluoroproducts segment, which is the company’s other significant EBITDA driver. Prior to covid, Street estimates were for $600-700MM in 2020 Fluoroproducts EBITDA, which I believe was a reasonable range. Covid has thrown that estimate into doubt, and the question is by how much. I estimate Opteon drives at least 50% of segment profits or $350MM of EBITDA. While the majority of Opteon sales are cyclical with global car sales, ex-covid, Opteon was experiencing double digit sales growth and the duopoly market implies limited pricing pressures. In a sharp 20% decline in global auto sales, I estimate Opteon EBITDA would fall at most 20%, yielding $280MM. The rest of the Fluoroproducts segment are legacy refrigerants and fluoropolymers, which are modestly cyclical. For conservatism, I assume a 50% drop in the rest of Fluoroproducts EBITDA, yielding a whole segment trough EBITDA of $450MM.

Whole Company Math

On conservative trough conditions, I estimate TiO2 EBITDA of $500MM, Fluoroproducts of $450MM, and “rest of company” including corporate expense of -$50MM, yielding $900MM of whole co. EBITDA. This compares to 2020 capex guidance of $400MM, which could be reduced to $300MM or less if needed, and $200MM of interest expense, which yields ample coverage. Further, assuming a 20% tax rate, CC would earn FCF of $240MM or $1.50/share in a harsh trough environment, a 15% yield at current prices. I believe CC is a fundamentally conservative bet.

Covid and Economic Thoughts

“In some parts of the country [the pandemic] has caused a decrease in production of approximately 50 percent and almost everywhere it has occasioned more or less falling off. The loss of trade which the retail merchants throughout the country have met with has been very large. The impairment of efficiency has also been noticeable. There never has been in this country, so the experts say, so complete domination by an epidemic as has been the case with this one.” - The Wall Street Journal, October 24, 1918

Some quick covid observations:

  • Covid is likely 2-3x as contagious as the flu
  • Every year 20-35% of the world’s population gets the flu, despite the existence of a partially effective vaccine
  • The record for fastest development of a vaccine is five years
  • While difficult to estimate due to imperfect testing data, most epidemiologists put the disease’s current fatality rate at 2-5x that of seasonal flu if the healthcare system functions
  • In virtually every epidemic, a virus’s virulence diminishes over time
  • Nursing home residents accounts for around 50% of deaths in various European countries and US states
  • For those under 65, and those over 65 without multiple comorbidities, the risk of fatality from infection is similar to driving to work every day

From a personal perspective, every death from this disease is a tragedy and my thoughts are with those who have lost someone. However, from an economic perspective, these deaths in and of themselves are not causing the economic contraction. What is causing the economic damage is our response to this disease, both from government regulations and individuals’ self-imposed social distancing. For investors, what matters is how long the current social distancing can continue and what its impact is to the economy.

I do not believe the social or political capital exists to extend the lockdowns on non-essential services much beyond the present timeline presented by North American and European governments. The extremeness of certain countries’ and the United States’ social distancing rules are simply unsustainable for any length of time. For example, Quest Diagnostics, one of the nation’s largest medical testing companies who has conducted almost half of the commercial covid testing in the USA, saw a greater than 40% drop in overall test volumes in late March and has furloughed a significant part of their workforce. That implies literally millions of delayed or canceled cancer screenings, heart disease checks, etc. From a purely public health perspective, it’s highly unlikely months more of this extreme social distancing would even save lives in aggregate. Fortunately, the tide seems to be turning and many states and countries are beginning to slowly reopen. There are now numerous examples of other countries, such as Sweden and China, who are managing the crisis in a more measured manner without breaking their healthcare systems.

The question then turns to the economic impact. I never really have a strong view on the economy, but something like a very bad Q2 contraction followed by a sharp rebound in H2 seems reasonable. This tracks other pandemics, such as Hong Kong following the SARS outbreak in 2003 and the US after the Spanish Flu outbreak in 1918. Most importantly, there is significant political will to use fiscal and monetary stimulus to right the ship. Here is a quote from Federal Reserve Chairman Jerome Powell on April 9, 2020:

"People are undertaking these sacrifices for the common good. We need to make them whole. We should be doing that, as a society. They didn't cause this. Their business isn't closed because of anything they did wrong. They didn't lose their job because of anything they did wrong."

Restarting the economy in the US and globally will be rocky at first, but I believe the significant political will to fix the situation and the logical benefit from simply reopening businesses will likely make the economic pain short lived. Further, politicians and central bankers are signaling they are prepared to deliver increased aid if the recovery needs further help.

For those interested, here are links to studies of prior pandemics:

Hong Kong 2003 - https://hub.hku.hk/bitstream/10722/88855/1/content.pdf

United States 1918 - https://www.chicagofed.org/publications/working-papers/2020/2020-11

As always, please feel free to contact me with any questions.

Sincerely,

Chris McIntyre

chris@mcintyrepartnerships.com

The post McIntyre Partnerships 1Q20 Commentary: Long Chemours [Analysis] appeared first on ValueWalk.

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Survey Shows Declining Concerns Among Americans About COVID-19

Survey Shows Declining Concerns Among Americans About COVID-19

A new survey reveals that only 20% of Americans view covid-19 as "a major threat"…

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Survey Shows Declining Concerns Among Americans About COVID-19

A new survey reveals that only 20% of Americans view covid-19 as "a major threat" to the health of the US population - a sharp decline from a high of 67% in July 2020.

(SARMDY/Shutterstock)

What's more, the Pew Research Center survey conducted from Feb. 7 to Feb. 11 showed that just 10% of Americans are concerned that they will  catch the disease and require hospitalization.

"This data represents a low ebb of public concern about the virus that reached its height in the summer and fall of 2020, when as many as two-thirds of Americans viewed COVID-19 as a major threat to public health," reads the report, which was published March 7.

According to the survey, half of the participants understand the significance of researchers and healthcare providers in understanding and treating long COVID - however 27% of participants consider this issue less important, while 22% of Americans are unaware of long COVID.

What's more, while Democrats were far more worried than Republicans in the past, that gap has narrowed significantly.

"In the pandemic’s first year, Democrats were routinely about 40 points more likely than Republicans to view the coronavirus as a major threat to the health of the U.S. population. This gap has waned as overall levels of concern have fallen," reads the report.

More via the Epoch Times;

The survey found that three in ten Democrats under 50 have received an updated COVID-19 vaccine, compared with 66 percent of Democrats ages 65 and older.

Moreover, 66 percent of Democrats ages 65 and older have received the updated COVID-19 vaccine, while only 24 percent of Republicans ages 65 and older have done so.

“This 42-point partisan gap is much wider now than at other points since the start of the outbreak. For instance, in August 2021, 93 percent of older Democrats and 78 percent of older Republicans said they had received all the shots needed to be fully vaccinated (a 15-point gap),” it noted.

COVID-19 No Longer an Emergency

The U.S. Centers for Disease Control and Prevention (CDC) recently issued its updated recommendations for the virus, which no longer require people to stay home for five days after testing positive for COVID-19.

The updated guidance recommends that people who contracted a respiratory virus stay home, and they can resume normal activities when their symptoms improve overall and their fever subsides for 24 hours without medication.

“We still must use the commonsense solutions we know work to protect ourselves and others from serious illness from respiratory viruses, this includes vaccination, treatment, and staying home when we get sick,” CDC director Dr. Mandy Cohen said in a statement.

The CDC said that while the virus remains a threat, it is now less likely to cause severe illness because of widespread immunity and improved tools to prevent and treat the disease.

Importantly, states and countries that have already adjusted recommended isolation times have not seen increased hospitalizations or deaths related to COVID-19,” it stated.

The federal government suspended its free at-home COVID-19 test program on March 8, according to a website set up by the government, following a decrease in COVID-19-related hospitalizations.

According to the CDC, hospitalization rates for COVID-19 and influenza diseases remain “elevated” but are decreasing in some parts of the United States.

Tyler Durden Sun, 03/10/2024 - 22:45

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Rand Paul Teases Senate GOP Leader Run – Musk Says “I Would Support”

Rand Paul Teases Senate GOP Leader Run – Musk Says "I Would Support"

Republican Kentucky Senator Rand Paul on Friday hinted that he may jump…

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Rand Paul Teases Senate GOP Leader Run - Musk Says "I Would Support"

Republican Kentucky Senator Rand Paul on Friday hinted that he may jump into the race to become the next Senate GOP leader, and Elon Musk was quick to support the idea. Republicans must find a successor for periodically malfunctioning Mitch McConnell, who recently announced he'll step down in November, though intending to keep his Senate seat until his term ends in January 2027, when he'd be within weeks of turning 86. 

So far, the announced field consists of two quintessential establishment types: John Cornyn of Texas and John Thune of South Dakota. While John Barrasso's name had been thrown around as one of "The Three Johns" considered top contenders, the Wyoming senator on Tuesday said he'll instead seek the number two slot as party whip. 

Paul used X to tease his potential bid for the position which -- if the GOP takes back the upper chamber in November -- could graduate from Minority Leader to Majority Leader. He started by telling his 5.1 million followers he'd had lots of people asking him about his interest in running...

...then followed up with a poll in which he predictably annihilated Cornyn and Thune, taking a 96% share as of Friday night, with the other two below 2% each. 

Elon Musk was quick to back the idea of Paul as GOP leader, while daring Cornyn and Thune to follow Paul's lead by throwing their names out for consideration by the Twitter-verse X-verse. 

Paul has been a stalwart opponent of security-state mass surveillance, foreign interventionism -- to include shoveling billions of dollars into the proxy war in Ukraine -- and out-of-control spending in general. He demonstrated the latter passion on the Senate floor this week as he ridiculed the latest kick-the-can spending package:   

In February, Paul used Senate rules to force his colleagues into a grueling Super Bowl weekend of votes, as he worked to derail a $95 billion foreign aid bill. "I think we should stay here as long as it takes,” said Paul. “If it takes a week or a month, I’ll force them to stay here to discuss why they think the border of Ukraine is more important than the US border.”

Don't expect a Majority Leader Paul to ditch the filibuster -- he's been a hardy user of the legislative delay tactic. In 2013, he spoke for 13 hours to fight the nomination of John Brennan as CIA director. In 2015, he orated for 10-and-a-half-hours to oppose extension of the Patriot Act

Rand Paul amid his 10 1/2 hour filibuster in 2015

Among the general public, Paul is probably best known as Capitol Hill's chief tormentor of Dr. Anthony Fauci, who was director of the National Institute of Allergy and Infectious Disease during the Covid-19 pandemic. Paul says the evidence indicates the virus emerged from China's Wuhan Institute of Virology. He's accused Fauci and other members of the US government public health apparatus of evading questions about their funding of the Chinese lab's "gain of function" research, which takes natural viruses and morphs them into something more dangerous. Paul has pointedly said that Fauci committed perjury in congressional hearings and that he belongs in jail "without question."   

Musk is neither the only nor the first noteworthy figure to back Paul for party leader. Just hours after McConnell announced his upcoming step-down from leadership, independent 2024 presidential candidate Robert F. Kennedy, Jr voiced his support: 

In a testament to the extent to which the establishment recoils at the libertarian-minded Paul, mainstream media outlets -- which have been quick to report on other developments in the majority leader race -- pretended not to notice that Paul had signaled his interest in the job. More than 24 hours after Paul's test-the-waters tweet-fest began, not a single major outlet had brought it to the attention of their audience. 

That may be his strongest endorsement yet. 

Tyler Durden Sun, 03/10/2024 - 20:25

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The Great Replacement Loophole: Illegal Immigrants Score 5-Year Work Benefit While “Waiting” For Deporation, Asylum

The Great Replacement Loophole: Illegal Immigrants Score 5-Year Work Benefit While "Waiting" For Deporation, Asylum

Over the past several…

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The Great Replacement Loophole: Illegal Immigrants Score 5-Year Work Benefit While "Waiting" For Deporation, Asylum

Over the past several months we've pointed out that there has  been zero job creation for native-born workers since the summer of 2018...

... and that since Joe Biden was sworn into office, most of the post-pandemic job gains the administration continuously brags about have gone foreign-born (read immigrants, mostly illegal ones) workers.

And while the left might find this data almost as verboten as FBI crime statistics - as it directly supports the so-called "great replacement theory" we're not supposed to discuss - it also coincides with record numbers of illegal crossings into the United States under Biden.

In short, the Biden administration opened the floodgates, 10 million illegal immigrants poured into the country, and most of the post-pandemic "jobs recovery" went to foreign-born workers, of which illegal immigrants represent the largest chunk.

Asylum seekers from Venezuela await work permits on June 28, 2023 (via the Chicago Tribune)

'But Tyler, illegal immigrants can't possibly work in the United States whilst awaiting their asylum hearings,' one might hear from the peanut gallery. On the contrary: ever since Biden reversed a key aspect of Trump's labor policies, all illegal immigrants - even those awaiting deportation proceedings - have been given carte blanche to work while awaiting said proceedings for up to five years...

... something which even Elon Musk was shocked to learn.

Which leads us to another question: recall that the primary concern for the Biden admin for much of 2022 and 2023 was soaring prices, i.e., relentless inflation in general, and rising wages in particular, which in turn prompted even Goldman to admit two years ago that the diabolical wage-price spiral had been unleashed in the US (diabolical, because nothing absent a major economic shock, read recession or depression, can short-circuit it once it is in place).

Well, there is one other thing that can break the wage-price spiral loop: a flood of ultra-cheap illegal immigrant workers. But don't take our word for it: here is Fed Chair Jerome Powell himself during his February 60 Minutes interview:

PELLEY: Why was immigration important?

POWELL: Because, you know, immigrants come in, and they tend to work at a rate that is at or above that for non-immigrants. Immigrants who come to the country tend to be in the workforce at a slightly higher level than native Americans do. But that's largely because of the age difference. They tend to skew younger.

PELLEY: Why is immigration so important to the economy?

POWELL: Well, first of all, immigration policy is not the Fed's job. The immigration policy of the United States is really important and really much under discussion right now, and that's none of our business. We don't set immigration policy. We don't comment on it.

I will say, over time, though, the U.S. economy has benefited from immigration. And, frankly, just in the last, year a big part of the story of the labor market coming back into better balance is immigration returning to levels that were more typical of the pre-pandemic era.

PELLEY: The country needed the workers.

POWELL: It did. And so, that's what's been happening.

Translation: Immigrants work hard, and Americans are lazy. But much more importantly, since illegal immigrants will work for any pay, and since Biden's Department of Homeland Security, via its Citizenship and Immigration Services Agency, has made it so illegal immigrants can work in the US perfectly legally for up to 5 years (if not more), one can argue that the flood of illegals through the southern border has been the primary reason why inflation - or rather mostly wage inflation, that all too critical component of the wage-price spiral  - has moderated in in the past year, when the US labor market suddenly found itself flooded with millions of perfectly eligible workers, who just also happen to be illegal immigrants and thus have zero wage bargaining options.

None of this is to suggest that the relentless flood of immigrants into the US is not also driven by voting and census concerns - something Elon Musk has been pounding the table on in recent weeks, and has gone so far to call it "the biggest corruption of American democracy in the 21st century", but in retrospect, one can also argue that the only modest success the Biden admin has had in the past year - namely bringing inflation down from a torrid 9% annual rate to "only" 3% - has also been due to the millions of illegals he's imported into the country.

We would be remiss if we didn't also note that this so often carries catastrophic short-term consequences for the social fabric of the country (the Laken Riley fiasco being only the latest example), not to mention the far more dire long-term consequences for the future of the US - chief among them the trillions of dollars in debt the US will need to incur to pay for all those new illegal immigrants Democrat voters and low-paid workers. This is on top of the labor revolution that will kick in once AI leads to mass layoffs among high-paying, white-collar jobs, after which all those newly laid off native-born workers hoping to trade down to lower paying (if available) jobs will discover that hardened criminals from Honduras or Guatemala have already taken them, all thanks to Joe Biden.

Tyler Durden Sun, 03/10/2024 - 19:15

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