The episode is based on this week’s newsletter that is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:10 Prevailing Optimism

00:01:50 Low-Income Consumer Strains

00:03:54 EV Market Dynamics

00:04:56 Automaker Bets and Brand Loyalty

00:07:01 Hybrids Gaining Ground

00:07:54 Conclusion

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, editor of The Transcript, along with Erick Mokaya, who's our lead author. We sent out a new issue of the newsletter on Monday.

Prevailing Optimism

"Looking ahead, 2024 appears to have a more stable outlook than may have been expected just a few months ago, with a reasonable probability of seeing the much-discussed soft landing. As Leon mentioned in his opening remarks, the U.S. economy appears relatively healthy with inflation and unemployment metrics continuing to trend favorably" - Nucor (NUE 0.00%↑) SFO Stephen Laxton

What we saw was that companies are feeling positive about the outlook. That's not surprising to most people. I think that companies are feeling more optimistic about 2024 but the thing that we did note is that markets may be getting a little bit ahead of the Fed who may be lowering interest rates more slowly than people are hoping for or expecting. And we got a CPI print this morning that showed that maybe inflation is a little bit more sticky than people were hoping for. And so that could keep the Fed on hold as well. That could impact the outlook for the rest of the year as well. Erick, any thoughts?

[00:00:47] Mokaya: Yeah, I agree. I think what I've seen, especially in most earnings calls that I've read, is that companies are quite positive about the year and especially about the second half of the year based on the expectations that the Fed will reduce rates at some point before or during the summer this year.

So I don't know. As you say, maybe they're getting way ahead of themselves because the consumer has been doing well for the past couple of years, but they are at a point where they're struggling a bit. The expectations for most companies are that the Fed would ease the burden on consumers by reducing rates and that would boost a bit of confidence in markets and companies and company execs.

So yeah, the inflation is sticky here. There are lots of companies that are noting that inflation is not yet done. It's lower, but it's still at a high end, so to speak. The Fed would not be able to act until they say they have enough data to prove that inflation has gone down substantially. The expectation from company execs is that the Fed is going to lower rates in the 2nd half of the year. 

Low-Income Consumer Strains

And the most impacted people so far are the low-income consumers. That has been true for a while. They're trading down pretty significantly. And because of that, I think because of the high prices that they've experienced the past couple of years, they're not able to handle them so well. So most companies, especially the retail companies, what I've noted is they're saying that they've hit their peak in terms of pricing increases because if they keep increasing further, volume is going to decline quite significantly a bit more. Any thoughts on that, especially on the low-income consumer and how they've been impacted so far?

[00:02:27] Scott: Yeah, I think the lower-income consumer is a cross-current relative to what expectations are in the market because we've been seeing for a long time now, probably 18 months, that the low-income consumer is displaying behaviors of trading down, like you said, more price sensitivity. And that their balance sheets are getting weaker. One data point that we pulled out that's particularly concerning was from Equifax talking about delinquencies among subprime consumers are as high or higher than they were in 2009, which I think is something that is not on anybody's radar screen.

"Credit card delinquency rates for prime consumers, which represent about 80% of the market are stable and at historically low levels at less than 1%, but above pre-pandemic levels…Delinquencies for subprime consumers are above pre-pandemic levels, as well as above the levels we saw in 2009. And any credit tiding that we've seen has been largely in fintech and subprime, which started well over a year ago" - Equifax (EFX 0.00%↑) CEO Mark Begor

In fact, it's so far off from what people are talking about that I actually don't even know that I really believe the data. I need to go back and look at that data. What Equifax is talking about in terms of subprime delinquencies, because obviously, subprime delinquencies were extreme in 2009. So if they're that high right now, that would be a surprise to markets I think. Any thoughts on that specifically?

[00:03:25] Mokaya: I was actually wondering about that because Equifax is a company I've tracked for a while. So I think at some point they said that the delinquencies are at pre-pandemic levels. And now they're saying you have to go way back to 2009. So my question was how big is Equifax in terms of the kind of consumers they interact with?

[00:03:43] Scott: Equifax is huge. They're one of the three largest credit rating bureaus. So they touch basically every consumer in the United States. So this is notable. They have good data. Yeah, this is definitely a noteworthy quote.

EV Market Dynamics

"Now someone portrayed the change in the EV market as Darwinian. That could be a slow evolutionary change, but we think this has been a seismic change in the last six months of last year. That will rapidly sort out winners and losers in our industry. Now the catalyst for that seismic change is a combination of EV manufacturers cutting their price by 20% across all major geographies and a tremendous amount of capital flowing and a ton of new capacity into one single segment, two-row crossovers." - Ford Motor (F -0.08%↓) EVP & President of Global Markets James Farley

[00:03:54] Mokaya: Yeah, but beyond that, there was the issue of EV markets, quite a seismic shift that is happening in terms of how the market is positioned. I should say I used an EV for long-distance travel during Christmas and my experience was actually quite negative in the sense that we had to put up with it, a four-hour journey, but it extended to eight hours because of bad weather. But the important thing is that you have to plan your journey in such a way that you have points where you stop for almost half an hour to charge. And then that's when I realized, like long distance, these things are not yet at the level where you can actually drive for such a long distance as you would under ICE vehicles. So I think that's the same thing that's happening in the market. The early adopters are done. And now the people who are supposed to buy them for mass market adoption are the guys who really need to think through what they need to do with the electric vehicles, so to speak. What's your experience so far with them?

Automaker Bets and Brand Loyalty

[00:04:56] Scott: Yeah. This is a super interesting industrial cycle to be watching because obviously the big automakers - GM, Ford, and others, Volkswagen really bet heavily on the transition from the internal combustion engine to the EV. And we're seeing that, as you mentioned, this cross of a chasm from the early adopter into mass market adoption. And we may be seeing that mass market demand isn't there, which is surprising to me as well. Because thinking back 12 months ago, when these companies were making these bets, it really felt like we were making a transition to EVs. And so to see that maybe the demand isn't there again is surprising. Part of the reason it may be surprising to me is because I live in California and Penske was talking about how 50 percent of their EV sales are in California. So there's a lot of really negative data points around EVs, though, not only from Penske where inventories are piling up, but also among the rental agencies. Hertz was talking about cutting a third of their EV fleet because there's no demand for the EVs from a rental standpoint. It'll be interesting to see how far ahead of itself the industry got, and how big of a glut of inventories will happen. And obviously, as a result of that glut of inventories, there will be a trend towards price cutting. So you're actually starting to already see some really good deals on EVs like I got a flyer from Volkswagen the other day talking about an $88 a-month lease on on one of their ID.4, which feels like an extremely low price for a 45, $50, 000 vehicle. So somebody is taking a huge loss on that. Again, if you're looking at these automakers, I think it's probably most acute among those mainstream automakers like GM, Ford, and Volkswagen, that were getting into this space without strong brands in EVs. Those companies’ customers didn't necessarily want to follow them into EVs. So this may be the biggest penalty for those companies.

Hybrids Gaining Ground

[00:07:01] Mokaya: I'm actually going to maybe after the episode check out Volvo because Volvo had targeted by 2030 to face out all ICE and to be exclusively EV. So I wonder, consumers, as you said, have not followed them to that plan that they had in mind. But the big gainers, and I think I saw a note from Morgan Stanley that said we apologize to Toyota and Hybrids. So I think the big winners here are actually hybrid where consumers want a little bit of, okay, we can charge and reduce our consumption of fuel, but at the same time, we can experience the possibilities of ICE vehicles. So I feel like those are the big winners. Toyota had a very good quarter in that regard. And the big manufacturers, I think the challenge that they're having is that currently, it's in the phase where investors want to see profitability or at least a path to profitability. 

Wrapping Up

Any other thing that you have picked up in earnings?

[00:07:55] Scott: No, I think that's a good point.

[00:07:56] Mokaya: That's a good place to close this week. Thank you so much for joining us on our weekly episode. See you again next week as we continue our tracking earning seasons and the key quotes from earnings this week Thank you and bye. Bye.

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:15 Decoding the Fed's Signals

00:03:18 Soft Signals from Europe's Economy

00:04:21 Natural Gas Inventory Surprises

00:05:06 Tech Earnings and AI

00:07:58 Meta's Dividend Debut

00:09:16 Chips and Games: Industry Trends

​​00:10:51 Conclusion

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript, along with Erick Mokaya who's our lead author. We sent out a new issue of the newsletter yesterday. And last week was Fed week in addition to an extremely busy earnings week.

Decoding the Fed's Signals

"We believe that our policy rate is likely at its peak for this tightening cycle and that if the economy evolves broadly as expected it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2 percent inflation objective is not assured. The economic outlook is uncertain and we remain highly attentive to inflation risks. We are prepared to maintain the current target range for the federal funds rate for longer if appropriate." - Federal Reserve Chair Jerome Powell

So there was a lot of data that was coming to markets last week. I think starting with the Fed, probably the most important thing was they signaled that rates are likely to come down at some point this year. They believe that we are at peak rates, but they said that not in March most likely. So expectations that they could start to be coming down soon may get pushed out a little bit. We had seen in past weeks that people's expectations of rate cuts in March starting to wane anyway, and people more thinking that rate cuts would be in the back half of the year. And so I think the Fed didn't necessarily surprise anybody here. The surprising data point from a macro perspective came at the end of the week when labor markets showed that new job creation was still really strong. And so that seems to change people's perspective a little bit on potentially persistent inflation with strong labor markets. Erick any thoughts on any of this?

[00:01:10] Mokaya: I think I agree. A very busy week last week. I think it was one of the heaviest I've seen. I haven't seen in a while where 5 tech companies are reporting in one week and in addition, we have the Fed. So I think the key takeaway is what you've picked out that it's probably not March, but sometimes this year, but it's very interesting, though. The feeling I get is that the market is waiting with bated breath when the Fed signals that we're actually cutting rates significantly.

But then there's one thing that stood out. The Fed chair talked about wanting to see six months of good data. I wonder at this point in time, don't they have enough data to see? What exactly is holding them back in terms of cutting rates? Is it that they don't want to signal to the market that we are done and dusted in terms of dealing with inflation? Any thoughts on that, on why exactly they actually haven't pivoted so far now, or at least cut rates so far?

[00:02:06] Scott: Yeah, it is interesting. It seems they are being a little maybe overly hesitant. It certainly seems like inflation has come down. But at the same time, Jerome Powell has shown in the past that his Fed will act over a longer arc than probably financial markets may be ready to proceed.

And I'm thinking specifically with respect to actually raising interest rates. As we saw inflation coming out of the pandemic, they were very slow to raise interest rates. It took them probably a year too long to raise interest rates, so they're risking running the same sort of mistake here on the other side of being overly tight for too long because I think that the inflation data and the markets are certainly hoping that they start boosting up soon.

[00:02:52] Mokaya: And there was a quote from New York Community Bank that says borrowers are also waiting on the sidelines for lower rates. It's like everybody in the markets is just waiting for that moment when the Fed cuts in order to be able to get back into the market. But interestingly, capital markets are opening up. We saw the quote from Lazard. So I think generally it's just a hold-your-breath kind of sentiment that you get in the market so far. Do you agree?

Soft Signals from Europe's Economy

[00:03:18] Scott: Yeah, I think so. One thing in the newsletter this week that I wanted to ask you about being in Sweden is UPS talking about weakness in Europe. What are you saying right now in Europe? Is the economy feeling any weaker? Any noticeable changes?

[00:03:35] Mokaya: I think what I've seen most significantly impacted, I was talking a bit to students who are almost joining the job market. It feels like the job market's a bit stagnant, especially to do with markets associated with real estate. Especially in Sweden, they've been significantly impacted by the very high rates so it’s a very soft environment.

The funny thing is that market prices are not that significantly impacted. It's just that this general lull now in terms of no new constructions are happening. I actually noticed some constructions nearby which have been going on since 2021. If this was before the pandemic, they would have been constructed really fast. But right now it's like everything is at a pause. In terms of purchases, you can feel in the economy, demand is a bit subdued. So I do agree. There's a bit of softness in Europe.

Natural Gas Inventory Surprises

“Gas is a little bit different. The inventories are high in the U.S. Inventories are high in Europe. We're kind of mostly through the wintertime, certainly through the riskiest period of the wintertime, and now, there's these questions that are not going to really weigh in the market in the near term, but maybe longer term, about exports out of the US and so all of that has got, gas markets under a little more pressure than oil markets or refined products and it's not unusual." - Chevron (CVX 0.00%↑) CEO Michael Wirth

[00:04:21] Scott: I did see though, Chevron said that natural gas inventories are high in the U.S. and in Europe. Has that filtered through to energy prices or are energy prices less burdensome than they had been?

[00:04:36] Mokaya: Yes, significantly this year there's been absolutely no talk about high energy prices. It's one of the coldest winters I've experienced in Europe, but there's been absolutely no talk about high energy prices around Europe. And if you look at the data the European Central Bank came out with, it seems like energy prices, the fact that they're lower this year than last year has helped a bit to cool the inflation, especially in Europe. So not talk about energy. People are very well prepared for this winter.

Tech Earnings and AI

But beyond that, it was tech week. So I think maybe we should discuss a bit of the tech week. And I think my key takeaway was issues to do with cloud optimizations. They're softening in that regard. And Cloud companies, especially the big three, are doing very well. A significant chunk of growth for let's say Microsoft Azure is coming from AI. So I feel like the beneficiaries of AI at this very early stage are mostly tech and the providers of shovels for digging, as we say. But the companies themselves, if I look on the other side, the companies are talking about AI, they're mostly talking about AI helping them do their tasks a bit more efficiently. So there's not many companies outside big tech are talking about new revenue generation streams because of AI. What's your takeaway from the tech earnings season?

"But that period of massive, I'll call it, optimization only and no new workload start, that, I think, has ended at this point. So what you're seeing is much more of that continuous cycles by customers, both when it comes to AI or whether it comes to the traditional workloads." - Microsoft (MSFT 0.02%↑) CEO Satya Nadella

[00:05:56] Scott: Yeah, I think what's going on at the data centers is really the thematic element for the big tech companies. And at the data centers, number one, there had been weakness in cloud spend from cost optimization. So you had other technology companies who were trying to rationalize their spend at the hyperscalers data centers. The hyperscalers were talking about that basically being done now. So companies are done cutting costs, which is his own macroeconomic indicator that companies are getting more bullish, ready to spend more and invest more in things like cloud. So that's a positive data point just for I.T. spend, the capex in general, capex budgets. So there's that.

"CapEx will go up in 2024. I'm not giving a number today, but we do -- we're still working through plans for the year, but we do expect CapEx to rise as we add capacity in AWS for region expansions, but primarily the work we're doing with generative AI projects…. the trend for most of the large percentage of the spend will be in infrastructure is going to continue into 2024." - Amazon (AMZN -0.03%↓) CFO Brian Olsavsky

And then the second big thing that's going on in data centers is obviously the transition to AI. And the investment in GPUs and compute that is capable of processing AI workloads. And so you're seeing major CapEx spend from the hyperscalers, from the big tech companies, the seven horsemen or whatever we're calling them these days. AI is a huge theme in tech.

[00:07:02] Mokaya: Definitely. But what struck me a bit was also the use cases that Amazon has found for AI in its businesses. The really interesting use cases, like, they have this AI tool that is able to read thousands of summaries for you. And then you don't have to read everything. I feel like the best use case so far for most AI products, especially for the consumer side is summarizing content for you so that you don't have to read the whole document. You're able to read a bit of it and still get a feel of everything.

[00:07:32] Scott: Yeah, it is, I think the game changer for our perceptions of AI obviously have been the large language models, which are very good at reading large amounts of written language and summarizing them. So it’s a clear, obvious use case for them but yeah, it's interesting seeing the way these things are going to be filtering into the economy.

Meta's Dividend Debut

[00:07:58] Mokaya: Let's talk Meta. You've been bullish. It's finally a dividend stock. It's joined the likes of Caterpillar now as a dividend stock. 

[00:08:10] Scott: Meta is up now five times over the last 18 months. We highlighted that there were changes going on in the earnings call that people should be aware of. I don't know that I have much more to say than that, but nice one for The Transcript.

[00:08:26] Mokaya: Yeah, so for me, what stood out was the fact that they actually talked about the tens of billions of public videos and publicly shared images that they already have in the backyard to train their AI models on. So I feel like some of the companies are going to win in this are companies with unique data sets like that.

And maybe one more thing by the way. Apple and AI. Still not much talk in earnings in terms of what they want to do with AI, but the CEO did say look out for us in the next couple of months and we will be able to show you something. Apple is not known to talk about stuff in advance. So I guess they're keeping it low. So let's see how that goes. And Apple Vision Pro, of course, was launched last week. And it's going to be one of the categories in their wearable section going forward. So that's an interesting one to keep track of going ahead. Any other takeaways from earnings in terms of tech?

Chips and Games: Industry Trends

[00:09:16] Scott: Yeah, a couple of important ones within the tech section. One was that Microchip Semiconductor company was talking about weakness in all of their end markets. Just highlight that because Microchip has historically been a leading indicator for the broader semiconductor industry. When they talk about weakness, I always look twice at that. This time around it feels like it's a little bit more of a lagging indicator than the leading indicator, but still wanted to point that out.

"And in the gaming segment as we enter the fifth year of what has been a very strong gaming cycle and given current customer inventory levels, we expect revenue to decline by a significant double-digit percentage." - Advanced Micro Devices (AMD 0.03%↑) CEO Lisa Su

And then the second thing was AMD talking about extreme weakness in its video gaming segment. Down double-digit percentages, they said in 2024. I bring that up because it is an industry that is one to keep an eye on specifically with respect to GameStop. My mind goes back to being a legacy meme stock that still is carrying quite a bit of a premium to it from those days. If fundamentals are turning negative against it, that would be an area to be concerned about if you're a GameStop shareholder. Any thoughts specifically on that part of the video game stuff?

[00:10:19] Mokaya: I don't have much. It's interesting though that Microchip is struggling when others like AMD and Nvidia are really having a good time. I feel like AI has maybe overshadowed what would've been quite a tough period for some of these companies in the last year or so. So AMD and Nvidia are benefitting from data centers. So that's covering up for some of the weaknesses that are in the other pockets of the market. So I think that the chip industry seems to be going through a downturn save for AI which is boosting growth. And I think that's key.

Conclusion

A good place to close at?

[00:10:52] Scott: Yeah, I think that's a good place to close.

[00:10:55] Mokaya: Yeah, so I think last week was peak earning season, actually, so from now it's going to get a little bit easier. I think around 70 S&P 500 companies are reporting this week, so we'll be keeping an eye on all of them. Subscribe to our newsletter and be able to get top content from us every week. See you next week and thank you for joining us this week. Bye. 

[00:11:07] Scott: Thanks, everyone.

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:36 Is It a Soft Landing for the Economy?

00:00:52 Consumer Resilience

00:01:44 Inflation and the Fed's Tightrope

00:02:29 Luxury Spending Unfazed

00:04:50 Tesla's AI Drive

00:06:29 Elon Musk's Power Play

00:09:03 Boeing's Turbulence

00:11:39 Big Tech’s Week of Truth

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. We are back for 2024. Apologies for the delay and podcasts, but we've got earnings season off to a roaring start already, and this week we sent out a new newsletter that captured some of those earnings call insights.

In the Macro section this week, we found that the economy is still pretty strong, which is what we've seen throughout this earning season. Consumer spending has been resilient. To use a word that's been used over and over again in earnings calls and, it looks like the soft landing may have happened, honestly. What do you think, Erick?

Is It a Soft Landing for the Economy?

[00:00:36] Mokaya: Yeah, I think that's the key takeaway. It feels like everyone feels like the plane landed without any mishap. It didn't do a Boeing. So I think it feels like it's okay so far. There's nothing that is standing out, at least since the beginning of the year that makes us think there's anything that's gone wrong.

Consumer Resilience

[00:00:52] Scott: Do You think we've had a soft landing or not?

[00:00:56] Mokaya: That's really hard to tell, but I feel like we've landed softly so far. You can't tell what's going on far ahead, especially with elections coming up. I think there was a quote there that said around 4 billion people around the world are having elections this year.

So that's a substantial risk that is in the process. And of course, the issues to do with the Red Sea and the oil is flaring up. Some geopolitical tensions around the world, which seem to be easing a bit. But I feel so far, looking at the data, looking at the quotes, everybody's a little cautious, but it seems like there's a general agreement that we are in a soft landing. That seems to be the consensus, at least from the first three weeks of reading earnings transcripts this year. Do you agree?

Inflation and the Fed's Tightrope

"While raw materials will likely be a benefit for us, other costs, including wages, health care, energy, and transportation are expected to be up in the mid to high-single-digit range in 2024. I will remind you that these categories also inflated in 2023. Working with our customers, we delayed additional Paint Stores price increases last year given the pricing actions that we took in 2021 and 2022. We cannot however ignore these escalating costs indefinitely. As I mentioned earlier, Paint Stores Group is implementing a 5% price increase effective February 1st." - Sherwin-Williams (SHW 0.00%↑) President & GM of Retail - North America Heidi Petz

[00:01:44] Scott: It definitely seems like a consensus. Inflation has certainly come down, although there's still some lingering amounts of inflation that we're seeing and calls in the insurance industry are talking about it. Sherwin Williams was talking about. Still having inflation is not necessarily in raw materials, but in labor costs and things like that. So there are still some areas of services inflation, but it certainly doesn't seem like the type of inflation that the Fed needs will feel like it needs to actively fight. And so the interest rates are already in a somewhat restrictive position as the Fed has talked about before. And so it'll be interesting to see as the Fed starts talking, they really have been pretty quiet for the last few weeks, but as they start talking again and understanding how their mindset is evolving around this data as well is going to be the story of, at least the quarter, if not the year.

Luxury Spending Unfazed

[00:02:36] Mokaya: I think they are meeting this week. So that would be interesting how they start the year. But my feeling is that it's another pause or nothing really has changed. I think it's been seven months or so the Fed pauses. So nothing much has happened.

But maybe something that stood out for me is that regards consumer spending, it seems to be, especially among the affluent, they're still doing well. LVMH had a record year in 2023. And American Express. They're growing, total billed business is growing at 9%. And then you look at Visa, they're saying that US payments grew around 5 percent year over year last year. Doesn't feel like we're really in that recession, at least for the kind of consumers that Visa, American Express, and LVMH serve so far. So it doesn't feel like there's anything to be worried about in that end.

[00:03:24] Scott: Yeah, honestly, the quotes from Visa and American Express in terms of volumes that year over year payment volume at Visa is still at 8 percent growth. U. S. payments volume grew 5 percent year over year is what they said. American Express showed a 9 percent growth in billed business on an FX-adjusted basis. Those are very large comps, so we may have even stronger growth than is really being recognized right now.

"We are off to a solid start in 2024. Consumer spending remained resilient with first quarter year-over-year payments volume growth at 8%, U.S. payments volume grew 5% year-over-year, international payments volume grew 11%. Cross-border volume, excluding intra-Europe, rose 16% year-over-year in constant dollars with cross-border travel at 142% of 2019 levels, up from 139% in the fourth quarter... Consumer spend across all segments from low- to high-spend has remained relatively stable. Our data does not indicate any meaningful behavior change across consumer segments." - Visa (V 0.00%↑) CFO Chris Suh

[00:03:51] Mokaya: Yeah. The area of concern, though, has been China of late. The geopolitical situation that they have with the U. S. If you look at some of the companies that were reporting, especially semiconductors, they're not factoring in large growth in terms of China because of the restrictions that have happened because of geopolitical issues.

But then also that there is a bit of slowdown growth in China. There is an anti-corruption drive that is slowing down business over there. But perhaps maybe a transition to the other sections that we had. One of the quotes was from Elon Musk acknowledging that the auto companies, especially in China, they're very competitive. And the only way the U. S. companies are going to survive is if there are restrictions in trade in that regard. That stood out for me as an acknowledgment of the forcefulness of the competition that is out there in EV markets and car companies generally.

[00:04:41] Scott: Yeah, it's interesting because they are his strongest competition. And in the U. S. we're not seeing a lot of Chinese car companies. I don't know in Sweden if you're seeing Chinese cars.

Tesla's AI Drive

[00:04:50] Mokaya: I was surprised. I was surprised at the airport. I did see a BYD and I've never seen a BYD in my life. So I think they're forcefully entering the European market so far.

[00:05:00] Scott: Yeah. Ford's CEO has been talking about how they are now the largest exporter of vehicles in the world, which is incredible as well. So U. S. markets may not be really recognizing how strong Chinese cars are as competitors from an E. V. standpoint. And so that is definitely something that could become appreciated, especially given that Elon's talking about it. Those are his competitors again.

[00:05:26] Mokaya: Something else that stood out also from Elon Musk was about the investments in AI and how he wants a bit of more share in the company because he is making it into a wild beater in terms of AI. What's your take on that? 25%?

"Yeah, I guess. Let me explain what my concern is here, which is that I see a path to creating an artificial intelligence and robotics juggernaut of truly immense capability and power. And my concern would be, I don't want to control it. …So I want to have enough to be influential. Like, if we could do a dual-class stock, that would be ideal. I'm not looking for additional economics. I just want to be an effective steward of very powerful technology. And the reason I just sort of roughly picked approximately 25% was that's not so much that I can control the company, even if I go bonkers and if I'm, like, mad, they can throw me out. But it's enough that I have a strong influence. That's what I'm aiming for, is a strong influence, but not control. If there's some way to achieve that that would be great." - Tesla (TSLA 0.72%↑) CEO Elon Musk

[00:05:39] Scott: Yeah. It's really interesting, right? I actually think Tesla shareholders, because he says he doesn't care about the economics, he just wants the voting power. I almost think it's a good deal for Tesla shareholders to give him 25 percent voting rights. Like just give him a share class that has extra voting rights. Most people who are invested in Tesla are invested in it for Elon Musk anyway. And if he basically says, okay, I'll take 25 percent control of the company, no change in economics, and in exchange, I'll build Tesla into an AI powerhouse, you have this very strong play on AI, which Tesla's you know, what, 500 billion market cap now or less, compared to Microsoft's a 3 trillion dollar market cap. It could be a really meaningful catalyst for Tesla.

[00:06:26] Mokaya: So to keep him, give him his carrot and let him eat it.

Elon Musk's Power Play

[00:06:29] Scott: Yeah. I think the other thing that was in the Tesla earnings call was about AI, that he wants to build AI and think of Tesla as an AI and robotics company. Obviously, Tesla is very premium priced compared to other automakers, but it seems to me that the price is mostly reflecting the auto business, not anything that's going on in AI or robotics at Tesla. So there is additional upside to Tesla stock from that perspective. And yeah, several times on the call, Elon in his Elon way said, I used to not see a path to being the most valuable company in the world, but now I see a path to becoming the most valuable company in the world at Tesla. And if all of that gets resolved and Tesla starts trading like an AI company, it really could be a lot of potential value unlocked at the company for the stock, basically.

[00:07:26] Mokaya: Yeah, and guess who's selling shovels to Tesla? NVIDIA. I noticed that there. That was a bit of a significant data point for me.

[00:07:35] Scott: Yeah, NVIDIA is selling to everybody, right? But Elon's comments on AI, NVIDIA, he downplayed the ability of Dojo to be able to compete with the NVIDIA chips was an interesting data point I noticed and then also talked about a few billion dollars a year and spend as table stakes at this point in order to compete in AI, is very interesting. In the AI marketplace in general, you just need a lot of scale in order to compete. It's not a world for startups really. It's actually very capital-intensive.

[00:08:09] Mokaya: Yeah, to build anything worthwhile right now, it raises the stakes in terms of who can compete in this kind of business. It means big tech will keep being the magnificent seven they are, but they stick here.

[00:08:24] Scott: I think that's what people are betting on. At the same time I think we have in there a very negative data point for Apple which was that Netflix isn't even planning on creating an app for Apple's vision pro. Seems like a bit of a slap in the face. I recognize that they are competitors of sorts because Apple is in the content generation business now, but it still seems like if it were truly a flagship product, a blue chip supplier like Netflix would be on the platform. So I think expectations are extremely low for the vision pro.

"Not by any unwillingness or lack of desire to do that, but even when you note we look at as close to ubiquity on devices perspective, the decisions that lead to that are we try and be very rigorous about, “What’s the effort to integrate on any given set of devices and what’s the benefit for the members that we serve?”. We have to be careful about making sure that we’re not investing in places that are not really yielding a return, and I would say we’ll see where things go with Vision Pro. Certainly we’re always in discussions with Apple to try and figure that out but right now, the device is so subscale that it’s not really particularly relevant to most of our members." - Netflix (NFLX 0.00%↑) Co-CEO Greg Peters

[00:08:57] Mokaya: Have you acquired it? Have you acquired one? 

[00:09:00] Scott: I have not. I haven't gotten a chance to play with one yet. Have you? 

[00:09:00] Mokaya: Not yet. It will come much later, I think, in the process. But I feel like the companies that are actually not creating apps for the Apple Vision Pro are mostly companies that have a bone to pick with Apple, like Spotify, and Netflix.

I feel like they are reaching a point where they're like, okay, you are becoming more of a gatekeeper for us. And they don't want to pay the 30%. So I think that's a bit of a hindrance for them. But it does feel like the uptake for vision pro may not be as huge as maybe expected of an Apple product normally in the scale of iPhone. It’s also an interesting point.

Boeing's Turbulence

So maybe one more point I wanted to point out is how unhappy Boeing customers are and that some airlines are considering Airbus. That's quite a significant point to check out. They're telling Boeing to get their act together. That's quite significant and strong language to see in earnings calls sometimes.

[00:09:58] Scott: Yeah, I'm glad you brought it there because that really stood out to me as well. The language that Boeing's customers were using, to your point, was some of the strongest language I've seen of a customer in that institutional space condemning a supplier. We're going to hold them accountable. Boeing needs to get its act together, is what American Airlines said about it. And then the Ryanair comment from last week as well was like, this is totally unacceptable and it is. And I think the headline today in the Wall Street Journal is that Boeing shipped that plane, like without important bolts in the doors and you add all that up. Not only are they losing the confidence of their customers, their direct customers, the airlines, they're also losing the confidence of the airlines’ customers, the flyers and so from that standpoint, Airbus has an opportunity to take a lot of market share here.

"We're going to hold them accountable. Boeing needs to get their act together. The issues that they've been dealing with over the recent period of time, but also going back a number of years now is unacceptable. And no matter who it is, all of Boeing needs to come together and to get back on the right track" - American Airlines Group (AAL -0.21%↓) President Robert Isom

Who knows how Boeing really rehabs itself from here? It seems like the CEO has got to go or something like that. There needs to be a change in leadership. There needs to be something big. Some big cleansing at Boeing it seems in order to really rebuild the confidence among their customers and the broad public. 

But at the same time, it's not like this is a hyper-competitive industry. You basically have a duopoly, so there's not really anywhere else to go. So from an investment standpoint, I look at this and go, there's a lot of negative sentiment on Boeing in some cases, but their fundamentals are extremely weak.

[00:11:27] Mokaya: It's Big Tech Earnings Week, any pick on top of your head, things that you're looking out for? It's the week of, I think someone called it the Super Bowl of tech earnings season.

[00:11:36] Scott: Apple. I'm very curious to see what's going on at Apple right now.

Big Tech’s Week of Truth

[00:11:39] Mokaya: I saw a chart that said nothing is growing at Apple now, and that's a bit concerning.

I don't know.

[00:11:46] Scott: It's the big tech company that has very little presence in AI, and that's the biggest catalyst within the investment world right now.

[00:11:55] Mokaya: And Microsoft has been growing so fast as to overtake them in terms of market cap and all. Microsoft reports this week also so really interesting to see what they are doing. I don't like their Bing, by the way, the new Bing, I tried it, and I went back to Google. So I hope they're doing a little more dancing this week.

[00:12:14] Scott: It is hard to get away from Google. They've got such a position, but, it's interesting that you mentioned Microsoft did a 3 trillion market cap right now. It was a pretty good quote that you found this week about IT budgets. The world tax spending is expected to be six and a half trillion by 2027 with three trillion spent on AI. So this may be the sorts of dollar numbers that people are putting into their models as they're thinking about what the value of these companies are.

[00:12:46] Mokaya: It's AI. Let's see who mentions AI the most. Like that's the cut at least in earnings calls. Yeah. So I think that's a good place to close up this week. Thank you so much. It's our first. We should do this more often, Scott. It's our first podcast for 2024. Looking forward to doing a bit more and covering the earnings season. Make sure to subscribe and to keep tuned in to The Transcript as we cover the earnings season. Bye for now. 

[00:13:13] Scott: Bye.

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, and Amazon Music.

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Show Notes

00:00:00 Introduction

00:00:35 The Consumer Is Still Very, Very Strong

00:01:40 Excess Savings Are Starting To Run Out

00:02:17 There Is No Landing

00:03:08 2024 U.S. Elections

Introduction

[00:00:00] Scott: Hi, everyone. Welcome to a new episode of the transcript podcast. You've got me, Scott Krisiloff, along with Erick Mokaya. We are back to podcasting today, trying to get back in the groove. I know it's been a little while since we've had a podcast and we've been less consistent than we used to be, but trying to get back in a consistent space for the end of this year and into next year.

And so what we saw last week was Visa and Amex. Both were speaking at conferences, and both of them said that consumer spending is still very strong. Both of them said the same thing.

The Consumer Is Still Very, Very Strong

And so that was a little bit surprising because not only have we seen, consumers starting to get weaker and weaker over the last few weeks, but it seems even this week in other calls like Dollar General and Lowe's also were saying that their customers were under some pressure.

And so I think maybe the takeaway for me is that at least the low-income consumer, continues to be under a lot of pressure and then also interest rates sensitive sectors like housing, maybe seeing a little bit more pressure than other sectors.

Whereas places where consumers would spend on credit cards. Like travel entertainment things like that still doing very well Eric any takeaways from you?

[00:01:18] Mokaya: Did you feel that people are living on credits going into the new year? It's been the story of the year, to say the least. For the consumer is very strong where we expect them to weaken But then these are companies that kind of deal with the platforms. So I don't know like the real takeaway is that the low-income consumer is pressured as you can see from the retailers.

Excess Savings Are Starting To Run Out

And then something else that excess savings are starting to run out, but then this has been predicted for a long while to run out I don't know where consumers are getting extra cash from to keep spending up.

But the good thing at least is that inflation is subsiding, and that's a good thing, and interest rates are especially some of the interest rate sensitive sectors are moving down slightly, so they're getting a little boost from that. That's like the high-level takeaway.

So it feels like everything is steadily okay, but it's steadily okay to the extent that some most people expect it to crack at some point. Do you feel like that's a good characterization of the earnings call so far?

There Is No Landing

[00:02:17] Scott: Yeah I think the headline for today's piece was that There's no landing.

And that came from an S and P global call in which the CEO was talking about; Is it going to be a hard laugh landing or a soft landing? And he said, the reality is still no landing at all this year, meaning in a good way that the economy hasn't really slowed down, that there's still been strong consumption growth, strong job growth, and the landing, so to speak that everyone has been

looking for almost two years, if not two years now hasn't come to fruition. But on the flip side, you see these areas where there are weaknesses, like in consumer electronics markets where it looked like things were getting better and then they seem to be softening again. So not sure where to make all of that.

2024 U.S. Elections

[00:03:08] Mokaya: It's very confusing data leading into 2024, and then there's general elections in the us. I don't know how much of a factor that is usually in terms of earnings and all, but like it's a factor that investors have to consider going into next year. Globally, looks like China has not recovered to the same extent that people wanted. People are very bullish at the beginning of the year, it seems like it's starting to sink in that it may take a little bit longer than expected. And then if you look at the Eurozone itself very sluggish growth going into next year.

The U. S. is doing a bit better than most economies, but then there's an election next year. So I don't know what to take away from that in terms of our investors being concerned that the election factor Will be a key factor going into next year, though.

[00:03:53] Scott: Yeah, it certainly could be. The policy element that's still the biggest impact on markets, as we know, is the Federal Reserve policy.

And I think that is the big swing factor right now in terms of why markets are feeling more buoyant and optimistic: inflation has come down. The Federal Reserve is signaling that there doesn't need to be more interest rate increases, and I think that investors are starting to anticipate interest rate decreases which would be letting off the lid on the economy that the Federal Reserve has put on it since inflation started again a couple of years ago.

Three years ago now. And if the Federal Reserve does start to lower interest rates, obviously, Yeah. That would be a big boost to the economy.

[00:04:42] Mokaya: And, this is the last definitely, and this is the last week of the year in terms of the Fed week, this is the week they're supposed to give us where interest rates are going for the next. I would expect that they will be holding going into next year, give people a bit of a cool holiday period, and check again next year.

Any other takeaways from the earnings?

[00:05:05] Scott: No, just, it'll be light now through the end of the year, obviously fed week this week, but besides that, I don't know if we'll do another podcast before the end of the year. So everybody have a happy holiday and see everyone in the new year.

[00:05:20] Mokaya: Definitely. And please don't forget to subscribe. I wish you could give someone a gift, the transcript gift as a gift for the, uh, Christmas and the new year. We always collect the best in terms of, quotes for learning schools and we are right here every week to analyze them so make sure to give it as a gift and to keep subscribing to us and become a premium subscriber to definitely support our content and to also get access to really good content.

See you in the new year then if you don't manage to do an episode before Thank you so much from me and Scott.

See you soon again.

Bye

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:20 A Real Slowing

00:01:30 A Stressed Consumer

00:03:22: Rising Geopolitical Tensions

00:06:23 Soft EV Demand

00:05:20 Stabilization in Cloud

00:08:20 Sharp Rise in Defense Spending

00:09:22 Conclusion

Introduction

[00:00:00] Scott: Welcome everyone to The Transcript podcast. You've got me, Scott Kristoloff. I'm editor of The Transcript along with Eric Mokaya, who's our lead author. We have a new episode of the podcast for you.

A Real Slowing

We haven't been around for a little while, but it's earning season. So we figured we would hop on and discuss the trends that we're seeing in earning your skulls again. Last week there were a number of companies that reported a lot of tech companies. And in the last two weeks of the earnings season, I feel like we're seeing a real slowing in the economy. Still, the only real positive data point that we saw last week was Visa and MasterCard saying that things are stable. But besides that, I feel like most companies are talking about a slowdown. Real interest rates starting to really impact actual spending in the economy. We saw that from Harley Davidson. We've seen that from banks. We're seeing that in construction and housing and things like that. But I'm getting a sense that the economy is slowing some here. Eric, what's your take?

[00:54:00] Mokaya: I think we agree on that. I remember when you met, especially last week's newsletter, the previous week, not this one. The agreement was that there's a specific, very significant kind of time that has happened from observations, especially from CEOs in earnings calls. And then one of those is, of course, the slowing down of consumer spending, the fact that high, the higher rates are starting to finally hit the consumer where it hurts the most. So consumers are cutting down on spending and channeling it towards places where they find value. And interestingly, I think the comment for me that stood out this week is that the consumer is stressed, but it's barely hanging in there. So it feels like we're at that point where maybe a little bit more high interest rates would actually push your consumers towards And even a really bad place where they can be at.

A Stressed Consumer

So I think excess savings are mostly gone. And I think that's a key point to keep in mind because the consumers have actually been spending a lot on that. And especially this is something else that I noted is that personal unsecured personal loans are actually very the demand for them is very high at this point in time. I don't know if that gives you a sense of where the consumer is very stressed and borrowing as much as they can to be able to keep up with the spending so far. I wouldn't really read much into MasterCard and Visa. They are conduits in terms of where payments get done. I don't know how much visibility they have in terms of the level of stress that the consumer has. What do you think about that, especially given maybe the last financial crisis and all?

[00:02:20] Scott: Yeah, I think that the excess savings that the consumer had built up post-COVID from all the stimulus certainly seems to be dwindling at this point and is coming close to being exhausted. And so I think the stress that we've been seeing in the consumer, especially among low-income consumers, continues to show its way, make its way through the economy.

Last week, there was a quote that we picked up that said that subprime delinquencies were verging on 2009 levels, 2008 levels, which says to me that the consumer is in really bad shape, actually worse shape than people had been expecting. Yeah, the Visa MasterCard data, I think they, they see a lot of spend, but I think the spend tends to be more with affluent consumers, which does show, does impact the overall economy, but I think they're, I think they're missing some dynamics.

Rising Geopolitical Tensions

[00:03:22] Mokaya: I think so, too. I think the certain dynamics which we may not be able to get from them may be going back to perhaps one of the risks that has actually become heightened in the past couple of weeks is the geopolitical risk. If I remember well, when I was working at Klana, I think that was back in 2000 and 22, 23 there 20, 21, 22. The consumer was doing quite well in terms of the data that you were looking at back then until the crisis in Ukraine-Russia happened and then that kind of triggered a series of events where interest rates started going up and all. And I feel like at this point in time, this is a danger political risk, which has arisen in the past couple of two weeks, is actually a trigger in the sense of heightening the level of risk and maybe caution from banks in terms of lending, in terms of, we don't know how this situation may unfold. The Ukraine crisis has been with us for almost two years now. And still no resolution to it. Now there's a crisis in the Middle East and Demi Diamond was talking about it as being a very significant event. What's your take on that, especially in terms of how it may impact consumer spending going forward? 

[00:04:31] Scott: Yeah, I would say at best. I'm an armchair geopolitical analyst, but certainly, I think I like others in the world are watching the events of the Middle East with a lot of concern over like it happened and a lot of sadness over what has already happened. I think that clearly, the Middle East is an important lever on the price of oil. And if oil prices were to rise in something from an economic standpoint, it would have a really large impact on the global economy with where we're teetering right now. Similarly, just the parties in play in the Middle East certainly have me concerned as others, and that can weigh on global economic productivity just by virtue of people being concerned about what's happening geopolitically.

Stabilization in Cloud

[00:05:20] Mokaya: Yeah, I think so. And beyond that, as a big tech big tech was reporting earnings last week. And I think one of the things that stood out for me was the impact that geopolitical risk is having a bit of the ad spend. There are a couple of companies, I think, Snap and Meta, which noted that some customers have pulled back on spending slightly just to monitor how this develops. I don't know how that will be prevalent, especially going into Q4 for most of these companies, but I think that's something that is notable and worth paying attention to. And then also the fact that cloud spend is still very strong. A lot of these companies are still taking time to move some of their data needs from offline to online in terms of storage. And I think Amazon notably noted that the pace of deals is picking up. After a quiet kind of period, especially in the last two or three kind of quarters. Is there anything else you picked in terms of big tech earnings this week that would be interesting for our readers and listeners and readers to take note of?

Soft EV Demand

[00:06:23] Scott: Yeah, this wasn't necessarily in tech, but I thought there was a really important group of quotes from Ford and General Motors in this week's issue around electric vehicle demand and it seems like the demand for EVs that is being seen by at least Ford and GM is lower than their expectations, and I don't know what to make of that, whether it's just Ford and GM's product lineup that people aren't as interested in, or if broadly expectations for electric vehicles got a little bit out over overextended, but it seems like a pretty important group of quotes that there was, especially Thank If you rewind a year or two ago, in terms of the way that these companies were thinking about electric vehicle production and the amount of demand that there were, was for EVs, when you put those types of investment plans in motion, and then they don't show up. The demand doesn't show up to the extent forecasted. It can be very disruptive, not only to those companies, but supply chains that we're planning to supply those companies. And so I think that this is a very important dynamic that probably isn't fully fully appreciated by markets right now. And that can show up in a lot of different places because there are a lot of companies that are basically easy Evie plays right now in different areas that can be lithium companies. That can be power semiconductor companies. There's a lot of there was a lot of hype around EVs that may not be coming to fruition for those two big players.

[00:08:04] Mokaya: Yeah, I think one of the things that has notably come that I've noted the past couple of weeks or so around, as you say, EV companies, there's a lot of pricing pressure that is happening in the market. They're having to to reduce prices, which of course puts them under margin pressure. And I think there's a lot of, and a couple of quotes that we picked several weeks ago about the EV market, especially in China.

Sharp Rise in Defense Spending

Did you have anything else to discuss? Talk a bit about defence spending by the way, a lot of companies are having this huge backlog of just a sp in terms of demand for defence spending the past couple of weeks, given the high-tech geopolitical risks around them. I'm actually very surprised that they ramped up so fast.

[00:08:47] Scott: Yeah, I think defense contractors are a place where certainly from a financial standpoint, a trader could benefit from the geopolitical tensions that are happening around the world. It feels not entirely moral or ethical to me to make those sorts of investments, but that certainly is something that you know. Certain investors could potentially take advantage of here.

Conclusion

[00:09:16] Mokaya: Yeah, you are the same school. All right. Is that a good place to close our first episode in a long time?

[00:09:22] Scott: I think so.

[00:09:24] Mokaya: We should be back again next week, hopefully, to do this since it's peak earning season. I think this week, almost 170 S&P 500 companies are reporting. So we should have a lot of nuggets to speak, to pick up on. So see you again next week. And thank you for joining us on The Transcript podcast. Bye. Thanks, everyone. Bye.

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:20 Takeaways From Jackson Hole

00:03:25 Poor Comps for Many Retailers

00:05:17 A Pressured Consumer

00:06:38 Shrinkage

00:07:38 Nvidia and the AI Hype

00:10:40 Nvidia’s Moat

00:12:40 Conclusion

Transcript

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of the Transcript podcast. You've got me, Scott Christoff, I'm editor of the Transcript, along with Erick Mokaya, who's our lead author. 

Takeaways From Jackson Hole

We sent out a new issue of the newsletter yesterday, and we had some comments from Jackson Hole last week. We also had a big chunk of commentary from retailers who are reporting most recent results. Starting with Jackson Hole, it looked like Jerome Powell's speech was a little bit more leaning hawkish still it definitely didn't feel like a mission-accomplished type of speech. And in fact, we titled the newsletter Mission Not Accomplished. Jerome Powell saying that we still have a long way to go until we fully get inflation under control and showing commitment to that 2% inflation rate. Eric, any thoughts on this?

“My remarks this year will be a bit longer, but the message is the same: It is the Fed's job to bring inflation down to our 2% goal, and we will do so. We have tightened policy significantly over the past year. Although inflation has moved down from its peak—a welcome development—it remains too high. We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.” - Fed Chair Jerome Powell

[00:00:46] Mokaya: In his speech, he talks about them hiking, the possibility of them hiking further or pausing. There is nothing like cutting rates anytime soon. So that's clearly a hawkish trend in terms of talking. And then it seems like nothing really has changed since last year in the sense that the job is not yet done. That's a key message you take away from this, A bit of reiteration, the fact that 2% is the target. That's also a general reminder that hey, we may be at around 3% or 4%. We need to get below 2% for us to feel like it's mission accomplished. So the title of this week's newsletter is clearly mission is not yet accomplished. And then the other thing that I picked up is he's been saying that for the past couple of months is about balancing risks. I feel like the other point where they're really evaluating whether they should touch in a little bit further or wait for what they've tightened so far to see what the impact is on the economy. So that's the point at which we are. So my bet is next month, maybe a 25 basis point hike a little bit to see where we are at now. What's your feel so far from Jackson Hole?

[00:01:52] Scott: Yeah, I think the idea of a hike is still not probably what my expectation is. I think that they're probably on pause at best unless the data starts to support some sort of hike. I think the data would have to change in order to get to some sort of hiking scenario at their next meeting. But I think that markets had been expecting them to turn incrementally more dovish rather than maintaining their hawkishness. And so from that standpoint, just a maintenance of hawkishness is bearish for capital markets on the margin, I think. And so I think you may see some movement around recognition of where the Fed's stance is.

[00:02:39] Mokaya: But if you look at markets last week, it seems like they're very, Or whatever is happening at Jackson Hole it seems like it's just a continuation of the same thing. Nothing really drastic happened after Jackson Hole. Is that like they've already factored in the fact that the Fed will maintain a hawkish outlook and then they're waiting for the point where they tried to indicate that they've turned and then that's when maybe markets will actually respond.

[00:03:03] Scott: Markets had been pricing in turned towards a more dovish outlook, that less tightening and a little bit easier monetary policy. And so if the Fed comes in and reiterates that they're planning to maintain this policy that the Fed sees as restrictive, then that would be a letdown for capital markets for equity prices.

Poor Comps for Many Retailers

"At Macy's, net sales declined 9.3% and comparable sales declined 8.2% on an owned plus licensed basis." - Macy's CEO Jeffrey Gennette

"Comp store sales for the second quarter increased 4% versus our guidance of 2% to 4%. T…We are a little disappointed with these numbers…We had hoped to do better." - Burlington Stores CEO Michael O’Sullivan

[00:03:25] Mokaya: Maybe another point that we picked up of course is that consumer confidence is up, especially in the second half of the year. You can feel, especially as retailers report, they're saying consumers are starting to feel a bit more the fog is clearing up a bit. They're able to, they want to spend, but they're waiting a bit. They're under pressure, but they want to spend, but their confidence is a bit up. Let's contrast that to the first bit of the year where, Now also the most of last year where everyone was expecting a recession to hit the consumer really hard. And that's not turned out to be the case. Comps that the retailers are reporting are a bit weak but they're saying, especially as back to school season starts it's starting to be a bit better than expected. Any pickings for you from the retail section especially?

[00:04:12] Scott: Yeah I was surprised to hear you say that the commentary from retailers was more positive on consumers. I think my takeaway was that it was a pretty negative set of commentary from retailers. Mostly their comps were so negative. High single-digit negative comps for several of these retailers that we covered last week. , but then also talking about consumers being cautious. And this is something that retailers have been talking about for months as consumers being cautious. But I think the gravity of the actual performance struck me. And then the other part of it was Macy's talking about how their delinquencies rose sharply beyond their expectations, their credit card delinquencies. That was a big red flag to me. If credit quality is deteriorating, if the stimulus that had been going to consumers is really finally starting to run out and low and moderate-income consumers are starting to pull back that would be pretty bearish. That would be a change in economic prospects as well.

A Pressured Consumer

"While consumer confidence has strengthened, there are signs pointing to moderating growth going forward. Many consumers have begun to reduce overall spending, credit card debt remains high and the restart of student loan repayments is approaching." - Ulta Beauty President David Kimbell

[00:05:17] Mokaya: I should clarify that what I meant by being positive is consumer confidence, not the actual spending. The comps are pretty negative. It's just the confidence. I don't know if that is a bit of an indicator or a bit coming off from what is happening in the capital markets where consumers also see the stocks are not falling so much and it feels like they're okay. They're okay-ish. But the actual spending is as you said Macy is saying consumers are cutting back aggressively on spending. Trying to contain themselves. The low-income consumer especially is also very significantly challenged. And  I think for me the most interesting beat is Dollar Stores saying that they are receiving more high-income consumers coming to shop there. That's a pretty bearish indication because usually the kind of consumers who go there's mostly low-income, I would say. Is that something you agree with in that assessment?

[00:06:08] Scott: Yeah, I think it's also an indication that $125,000 isn't as high income as it used to be. And that's driven by inflation, yeah If you have inflation, that's just the way it is that incomes rise, but the purchasing power doesn't. And so a family making $125,000 a year now has a lot less purchasing power than they used to. And may try to shop at retailers like the Dollar Store where you can maximize your value. This podcast is not sponsored by the Dollar Store.

Shrinkage

[00:06:38] Mokaya: That's true. One more thing that retailers mentioned pretty much is shrink, stealing from shops. It's pretty heightened, and I don't know if it's an excuse for the negative comps but it seems like a real issue in Walmart I think the previous week talked about It's high, especially in states where there is a bit of a minimum below which they can't prosecute you for things like that. And then Gap saying Hey, we don't see shrink. Is it because Gap is not the kind of story anyone wants to steal from or what's the take, what's your take, especially on the issue of shrink?

[00:07:14] Scott: I don't know. I think this is more like a political commentary than actual economic commentary. I haven't seen numbers that suggested to me that this impacts profits in a meaningful way or a way that would register for our purposes. But certainly, if you're trying to push a narrative of the decline in society in the United States, shrink would be an issue for sure.

Nvidia and the AI Hype

[00:07:38] Mokaya: I actually didn't pick that up to be a political issue. Beyond that, we have Nvidia reporting earnings last week and they were extremely strong. The AI revolution keeps going on with Nvidia, It blew past people's expectations of what a normal quarter should be. And the expectations were pretty high in that regard, and it seems like for the rest of the year they have pretty good visibility in terms of very high demand for AI and they seem to be ramping up together with their supply chains in terms of being able to be able to supply, to meet this very high demand. That's a key takeaway for the tech section. Nvidia is still going strong and still benefiting a lot from the AI revolution that is currently happening. 

[00:08:19] Scott: Yeah do you feel like the AI hype is continuing to grow or do you think we're at like a moderating point right now?

[00:08:26] Mokaya: I feel like we are at the point where now we've heard a lot about the AI revolution happening, but I think now companies are having to have to produce actual products to match the hype. I feel like the next one or two quarters may be a bit harsh for some of the companies who have been hyping that we are actually doing something in terms of AI. And the adoption cover has not been that fast. So the companies are putting a lot of orders for chips that they expect to use, but I feel like the utilization may not be as big as they expect it to be, or at least the adoption of the products that they want to produce may not be as high as they want it to be meaning that there may be excess capacity soon in some of these companies. What's your feeling about where we are at in terms of the hype cycle?

[00:09:14] Scott: I definitely believe that AI is a long-term trend, and I think chatGPT was a huge lag for the world as to what AI is capable of doing. But I think that productization is lagging the perception of what AI is capable of doing right now. And I think it's gonna be a while before the productization actually is able to take on all of the hype. Like I see myself using chatGPT less right now than I was two months ago. I don't know how other people are feeling about it, but I don't know. I think the long-term trend is there and certainly the thing is that NVIDIA's really a Capex play from the data centers. And so as they're building more AI capabilities. The orders, to your point, the customers are there and are going to keep investing large amounts. I don't think the amount of investment that the hyperscalers or the big data center players are going to make into this is going to decline. I think that the tailwinds are real

[00:10:18] Mokaya: Over-ordering Issues. Does that concern you in the medium term at least?

[00:10:23] Scott: Over-ordering, not in the near term. I think the way that things flip on Nvidia is if there's some other competitor that comes out with a better chip that can do the same performance at lower volumes or lower energy.

Nvidia’s Moat

[00:10:40] Mokaya: And that's a hard thing to do. They have a pretty strong moat in that regard. To get to the scale at which they are at and to play at their level it will take you around 10 years to get to where they are.

And by the time you get there, they're way ahead of the curve. They've been doing this for 20 years and they have some extreme capabilities in terms of production. But I agree with you though. Nvidia has a huge tailwind behind them. And they will keep growing as much as possible. They seem to be like the only player in the market, the only game in the market, so to speak. In terms of the AI play, are there any other companies that you're tracking in terms of AI capabilities? 

[00:11:14] Scott:  That's it. In public markets, there's just not enough out there, and that's part of why NVIDIA's stock is going crazy, I'm sure.

[00:11:26] Mokaya: I agree with you. I've actually barely used ChatGPT in a while, and I think at the beginning as a bit of the hype thing, and then now you're back to using your Google back to Googling as you were before, and even being, you tried it a little bit and then you're back to Google at the end of the day.

[00:11:41] Scott: But if you, if you think about productization, there's a lot of companies that are probably trying to incorporate it. And you look at our own progression with it at the transcript and things that we're Loading up to do with AI. We're at an early touchpoint. It's really easy to use AI to do some of the things that we do. And so we're loading it up right now in our product stack, and hoping to be able to roll that out to people later this year. I would assume there's a lot of organizations that are going through the same investment cycle right now, so you may see more chatGPT productization out in the wild over the next six months than you have seen previously and that could boost psychology around the use of AI.

[00:12:25] Mokaya: So then prepare for more products infused with those kinds of Chat GPT-like capabilities?

[00:12:30] Scott: I think so. It'll be interesting to see what our own experiences with it on the backend and like the costs of using it and the value to our customers.

Conclusion

[00:12:40] Mokaya: I think from my observation, at least on our backend, I feel like it's very useful in terms of, especially the aggregation. It does, it's very good in terms of complimenting our skills and very good in terms of optimizing and helping us be a bit more productive from the backend. So I think our listeners will be very happy to see some of the stuff that we've been working on in a while. I think that’s a good point that we should close the podcast this week. Thank you so much for joining us and see you again soon on another edition of the Transcript Podcast.

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

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Show Notes

00:00:00 Introduction

00:01:39 Inflation has Peaked

00:02:20 A Tepid China

00:04:48 Capital Markets Are Healing

00:06:19 Adjusting to A New World of Higher Rates

00:09:05 The Taylor Swift Effect

00:10:40 Conclusion

Transcript

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of the Transcript podcast. You've got me, Scott Christoff. I'm editor of the Transcript, along with Erick Mokaya, who's the lead author. 

Optimism on the Rise

We sent out a new issue of the newsletter yesterday, and what we saw was an uptick in the US economy. This may not be too surprising because, as equity indexes have risen, I think optimism is just generally growing that we are at the end of the fed hike cycle, inflation is on the way down and the economy has normalized. And so I think people are starting to get excited that we might be at the start of a renewed upturn in the economic cycle. Erick, what are your thoughts on this?

"During the quarter, we also saw improvements in macroeconomic indicators across our North America and international segments but continue to see customers trading down and seeking value in their purchases." - Amazon () CFO Brian Olsavsky

“My sense, talking to customers, is that while the macro environment is still challenging, it has stabilized. And for the first time in several quarters, sentiment among IT buyers does not appear to be getting worse." - Cloudflare () CEO Mathew Prince

[00:00:40] Mokaya: I remember last year you said capital markets kind of tend to bottom before optimism kind of itself bottoms and then like goes on its way up. It feels like we are at that part of the cycle where people are a bit more optimistic. People feel like we are past the tough times. You remember last year. The major symbol was the hurricane. This time it's like, okay, we are past the hurricane may not happen after all things are looking good and looking forward, and that's translating a lot to the consumers also. So I think the keyword, I think from many earnings calls last week was stabilization, if it's AWS, the cloud growth has stabilized so it stopped going down. Freight recession is ending, inflation is abating. So I think like all around kind of positive sentiments. So I don't know how long this will last. It depends a lot on what the Fed does in September and then Jackson Hole is coming up. So then I don't know what any other pickings that you have in terms of like the outlook, especially for the economy going into the second half of the year now. 

Inflation has Peaked

[00:01:39] Scott: Yeah. Well, I mean, I think we've been Picking up for a long time now that inflation has peaked. And this week felt very definitive in the way that people were talking about it. I think it was like, almost like, and of course, inflation has peaked, or of course, inflation is coming down now. I think there was a question over the last 12 months of, yes, inflation has come down, but we're still in an inflationary environment today, it's more like, yeah, inflation seems to be, seems to have peaked and seems to be coming down quite a bit. So that should make the Fed really happy, I think, as they are looking forward in terms of what policy they should maintain. Still, though, it doesn't seem like they're ready to signal a decline in interest rates but at least maybe. The hike cycle seems to be almost at the end, if not over.

"...Across our North America and international results, inflation headwinds also continue to ease, most notably in fuel prices, linehaul rates, ocean and rail rates." - Amazon () CFO Brian Olsavsky

"What we are seeing in terms of inflation is it is flattening and we're not seeing the increases we saw in 2022, in early 2023. And we're seeing a few items decrease, mainly on the steel side of things. So our casing and our tubular goods, anything that's fuel related, we've seen some relief chemicals, we've seen some relief" - Pioneer Natural Resources () CEO Richard Dealy

[00:02:30] Mokaya: I mean a key picking in regards to inflation picking and being past that. There's a quote there about we're starting to, it becoming more difficult for companies to pass through the increased costs. To the consumers, it feels like we are hitting that point where the consumer can no longer take any more price increases, and companies have to rethink their strategies beyond just increases in pricing.

And that feels like that can call the end of a price increase hike cycle. And then now it's about now, okay, what else can we do in terms of maybe cutting costs and also like to preserve margins at the end of the day? So I think this is a key thing that I've been looking at for a couple of months where companies, because early this year what was happening is that we can still increase prices. Now consumers are like, we can no longer actually do price increases without hitting our volumes a bit too much. So I think that's a key picking. 

A Tepid China

[00:02:20] And beyond, I think the US I think one key picking I have also been checking out the past couple of weeks is about how China is struggling to actually I mean, coming into this year most. People are very optimistic about China's growth. Lots of companies are betting on picking up growth in China to boost their growth this year, but it feels like that has not materialized. And going into the second half of the year, it feels like China now needs an economic stimulus package that is almost equal to what the US had. What are your pickings around China and what companies are saying about it?

"What we're seeing is that China really slowed quite meaningfully in Q2, right?...we saw the slowdown really cut across the portfolio if you will, and it seems to be economic activity. We always assume, hey, are we doing something wrong? Are we losing share?...it just feels like customers got extraordinarily cautious in China, activity slowed and it showed up across the portfolio." - Thermo Fisher Scientific () CEO Marc Casper

[00:03:53] Scott: Yeah, it's a. It's been a bit surprising to me, I guess, that the Chinese economy has been so sluggish, and has continued to be sluggish. I would've expected more of a rebound from the Covid opening. And so my own view of it is that the geopolitics of China makes it such that I think companies are trying to turn away from China more and near-shore manufacturing, for instance. And so that provides probably a pretty strong headwind for the Chinese economy on top of everything else.

[00:04:26] Mokaya: But big tech, at least like Apple, is really growing in emerging markets. It feels like Apple is betting on a lot of growth, especially in India, and it was one of the boosts that came this quarter. I don’t know how much further that growth has because they mostly focus on high-end consumers. Dunno how many of those they have to tap into.

Capital Markets Are Healing

[00:04:48] But something else that we noted also, capital markets are healing in terms of, that's been the theme in the past two or three weeks, it feels like we passed the bottom of the capital market issues that they've been having for a while. But then something you noted was about the implications of higher long-term interest rates. For many of us, we've not lived through these very high interest rates that we have currently. And I mean, when I talk to my father-in-law, he tells me about 15% interest rates in the eighties in Scandinavia. I think that's surprising and shocking for me because we've grown up in an environment where we have, you know, 6% is so high, 7% is very high for us. So I don't know. What's your thought about the long-term implications in terms of market processing? The fact that we have high interest rates that we need to cope with even as we borrow and lend to companies and all. 

"As you'd expect, these economic forces have slowed the pace of investment across the industry. You see this in the amount of capital we are deploying and you see it in lower fundraising LPs slow decision-making on new fund allocations. Having said that, in general, our teams are seeing signs of an increasing pace of early deal flow access across most asset classes" - Carlyle Group () CFO Harvey Mitchell Schwartz

[00:05:35] Scott: Yeah, I mean, I think this is the biggest thing for capital markets is that ultimately equity prices are a pass-through of the cost of capital. And the cost of capital is primarily set by the Fed in the short term. And then, you know, you extend duration as you go out. Asset classes and equities are the longest duration asset class so, you know, if to the extent that long-term interest rates stay higher and that equity prices actually start to discount those long-term interest rates, you can have very significant multiple compression in equity prices.

[00:06:11] Mokaya: So does that then like imply we could be having like a bear market in the stock market because we.

Adjusting to A New World of Higher Rates

[00:06:19] Scott: Potentially. Yeah. I mean it reminds me early in my career, as an analyst, I remember it was like 2008. We had just gone to the zero interest rate policy or in 2009, and I remember doing DCFS for portfolio managers and plugging in at two and a half percent tenure wherever we were at the time. And it would show that the price of the stock should be like five times higher. And I would show it to our senior portfolio managers and they would be like, But you can't do that. That's not actually gonna it's not gonna stay there. That's not what the discount rate is. And lo and behold, you know, after 10 years, we basically priced that interest rate into every asset in the world. And so you actually do have these like pretty significant lags potentially between where long-term interest rates get priced into our long-duration assets, most importantly equity. And if we're in a world where really the zero interest rate policy is over. There's still, a lot that needs to be priced into capital markets around that, and it could provide a major headwind, you know, maybe not over the next three months, but over the next three years.

"The peak of the inflationary cycle may have passed, but our base case is that rates stay higher for longer as we shift away from a decade of 0 interest rate policy. It remains early days in understanding the impact of this shift on corporate capital structures and liquidity." - Carlyle Group () CFO Harvey Mitchell Schwartz

[00:07:23] Mokaya: So something really to think about there in terms of multiple compression and the impact that long-term interest rates have on that.

[00:07:28] Scott: It could, I mean, like the other thing I've been thinking a lot about in this. It seems like we're ready to get like an upcycle here just based on where the Fed's policy is, but. You know the last upcycles that we've gotten over the last 15 years have usually been with the tailwind of very low interest rates behind them. So even if we have an upcycle here, how much does the fact that interest rates are still higher impact economic activity? I don't know. It could just mean that we have more of a dampened upturn than what we've been used to over the last 10 to 15 years, and hopefully, that's not disappointing to people.

[00:08:07] Mokaya: What If the Fed then gets to cut interest rates, I mean they signal they're not going to cut this year. So probably next year we'll be on the lookout for that. So maybe that would be giving a boost to the uptick that most people are kind of expecting or it's just being implied by many of the companies that we're checking out. Who knows? Maybe. Yeah, but there was something that I picked up. I wanted maybe to get a few comments from you on. It was the weak IT spend that is continuing. I think ZoomInfo was a bit negative for the second half of the year. They were like, we don't see a pickup, especially in IT spend. And then you'll have companies like Amazon saying, okay, what we see is a continued stabilizing in terms of the growth in AWS cloud and all that. I don't know, how do you, what do you make of that, kind of like the weak IT spend going into the second half of the year?

[00:08:57] Scott: I mean, I think AWS is the market leader, so if they're seeing a normalization, then there's probably normalization happening in that industry.

The Taylor Swift Effect

[00:09:05] Mokaya: I mean, it seems like markets, I mean, especially the consumer electronics markets, at least from Apple's perspective, seem to be a bit still weak. But they are still to be getting a lot of growth from emerging markets. So that's kind of boosting their growth going forward. But, the most interesting aspect though also this summer was there's still a lot of travel happening and Leisure travel especially, it's very strong and I talked to a friend in the airlines industry. They've hiked prices significantly, but there's still a lot of demand that is still going on in this market. I don't get it. I expect people to stop traveling for a while, inflation having hit the pockets, but people really want to travel.

[00:09:46] Scott: Consumers are resilient. The economy has been resilient. People want to spend things on the things that they wanna spend money on. So,

[00:09:54] Mokaya: And travel is top of the list.

[00:09:57] Scott: Yeah. Experiences. We still live in a time and age of experiential consumers. And you know, the pandemic interrupted that for a bit, but not for long.

[00:10:09] Mokaya: We still want our experiences and we want them now. Yeah.

Source: Fed Beige Book

[00:10:12] Scott: I gotta go see Taylor Swift in concert, you know.

[00:10:18] Mokaya: I was surprised to see Taylor Swift being mentioned in the Fed press conference as a question in terms of boosting economic growth. She is like it's a Taylor Swift world. We are living in all Swifties.

[00:10:29] Scott: We live in quite a world. A time to be alive, Eric. Quite a time to be alive.

[00:10:36] Mokaya: Taylor Swift is boosting economic growth now. Yep. Alright, this is a good place to close up this week.

Conclusion

Thank you so much for joining us. See you again next week on the earnings calls. We'll continue giving you good quotes from earnings calls. Check out our newsletter and our podcast again. Bye for this week and see you next week.

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:15 A Sense of Optimism

00:01:33 Consumer Still Doing Well

00:03:14 Fed Talk

00:04:42 The AI Frenzy

00:07:44 Tesla and AI

00:08:57 Real Estate Opportunities

00:10:03 Heavy Week Ahead

Transcript

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of the Transcript podcast. You've got me, Scott Christoff, I'm editor of the Transcript, along with Eric Mokaya, who's our lead author. 

A Sense of Optimism

“I think we are beginning to see this pick up in activity. And as markets rally, that tends to lead people to have more confidence to transact, which plays its way through ultimately to our customers. Right now, we're still - - there's a bit of a lag as you think about it in terms of fundraising activity, but a sustained good period for markets is very helpful for our ability to raise capital, particularly from institutional investors, also from individual investors." - Blackstone () COO Jonathan D. Gray

We're back for a podcast. It's been a while since we had a new episode, but hopefully, everybody is still looking forward to hearing what we have to say about the markets. So set out a new issue of the newsletter yesterday, and what we saw last week is optimism in the economy. I think the thing that stood out most to me is that capital markets appear to be reopening or ready to. I think the investment banks, Goldman Sachs and Morgan Stanley both talked about having more robust pipelines in their capital markets groups in terms of both m and a and equity capital markets. I think those are really important signs considering that equity indexes are up a lot this year and to see capital markets reopening is a really big step forward for the economy. And so maybe we have avoided recession, although the Fed may want to raise rates one more time or two remains to be seen, but it would be strange if we didn't get one. But here we are. What do you think Eric?

[00:01:07] Mokaya: This is Fed week this week, and I think the consensus seems to be that there will be one more raise and then Jackson Hole. So I think it'll be a very important meeting to see what kind of talk the Fed comes up with this week. From the banks that have reported so far, what is, of course, most of them, the earnings that are slightly down I think affected a lot by those who have a little bit more exposure to investment banking. It's been a rough year, a year and a half I would say since the rates went up. 

Consumer Still Doing Well

But it seems like overall the consumer is still the same as we left two months ago when we did the last podcast. The consumer is still faring very well. They pretty much have good balances in their accounts. The high-end consumer is still spending as much as possible, American Express says, especially travel and entertainment is doing pretty well. Seems like people are still on that post-pandemic kind of party mode traveling the world getting as much entertainment as possible. And capital markets are starting to reopen back up. But I wanted to ask you a question. How do you reconcile the fact that capital markets are yet to open yet when you look at the, let's say the equity indexes, they're still up for the year. AI is driving a boost in growth in a lot of companies and Microsoft is driving one of the best years it's had so far. I don't know, How do you reconcile the two? Are we past the point where we can say comfortably that we'll have a soft landing or no recession at all? 

[00:02:26] Scott: That's a big question. I think this is a normal time for capital markets to re-opening. A rough year that we had last year. And even though we didn't really have a full recession, we certainly had a slowdown in capital markets activity, if not the whole capital markets were closed to companies trying to access it. IPOs barely happened last year. Are we at a soft landing? Has the economy avoided a recession? I think it's a little bit too early to say still, especially with the Fed planning to keep raising interest rates and hold them there throughout 2024. So equity indexes are clearly excited about the prospects for the economy. But I don't think it's a fully-baked story yet.

Fed Talk

[00:03:14] Mokaya: And a quick question also in terms of let's say like the market as they are currently. Why would the Fed want to raise rates when the inflation or when you look at the interest rate, the best lending rate is above the inflation rate so to speak, or somewhere there? Why would they want to keep raising rates? What's the message?

[00:03:32] Scott: First of all, I think that the inflation, the headline inflation rate that people are focused on at 3% is clearly lower than the core inflation rate, and the core inflation rate is still elevated, and so I think the Federal Reserve wants to make sure that the core inflation rate is coming down. So they're looking at that for one. Number two is what we've been talking about now for probably 18 months or more, which is that the Fed put, has turned into a fed call, whereas. When we heard, we were in an inflationary environment and we wanted to promote higher asset prices, the Fed always stood ready to buy securities, basically, not directly. Actually yes, directly. As indexes fell, the Fed would step in and try to promote economic growth, but as equity indexes are rising now, the Fed is sitting on top, and so I'm sure they're looking at. For instance, the performance of the NASDAQ and speculative companies in the NASDAQ stocks of speculative companies and are looking at that, thinking maybe the economy's a little bit hotter than what we want it to be, and maybe inflation could come back pretty easily.

The AI Frenzy

"The short-term frenzy about the AI demand definitely cannot extrapolate for the long term. And neither can we predict the near future, meaning next year, how the sudden demand will continue or will flatten out. However, our model is based on the data center structure. We assume a certain percentage of the data center processor are AI processors and based on that, we calculate the AI processor demand. And this model is yet to be fitted to the practical data later on." - Taiwan Semiconductor Manufacturing Chairman Mark Liu

[00:04:42] Mokaya: Beyond Fed Talk and inflation, I think the AI frenzy is still going on. It's been the main theme for the first half of the year, and it seems like it'll continue to be the theme for the second half of the year. Two things for me that stood out from the tech section. One is that the AI frenzy is a bit hard to extrapolate for the long term. So I think TSM was being asked what their projections would be in terms of benefiting from AI. But it seems like they're not able to, very quickly, give an estimate on how, what kind of an impact should be positive, but they don't know how much of that positive impact.

And I think the second thing that stood out was the fact that there's a shortage of skills in the US to build fabs. So I think with deglobalization what's happening is that a lot of the Global manufacturers of chips are being forced to move from Taiwan to the US but then they're coming to the US and realizing the talent is not there to be able to help them grow.

So it seems that's positive for companies or for individuals that are positioning themselves as to be good, at least to be skilled in this area, to skill themselves in this area of making fabs. But I think it also made me appreciate what kind of level of skill it takes to make some of these really minute things that we don't actually pay attention to until we get or we run out of whether until there's an issue, at least in Asia, to be able to help to make companies rethink the supply chains. Any thoughts on AI and all that?

"Our fab in Arizona started construction in April 2021 with an aggressive schedule. We are now entering a critical phase of handling and installing the most advanced and dedicated equipment. However, we are encountering certain challenges as there is an insufficient amount of skilled workers with those specialized expertise required for equipment installation in a semiconductor-grade facility. While we are working on to improve the situation, including sending experienced technicians from Taiwan to train the local skilled workers for a short period of time, we expect the production schedule of N4 process technology to be pushed out to 2025." - Taiwan Semiconductor Manufacturing Chairman Mark Liu

[00:06:06] Scott: Yeah, I think you make some interesting points, especially the Taiwan semi quote about the short-term frenzy not being able to extrapolate. That's a really important quote because Taiwan semi is obviously core to the AI ecosystem, and AI has been arguably the driver of equity markets this year. And so to the extent that the excitement over AI isn't translating into real physical earnings growth or top-line growth At a company like TSMC, it suggests that maybe the AI hype is a little bit overblown in the near term. Now, all that said, I think that this is still likely to be a transformative technology and there is an extremely large physical component to AI, which I think people are, it's easy to forget, given what we have seen the algorithms do. But, from a semiconductor standpoint and other physical materials standpoint. AI still, like all compute, ends up in a physical space. And so the quote that you were talking about having a shortage of skilled labor that can build semiconductor fabs in the United States. I think this is a key part of it, when you have an area where there's a lot of demand for new capacity, but there's a limited amount of supply that can come through. You have shortages, you have bottlenecks, you have increasing prices. This is fundamentally just an age-old industrial cycle but with a very new-age tech twist.

Tesla and AI

[00:07:44] Mokaya: All right. And then Tesla this week or last week, I think they had the earnings call and they believe they have a strong data advantage. In terms of AI, I think one of the key things we picked in the last couple of quarters is that companies with the correct level of data, can they be able to leverage. All the correct types of data can be able to leverage AI a bit better than others. And Tesla says they have a huge amount of data they've collected from being in the field and being an EV company for so long. What's your take on a FSD AI and generally Tesla and its positioning in this market?

[00:08:16] Scott: Yeah, you and I have been talking about full self-driving for most of this year, that we have large language models in AI that have been transformative to capital market psychology, and Elon keeps signaling that he believes they're very close to true full self-driving. And so whether that happens this year or next year or the year after, still will be pretty significant if all of a sudden we have cars on the road that don't really need human drivers and that is happening to us. Yeah, this is something that could provide another tailwind to the AI boom. The capital markets are starting, it's starting to price in probably, but maybe not fully.

Real Estate Opportunities

[00:08:57] Mokaya: All right. Real estate I think what's one of the things that banks are also talking about the exposure to the real estate market. It seems like there's a bit of positive science and residential real estate driven mostly by supply that is limited. So supply being limited means that demand even if it's slightly higher, it means that it pushes up a bit of pricing. So there's so much negativity around c r e, especially for the first half of the year. I think my key pickings for the first half, and especially for this earning season, has been that there actually could be opportunities for some of those bold players to, to actually have a look at CRE. So people are looking at it as a whole bucket, but then there are pockets, I think as Blackstone tells us that you can look at and maybe see some areas of investments. Do you agree with that or what's your take?

[00:09:41] Scott: Yeah, it's hard not to listen to Blackstone when it comes to commercial real estate, but it is interesting. There's certainly a lot of negativity around office. It's hard to see how office will come back in a robust way. But there could be opportunities here that are starting to form for adventurous value investors.

Heavy Week Ahead

[00:10:03] Mokaya: And beyond all this, I think it's the heaviest week in terms of earnings this week. This is a big tech week, so we have meta, we have Microsoft all of them reporting this week. Intel also. Anything that you're looking out for, or at least you've seen in the past couple of two weeks in terms of earnings season? Unless we go ahead.

[00:10:20] Scott: No, I think the earning season is big. Fed Week to your point is big too, I think. I'm not expecting a lot of surprises, but there should be a lot of data this week.

[00:10:30] Mokaya: Of course, we expect more AI talk. We'll be counting the number of times they talk about AI and positioning some of the products. I think this should be the quarter when we see a bit more substance in terms of what kind of product they put out there. I think last week I think we noticed Microsoft already is charging for its usage of AI and co-pilot, so they found a business model. So, for the past couple of weeks, what we've seen is companies trying to see. Which kind of business model would be best suited for an AI environment? I think it's a good time to learn all that. So I think that's a good place to close out, don't you think for this week? I think so. We hope to be back again next week. Depends on Scott a lot. Alright. Thank you so much for joining us this week. J check us out on Twitter or as it's being renamed to x. We are there at the transcript underscore. And of course, subscribe to our newsletter and we'll be back again as soon as possible for another edition of the Transcript podcast. Bye for now.

The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

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Show Notes

00:00:00 Introduction

00:00:07 Softening Trends

00:01:50 Inflation Still High

00:04:00 Tesla and AI

00:07:33 The State of the Supply Chains

00:08:30 Nuggets of Wisdom

00:09:12 Conclusion

Transcript

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff. I'm editor of The Transcript, along with Erick Mokaya, who's our lead author. 

Softening Trends

We sent out a new issue of the newsletter yesterday, and what we saw last week were some softening trends in the economy, especially among the consumer. I think Home Depot made headlines for bringing down their expectations for spend, and that wasn't terribly surprising because we know that housing markets are among the slower areas of the economy. Also, Target and Walmart had some negative thoughts on what the consumer was doing in March and April, saw impact to the consumer from the banking crisis that happened in March as well. But at the same time saw stabilization or there were a number of companies that were talking about stabilization and people still spending, consumers still spending. So even if things may be softening a bit with the consumer it seems like overall spending is still fairly healthy. Erick, any thoughts?

[00:00:56] Mokaya: I think that's the same thing I picked up. For a while now it's been a bit pretty balanced in terms of negative and positive comments we get in earnings calls, but it felt slightly negative last week. Even Walmart with the 7% comps up on the US business, I think they still had quite a lot of commentary in their earnings that was more like, okay the consumer is pretty pressured, especially the low-income one. The high income is starting to feel the pressure and making adjustments in that regard. Spending mix has shifted, but overall the consumer is still resilient and I think that's been the surprise. I think MasterCard had the same kind of comments in terms of spending and Visa also. So spending is holding up pretty well, but the commentary felt slightly negative, slightly that's what I would say because there's still a lot of positive commentary. But does it tilt your perception in terms of how we are going towards maybe the second half of the year, which starts next month actually in a month or two?

Inflation Still High

[00:01:50] Scott: Not yet because honestly, like the flip side of the consumer slowing is inflation. And while inflation is definitely slower than it was, it still seems like it's higher than the 2% underlying rate that the Fed is trying to get inflation to and doesn't really seem to be trending to the two, seems to be trending to a three or four, something like that. And I think the Fed is very serious about getting it to the two. So the two quotes that we picked up from Jerome Powell and James Bullard last week from the Fed were both about economic data coming in stronger than expected, and interest rates being higher than previously anticipated. And so even if they're pausing here they're signaling that they may start raising again. I guess that is what is more negative to me about the outlook for the back half of the year is if they're still fighting inflation. If inflation isn't coming down, that's gonna be bad for markets.

[00:02:44] Mokaya: I think one of the things that the Fed talked about, I think in the last press conference, was about the banking crisis being a bit of, they could have raised rates, save for the banking crisis, but the banking crisis feels like it's removed now. Last month it was like the crisis… the crisis. But now it's so far behind us now, but still, there's a lot of reflections on what exactly went wrong and how to prevent it. I mean there are a couple of quotes there we had about how this was unprecedented in terms of magnitude, in terms of the regulatory requirements that may be forthcoming to manage crisis risk as banks. So I think that's way behind us now. I feel from my perspective, it may not factor into the next press at least the Fed meeting in the next instance. So I think now it's about where, at what point should they stop raising because they've conquered inflation. I think that's where everyone is watching and so far from our earnings calls readings, inflation has stepped down a bit, but not to the level, as you said where the Fed is most comfortable that okay we've reached our goal and now we can at least like pivot completely away. So I think that's what we get from the earnings calls we've had so far. And I guess commentary is pretty tilted, slightly to the negative, slightly, not so much. 

Tesla and AI

Any other things that you may have picked up in earnings this week? I mean there's a lot of talk of AI and OpenAI’s Sam Waltman was actually in Congress showing them the power of AI and with a lot of worries on what the future looks like with AI. What's your take on that, especially the Tesla quote where they want to have the ChatGPT moment soon?

[00:04:19] Scott: Yeah, I think it was interesting to see Sam testifying before Congress last week, and obviously got a ton of coverage. It was everywhere, Sam testifying. I think the quotes that stood out to me in AI this week were the Chesky quote, talking about 130 years ago, only a few people knew how to use the camera. But now everyone can use the camera and there are a lot more photographs. And it's the same sort of thing with coding here is what large language models could unlock, is just the ability for all of us to develop software more easily, basically. And so there would be a lot more software in the world. I thought that was a really big quote. And then also Elon talking to your point about Tesla and how close they are with self-driving and that they're really…his quote was, Tesla is going to play an important role in AI and AGI. So really positioning Tesla as his AI company, and that there'll be a ChatGPT moment for self-driving maybe if not this year, I'd say no later than next year. Which is something that you and I have been talking about this year in podcasts, is that everybody's looking at large language models right now and there's a very real chance we'll have self-driving as well within the next 18 months. And that would just be explosive in terms of the mindset towards AI. So those are both pretty big. And the note on that is if Tesla's an AI company it's not really viewed as an AI company, right? Nvidia and Microsoft are really viewed as the only public market plays. If Tesla becomes viewed as an AI company off to the races, especially with Elon there and not CEO of Twitter anymore, there are catalysts coming for Tesla potentially.

[00:05:59] Mokaya: And the term may be pretty huge if they have an AI company at the end of the day, but the two quotes from I think JP Morgan is also very keen on positioning themselves as not behind in terms of AI. I think it's pretty interesting when the biggest bank in the US also is leveraging AI to make themselves a bit more efficient in the way they do business. And also the quote from Google for me, I was struck by the fact that they have a chatGPT kind of version for enterprise called Vertex AI because it seems like there's a bit of distinct preferences in terms of what the enterprise consumer wants and what the individual consumer wants. And then, the enterprise consumer has very specific needs that they want. They want their data to be localized. They don't want it to be used with everyone. And I feel like there's a huge play in terms of how companies position themselves there. I know Microsoft has been very big on b2b. They're quite well positioned there. I guess they're leveraging also chatGPT and all these tools to be able to deliver to their consumers really good value. And it was good to see Google is not that far behind in terms of also wanting to deliver some of these products to enterprise generally.

So something to watch in terms of AI and all, Nvidia is reporting earnings this week. So it's like the poster child for the AI moment. So it's going to be very interesting to see how many times they actually mention the word AI, and secondly also what exactly they're doing in the AI field so far. My bet is that they'll keep exploding, at least for this year. It seems like anything that touches on AI gets to explode in the positive or negative sense like Chegg did in the other sense. 

The State of the Supply Chains

Anything else that you may have picked in earnings this week? Housing is there something on housing?

[00:07:41] Scott: Yeah, the comments were mostly positive on housing, right? Actually, it's fairly stable. I think one other thing just on supply chains maybe, is that supply chains continue to heal, really are nearly fully healed. But the one data point that really stuck out to me is that car prices are back below MSRP now which auto supply chains had been the tightest and we know the semiconductors around auto supplies were the tightest of any of the semiconductors. And the fact that auto prices are below MSRP suggests that the tightness in that market has healed itself. And so that's a big indicator in terms of where supply chains are today.

[00:08:21] Mokaya: Yeah, I think the general commentary is also from earnings is that supply chains seem to be back to normal. I think now companies, even Walmart also commented on the same.

Nuggets of Wisdom

Maybe two things that stood out at the end are the nuggets of wisdom about generational change being a risk to brands and also being an entrepreneur is hard. I listened to both. I read both interviews by Daniel Elk and Brian Chesky. I really look forward to one of these days when we'll be able to host some CEOs on our platform to be able to discuss all these things with them in a bit more detail. I think it's a potential area of growth for us in the future. So I think that's something you've expressed for a long time. And I think I second that, and if any of our listeners is in touch they can be able to help us get in touch with some of these CEOs to bring them on board to discuss more from earnings calls and some of the takeaways that they have, some of the nuggets of wisdom that they have for us also. So I think that's something I would say that we are keen on.

[00:09:12] Scott: I would agree.

Conclusion

[00:09:12] Mokaya: So looking forward to more. So thank you for joining us this week on The Transcript podcast. Looking forward again to another week of earnings. As I said, Nvidia is reporting, so we'll be keeping an eye on that. And there's a JP Morgan tech conference that's happening this week. Lots of companies report there to present. So we'll be keeping you in touch in terms of the key quotes of earnings calls. So thank you so much and see you again next week.

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The episode is based on yesterday's newsletter which is available on Substack.

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:08 Softening Trends

00:01:23 The Impact of the End of First Republic

00:04:46 What will the Fed Do?

00:06:55 Price-Driven Growth

00:08:38 Takeaways from Tech Earnings

00:11:15 Conclusion

Transcript

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of the Transcript, along with Erick Mokaya, who's our lead author.

Softening Trends

"...we are seeing a slight decrease in units per transaction. So, things like did someone add fries to their order, how many items are they buying per order, we're seeing that go down in most of our markets around the world slightly, but it's still going down…we are seeing, in some places, resistance to pricing, more resistance than we saw at the outset. So I think all of those things are reflective of, again, a more challenging macro environment." - McDonald’s (MCD 0.65%↑) CEO Chris Kempczinski

We sent out a new issue of the newsletter yesterday and what we were seeing in a big week of earnings. We saw some softening trends in the macro economy and the consumer starting to deteriorate a little bit. We saw people talking about the freight recession again, which has been ongoing for a while. And we saw some indications that even credit card delinquencies were starting to rise from Capital One. Just all of the things put together look like the economy continues to slow a little bit. So we titled the newsletter Weakening Trends this week. Erick, any thoughts?

[00:00:44] Mokaya: I agree. I think the sense of the data that we have, or at least from the earnings transcripts is mostly to do with softening trends. They're not crushing, but slowly you can feel like from the time we've been reading the Q4 earnings calls to now we are reading the Q1 earnings calls, it's been a slow and steady going down. So not a rapid fall off the cliff I would say given the event of the banking crisis in March, but still decline. That's what we're seeing. Inflation is declining. And lower inflation of course means a bit of lower top-line growth for some of the companies that we're following, especially the fintechs and the financials.

The Impact of the End of First Republic

But outside that, I think the key thing last week was mostly the big takeaways from big tech. But before we go to that we should discuss a bit of the banking crisis that we are again pulled back into with the recent developments in First Republic. Any thoughts on that?

[00:01:41] Scott: I think before we went into earnings season, you and I talked about First Republic being the earnings call of the entire season, the one to watch, and it did not disappoint. First Republic reported its earnings from the first quarter and five days later, it's no longer a walking organization, a going concern on its own. Actually, I think one of the things that was really noteworthy to me about the First Republic staff was that they didn't take any Q&A on their earnings call. And I feel like that felt like they had something to hide because of that. I wonder if they had been a little bit more transparent with the dynamic that was going on if they could have avoided this second phase of the bank run for themselves. Because, underlying, they lost most of their deposits in the March timeframe. And then actually they were talking about how deposit outflows had more or less stabilized for them. So they were a little bit more stable until they weren't stable anymore. And this goes back to what has happened in this entire banking crisis. And going back to the financial crisis, the regulators just acted really quickly and forcefully. If it looks like a bank is going to fail, they will make sure that it does fail. Basically, they will make sure that it closes shop before anything contagious could happen. But, I don’t know. What are your thoughts, Erick?

[00:02:55] Mokaya: To add to that is mostly like the takeaway from their earnings call simply said that deposits were stabilizing. They had a lot of deposit outflows in March but from the beginning of April to the date when they reported earnings it was only like a 2% decline, which was very small. So the takeaway from the earnings call, they kept saying the word stabilizing, but then the whole week, and mostly because they didn't take the Q & A section so that people can allay their fears, all the talk was about this bank is going to fail. Then eventually it fails.

“Our government invited us and others to step up, and we did. Our financial strength, capabilities, and business model allowed us to develop a bid to execute the transaction in a way to minimize costs to the Deposit Insurance Fund” - JPMorgan Chase (JPM -1.59%↓) CEO Jamie Dimon

So now JP Morgan has taken over the bank. So it looks like quite tough times ahead for the smaller banks. If any of these small banks does fall into a tough time, they definitely will be taken over by the big banks, which is a bit of a sad situation to be in because I've enjoyed First Republic’s earning calls for the longest time possible. I've enjoyed SVB also, but now they're both gone and they served a very important part of the economy. Do you think the customers will miss them now?

[00:03:56] Scott: I think the customers will definitely miss them. I think that the true impact of these two banking failures has not totally been felt yet fully, and unfortunately as a Californian, I feel like California and the startup economy are two of the areas where credit will actually end up tightening most severely. High-end real estate mortgages in California, First Republic probably had a pretty large share of that. And then SVB, their client base, obviously in the startup ecosystem, they were the largest bank in town for that. And JP Morgan does not have the same underwriting standards that those two banks had with those client bases. So there will be restrictions on the amount of credit availability. I think it's a net negative for California as a local geography.

What will the Fed Do?

[00:04:46] Mokaya: And then this is Fed week by the way. So last time they were having the Fed meeting, it was just before the banking crisis. And once again, just before this one, there's another banking crisis. So I don't know how the Fed is going to incorporate some of this data. So from our transcript, of course, economic conditions seem to be weakening and credit conditions should be tightening. And at the same time, we have a little bit of a banking crisis all around which. The crisis around First Republic has been resolved, but generally, there's a bit of worry around deposits and deposit flows in the economy and how loan growth is going to be. Whether some parts of the economy are going to be starved off loans and mortgages going forward. So quite a bit of work to do in Jerome Powell’s hands this week. All attention is on him and the FOMC. Any thoughts on that?

[00:05:36] Scott: Yeah, I think what they're signaling is that they'll raise rates again, most likely, and then they may signal at this meeting that they're gonna pause raising rates going forward. At least there was an article in the Wall Street Journal this morning saying that the Fed would raise and then debate the pause. And I think it goes back to how much concern there is over the First Republic's failure and whether or not they want to pause and see what's going on. But I think on the flip side of that, we see inflation falling. In McDonald's quarter, for instance, they talked about inflation still being high single digits this year. That's very high. That's not 2% inflation that the Fed is trying to target. So even at 5% in interest rates, which they would be at the end of this meeting, it's still not that restrictive of a monetary policy stance. The rate of change has been high, but if you really wanted to get restrictive on the economy, probably going six or seven or 8% historically is where you have to get to in an environment like this. And so we're just tighter than neutral now, maybe. And so how that actually ends up impacting inflation and whether that's able to bring inflation down to the Fed's ultimate 2% target. We may not know the answer to that until midway or three-quarters of the way through this year.

Price-Driven Growth

"We delivered 12% organic revenue growth in the quarter. This was primarily driven by pricing actions across markets and revenue growth management initiatives to retain and add consumers. We also delivered volume growth of 3%, which is in line with last year versus 2019." - Coca-Cola (KO 0.23%↑) CEO James Quincey

"We delivered underlying sales growth of 10.5% in the first quarter, driven by price at 10.7% with underlying volume, down slightly at minus 0.2%" - Unilever (UL -0.20%↓) CEO Alan Jope

[00:06:55] Mokaya: So more tightening this week. And again, CPG companies don't give us a bit of hope. I compiled a little bit of data for our Twitter followers and it shows that most CPG companies are raising prices around double digits, low double digits, around 10% there. So it doesn't look like inflation is actually waning and this pricing is what is driving the growth of some CPG companies. They're reporting 12, 15% growth and these are not companies you expect to be growing at that kind of rate at this point in time. And the cost inflation should be a bit behind them now. I think they're just raising prices for the fun of it or to keep growing. That's my key takeaway from that. Any thoughts on that?

[00:07:37] Scott: Yeah, the thought in my head was, as a consumer right now, it feels like prices are painful, but not a deterrent yet. 

[00:07:46] Mokaya: So if we were to take you as a good sample, then CPG companies have more headroom to keep growing a bit of pricing.

[00:07:54] Scott: Yeah, I think that's what they're seeing right now. That's the elasticity stuff. The CPG companies are saying like, we're raising prices, but consumers aren't spending a whole lot less. Their volumes are flat, their top lines are going up, high single digits, double digits even. But the consumer, there's certainly signs of deterioration that we've been seeing for six, nine months plus. But it's just not slowing down the economy fully yet. And that's why this is the best forecast recession in history and won't be surprising if we get it a recession. But securities prices don't reflect even 5% interest rates. That's absurd. Treasury yield is still at 3. Nobody thinks that we're staying at higher interest rates for longer.

Takeaways from Tech Earnings

[00:08:38] Mokaya: Yeah, definitely. Maybe let's talk a bit about the tech takeaways. Cloud spending is moderating. Google Cloud is profitable. They did a bit of accounting maneuvers and it's now profitable.

AI investments are accelerating across the board. All the tech companies that are reported so far, they're reporting an increase in investments. They may be decreasing investment in other areas, but at least for AI, they're increasing it. And finally Bing in Microsoft search wars continuing. Microsoft wants to keep growing its share of the market. They're very focused on share and gaining market share. And of course, Google is very keen on consolidating and making sure that they're now, Google is now the incumbent and then Microsoft is now the challenger suddenly in the market. So those are my three top-of-the-head takeaways from earnings calls. Let's start with cloud spend. Any takeaways from that?

"And in terms of CapEx, we do now expect that total CapEx for the year 2023 will be modestly higher than in 2022…And as we discussed last quarter, AI is a key component. It underlies everything that we do." - Alphabet (GOOG -0.23%↓) CFO Ruth Porat

“We expect capital expenditures to have a material sequential increase on a dollar basis, driven by investments in Azure AI infrastructure. Reminder there can be normal quarterly spend variability in the timing of our cloud infrastructure build-out." - Microsoft (MSFT -0.29%↓) CFO Amy Hood

[00:09:29] Scott: Yeah, I think my biggest takeaway from the tech space this week was really got those economic trends, and that's what I ended up zeroing in on in the end. Tech companies are seeing the same sort of headwinds that the rest of the economy is on in terms of cloud spend and in terms of consumer electronics demand. So those are weak. And then to your point, everybody's talking about AI and their CapEx spend in that space. But at least right now, it feels like we're in some sort of psychological consolidation around AI where the big surprise has happened. We all think that something big is going to continue to happen, but there's not some catalyst right now that's changing our perception of AI.

[00:10:12] Mokaya: Is it this period then you see like maybe people are taking time maybe to digest what happened and then to take maybe a year or two to actually get some really good products that would actually shake up the market once again, because now people are over the shock of AI is here now. It's okay, what are we going to do with it at the end of the day? I think that's where we are at, and every company is doing that right now. And then the funniest bit for me in terms of takeaway was that CPG companies are growing revenues at around 10 to 15% driven by pricing. And then tech companies are growing at 2, 3%. And then Meta just came off like three-quarters of declining revenue growth and now they're suddenly growing a bit at around 2%. It feels like a flip in the economy where the CPG companies are the fastest-growing companies around. And then you're back to tech companies being there almost moderating in terms of growth and all. The new economy, so to speak. Is that a good place to close, or do you have any thoughts to add this week?

Conclusion

[00:11:15] Scott: No, I think that's a good place to close this week.

[00:11:16] Mokaya: All right. Thank you so much for joining us this week. We'll have a special Twitter Space this Wednesday to discuss the banking crisis with two experts. So join us there on our Twitter space. We’ll include a link in the podcast transcript. And see you next week. Keep subscribing and keep sharing our content here and on Twitter. Bye for this week.

The episode is based on yesterday's newsletter which is available on Substack.

The Transcript

Gradual Deterioration

Succinct Summary: Last week was a heavy week of earnings and the US economy showed signs of continued slowing across many segments. It’s still not clear how much of that slowing is an artifact of banking stress that has mostly healed. If the economy paused in March due to bank stress, it could be poised to pick back up because the underlying activity is still relatively strong. The Fed remains fairly hawkish…

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3 years ago · 21 likes · The Transcript

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:07 Slowly Declining

00:02:18 What Will the Fed Do? 

00:03:18 Banks are Stable For Now 

00:04:42 Credit Metrics Look Good

00:06:23 On Semis and Pool Demand

00:08:20 Freight Recession

00:09:10 Tesla Slashing Prices

00:11:06 Big Week Ahead

Transcript

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript along with Erick Mokaya who's our lead author.

Slowly Declining

"Specifically on the U.S., we saw a gradual deterioration over the course of the quarter that was building through the end of the quarter, so I’d say if you look at that average rate for the quarter of minus-13, we ended the quarter slightly, slightly higher than that" - ManpowerGroup CFO John McGinnis

We sent out a new issue of the newsletter yesterday and what we saw was that it was the first big week of earnings season for the first quarter, and we saw that the economy seems to be continuing to gradually deteriorate. It's definitely slower than it was even at the beginning of the year. You're seeing banks talk about spending patterns declining, and weakening among the consumer. You're seeing corporate spending patterns decline. And you're also seeing the labor markets start to soften. There were three of the big banks that we've pulled up. So there are weakening trends in the economy that are happening. But compared to a recession, it's actually still a pretty strong economic environment in the absolute, not the relative. And so people are still looking at the fundamentals and thinking it looks like we're going to hit some sort of very mild recession if anything. And the Fed is meanwhile looking at these trends and still feeling like they're not cooled enough in the absolute. And so the Fed seems to still be more hawkish than I think capital markets participants are expecting right now. Erick, any thoughts?

[00:01:12] Mokaya: I think it's a good point to start with the issue of where the Fed is because I think the quote from the Blackstone CEO was very interesting for me. He says that the Fed is likely to pause or maybe go 25 basis points higher, but they're unlikely to pivot as the market is expecting. And for a while, I've also been thinking the same. The market seems to expect a point where the Fed is going to turn, but it seems like from what you're reading in corporate earnings calls so far is that the Fed is not turning. It's not going to turn soon. In fact, if there is anything, they may pause, but not a turn in the sense of the market because market conditions don't seem to allow for it. First of all, inflation is still pretty sticky, very high from what we're reading in earnings calls. And secondly, generally, the bank's issue is still behind us, but still hovering over our heads at the end of the day. So I think because of those two issues, the Fed is kind of, their hands are tied. They will not pivot anytime soon. And that seems to be what the CEOs, at least we are reading from the earning calls are telling us. Is my reading correct there?

What Will the Fed Do? 

[00:02:18] Scott: Yeah. That's what I'm thinking as well. It looks like the Fed, even if the Fed is going to stop raising rates or pause on raising rates sometime soon, I think everybody expects that the Fed is still signaling that they expect to keep rates higher for longer and they expect that they're trying to get back to 2% inflation and it doesn't look like 2% inflation is necessarily going to happen this year. And in fact, there are some places where we're even starting to pick up re-bubbling of inflation in a way, like in basic materials where a lot of inflation had been wiped out, there's strong demand for steel for instance, and Steel Dynamics saying that steel pricing has strengthened recently. And so these are the types of things that you could get a little bit of a resurgence or at least not as much of a decline in inflation as people are expecting right now. And then that would keep the Fed, which is already oriented hawkish in a more hawkish stance for longer. And that would be a surprise, a negative surprise for equity markets. So these are things that we're watching pretty closely right now.

Banks are Stable For Now

"Roughly, when you look at the decline in total deposits over the quarter was about 60% happen before March and 40% happened in March." - M&T Bank CFO Darren King

"From March 8 through the end of the quarter, deposit balances were relatively stable, down only 0.6% as inflows from new customers were slightly offset by the impact of clients diversifying their deposits and seeking yield and money market funds consistent with broader industry trends." - U.S. Bancorp CEO Andy Cesari

[00:03:18] Mokaya: Yeah. And maybe we talk a bit about it, because a lot of banks have reported earnings so far. What are your kind of takeaways from the earnings, especially for banks? Because for me, one of the things that has been very clear is that, the bank deposit flows are not as bad as many predicted. It's actually mostly in line with seasonal flows for some of the banks, especially, let's say Bank of America and all. Is that something you also picked up? 

[00:03:40] Scott: Yeah. At this point, it looks like the bank earnings that were reported, that the banking stress that happened in early March really was like a very intense storm that passed through very quickly and really only hit the couple of banks that were directly in the center of the storm. And so what we're seeing from banks reporting is that it really isn't touching other even regional banks where people were concerned about contagion. And so basically anybody who wasn't in the eye of the storm did okay. And credit quality still remains relatively strong for banks. Even the deposit outflows for many of the regional banks weren't overly severe although it was accelerated a little bit by SVB, but it was a dynamic that was already in place. MTB talking about, there was a lot of deposit flows throughout the quarter, but 60% of the flows happened in January and February and 40% in March. Just a little bit of an uptick on a relative basis for a bank like MTB relative to the entire atmosphere. But any thoughts from you?

Credit Metrics Look Good

[00:04:42] Mokaya: Just the same, I think it seems as you say, like something happened and then it happened over a period of one or two weeks and then it was done. I think First Republic was reporting yesterday during our recording and one of the things that was noted is that the deposits flow, especially in the months of April, has actually been pretty stable for them. So I think generally it feels like all banks whatever issue there was, it's way behind us. But perhaps one thing that I've noted that strikes me, none of the banks I’ve looked at so far is talking about credit tightening at all in terms of the consumers, like the tightening credit lending standards to consumers. That's been pretty striking. And of course also, if you look at the credit metrics, they're pretty stable. So nothing much is happening, nothing unusual actually. And that's the unusual thing.

[00:05:30] Scott: Yeah, no, it's a good point. I think that people are expecting some tightening conditions, even among the banks, but nobody is directly themselves really saying we're tightening credit. I think the flip side of this though, in terms of banks doing better than expected, is that banks are still gonna be under a lot of headwinds because of this environment and the type of stress that happened over the last month and a half. And it's really all about their cost of funds going up and their profitability is getting hit because of that. And so if you are having to pay more for deposits, it's the net interest margin is stricken for banks. And so banks are not in a strong operating environment, even if they're not succumbing to bank runs. So the financial sector is still one that has got headwinds here as we go into, again, potentially this recession, mild recession, whatever it is in growing headwinds on around that.

On Semis and Pool Demand

[00:06:23] Mokaya: We are slow-walking into a recession, which has been happening for almost a year now. Moving beyond banks, any other things that stood out? I think one thing for me also, TSMC talked about two things. So one is obviously that AI demand is pretty high. The second thing, is they're talking about weaknesses in auto, and that's not something we’ve seen from anywhere else. So they are talking about them seeing a bit of weakness in demand for auto chips. That could be a pointer. We haven't seen anything else. So without supporting evidence, we can actually say maybe not this for next time. Maybe beyond the tech and TSMC area, is there anything else that stood out for you in earnings?

[00:07:03] Scott: Yeah. One thing that struck me was the quote from Pool Corp earnings about swimming pool demand starting to really level out or start to decline because this was something that was so hot during the pandemic. Again, people were spending on homes, people were investing in big-ticket items, improving their homes, and thinking they were gonna spend so much time at home, and now that we're post the pandemic, people aren't thinking that way and quite the same way anymore. And some of the backlogs that were honestly, the swimming pool industry was one place where we saw some of the worst backlogs in any part of the supply chain. 

[00:07:40] Mokaya: Yeah, I remember last year it was one of them, because Pool Corp is one of the companies we have followed for the last two or three years, and last year they were telling us how they have up to half a year of orders backlog in terms of pools that need to be constructed. And now things have changed.

[00:07:56] Scott: Yeah, things have changed. So it's really, it's a sign and indicator of just how far supply chains have maybe improved or how much demand has shifted from the pandemic era. And finally, this kind of leading and long-term construction item in swimming pools is seeing its demand curve shift the other way. So that was an interesting one for me there. Anything else for you?

Freight Recession

"As we have discussed shifting dynamics in the market for several quarters now, it should be evident that freight demand is muted, even when taking into account seasonal factors...To start, we're in a challenging freight environment where there is deflationary price pressure for an industry that continues to face inflationary cost pressures. Simply stated, we're in a freight recession." - J B Hunt Transport Services CEO John Roberts

[00:08:20] Mokaya: I don't think I have much, but I think one thing that also I noticed a little bit, I don’t know what to make of it is there's JB Hunt behind talking about this being a freight recession. Do you make anything of it?

[00:08:34] Scott: Yeah, it's interesting. Transports like JB Hunt and FedEx have been really negative for a long time, and it seems like it's something that we should be paying attention to. But again, it may just be the headwinds of the shift from goods demand to services demand, that there were so many goods being shipped around the economy during the pandemic and then as we've shifted more to services demand and then have mild recessionary headwinds going on, the transports are seeing this pretty significantly. They're getting hit pretty significantly by it.

[00:09:04] Mokaya: I think it's something noteworthy because they're pretty negative in their earning score. So I think it could be something to pay attention to. 

Tesla Slashing Prices

And while we reduced prices considerably in early Q1, it's worth noting that our operating margin remains among the best in the industry…we expect our vehicles, over time, will be able to generate significant profit through autonomy. So we do believe we're like laying the groundwork here, and that it's better to ship a large number of cars at a lower margin, and subsequently, harvest that margin in the future as we perfect autonomy. This is an extremely important point." - Tesla CEO Elon Musk

"Price wars are breaking out everywhere. Who's going to blink for growth? - Ford CEO Jim Farley

And one more thing, Tesla and SpaceX had some big moves. They're making some big moves last week. Elon Musk's the chief tweet, of course,he's doing a lot of things. So of course something to do with Twitter. And of course the issue do with blue ticks and all. But beyond that one, Tesla slashing prices to compete in the market. I think are they finally becoming a car company which has to compete with other brands? And then secondly, of course, SpaceX going out into outer space and all

[00:09:40] Scott: The reason that Elon is saying that they're cutting prices at Tesla would be terrifying to me if I'm another car company that believes him. Because what he's saying is basically, we're gonna make all of our margin on autonomous driving and we're gonna have fully autonomous driving this year. Which obviously Elon pushes timelines and is notorious for not meeting timelines. But if they really do have full self-driving cars this year or anything approximating that, and their strategy is to take the rest of the car and make it a commodity and then make margin on self-driving, they really will disrupt. the automobile industry potentially in a way that the traditional makers won't be able to keep up. And so it is a quite a shot across the bow that maybe people aren't paying full attention to right now despite the fact that everybody pays attention to Elon.​​

[00:10:30] Mokaya: The funny thing is two days later, they actually did raises prices on some of the goods. So it's a bit, it could be something like it's Elon’s way, maybe he's just shooting a bit and then seeing what happens and then, shifting around a bit until he finds a proper strategy, which he wants to fit in at the end. But it's something interesting because the Ford CEO reacted very sharply and said someone has to blink at the end of the day. So if they're slashing prices, we need to slash prices as well. And Tesla did slash prices in Q1 and it did not impact their profit margin. So I think that may make them bolder to actually make bigger moves in terms of share prices. 

Big Week Ahead

But it's a big week in tech earnings.

[00:11:09] Scott: It's a big week of earnings across the board So let's keep an eye on all the companies that are reporting and see what's going on in the economy.

[00:11:18] Mokaya: Definitely 178 S&P 500 companies are actually reporting. So it's a big week. We have to be flipping through a lot of earning transcripts to give you the best quotes. And I think the best place to be is at The Transcript because we digest these things for you and release them every week. So don't miss next week's edition of our newsletter and of course, keep sharing our newsletter because we are reader-supported and we really love and appreciate your being a subscriber to us. So I see you again next week for another edition of The Transcript. Bye from us.

The episode is based on yesterday's newsletter which is available on Substack.

The Transcript

Calmer Now

Succinct Summary: Earnings season began last week and it appears that the bank stress from a few weeks ago has calmed down. The economy also appears to be slowing. Inflation and labor markets are both moderating. For now, the slowdown is small though and it doesn't appear to be enough for the Fed. Rates may stay higher for longer than people think…

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3 years ago · 27 likes · The Transcript

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

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Show Notes

00:00:00 Introduction

00:00:07 Banking Stress Calms Down

00:01:56 How Will the Fed React?

00:05:23 Is The Banking Crisis Over?

00:07:03 The Car Market

00:08:40 Buffett and AI

00:10:57 Conclusion

Transcript

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript, along with Erick Mokaya who's our lead author.

Banking Stress Calms Down

We sent out a new issue of the newsletter two days. It was the start of the earnings season last week. So some of the banks started to report. JP Morgan reported. Wells Fargo reported, Citigroup reported and a couple of regionals. And of course, the thing that we were watching most closely for was what was going on with respect to deposits, with the financial stress that had happened in March, and how much was that impacting banks? And I think my big takeaway is that things have calmed down a lot. I think that you saw a deposit inflow to some of the big banks. That wasn't surprising. You did see outflows happening, but general outflows in deposits across the banking industry. But the stress that happened in March at least, has subsided for the moment. Erick, any thoughts about any of this?

[00:00:54] Mokaya: I agree with you. The key takeaway is of course that the banking crisis is a bit behind us. So I think there was a bit of impact of course for the small banks. There's a bit of deposit flows from the small banks to the big banks. So the big banks, although they had deposit outflows throughout the quarter, they decelerated towards the end as more inflows came in from the small banks. So most of the banks are a bit cautious in saying that they got inflows, especially the big ones. They're a bit cautious in saying that they took deposits from small banks. But generally the key takeaway is that all is well. Nothing is happening, especially in the banking circles that is out of the norm. So I think the outflows were as expected and everything is back to normal. Mostly driven by what the Fed did during March. So I think that's the key takeaway. But one key takeaway maybe. And that's something that a lot of people are paying attention to is CRE exposure. Any takeaway from the banks that reported in terms of how that's going? And also the cost of funds has gone up a bit for some of the banks. So I think CRE is one area that everyone is paying attention to. Any takeaway?

How Will the Fed React? 

[00:01:56] Scott: Yeah, I think before we go much deeper into what banks were saying, I think we should circle up actually on the implications for the macro side and Fed policy which are that as the banking press subsides, the Fed is more likely to go back to a hawkish stance. And so we saw some of that. Christopher Waller was talking last week and was extremely hawkish in the way that he was speaking about the economy, feeling like we still haven't made enough progress on inflation or labor markets.

“Monetary policy needs to be tightened further. I would welcome signs of moderating demand, but until they appear and I see inflation moving meaningfully and persistently down toward our 2% target, I believe there is still more work to do...Whether you measure inflation, using CPI or the Fed's preferred measure of personal consumption expenditures or PCE. It is still much too high and so my job is not done." - Federal Reserve Christopher J. Waller

And even though we're starting to see some of those pressures subside in earnings calls and seeing people starting to talk about more slowness in the economy and slowing and hiring, the Fed still seems to be gearing up for more interest rate increases going on this year. And so you have that dynamic. And then in addition, going back to the banking side, you have banks that have increase in cost and funds. I think everybody is looking at their deposits and seeing that interest rates on a headline basis are 4.75 to 5% and only receiving sub-1% on their deposits. And people are really starting to ship deposits into other areas. And so Schwab actually reported this week, not last week, but one of the things I noticed is that they saw, I think it was a 30% year over year decline in deposits, but then they saw a hundred billion inflow to their money market funds. So there's a lot of money moving into short-term money market funds, short-term credit, those sorts of things.

"And so we saw a lot of people move their portfolios out of the smaller banks that were, that had yields that were much lower into the larger banks as we saw today in some of the earnings and into the money market funds, we've seen over 500 billion of money leaving the banking system into the capital markets, and that's one of the pervasive things I talked about today...We expect to shift from deposits to money market funds to be a longer-term trend and are actively working with clients to help them diversify and enhance the yields they're earning on their cash." - BlackRock () CEO Larry Fink

[00:03:28] Mokaya: A key question for you perhaps, the inflation is now at 5% I think from last week's numbers and reading. The Fed funds rate is slightly above that. Isn't that a signal that they're about to stop soon? Or is this just a different market and they are hell-bent on putting that inflation back down from 5% to almost 2%?

[00:03:48] Scott: I don't think that it's above the 5% inflation rate and then core inflation was higher than headline inflation now. And so the Fed still probably is gonna bring above 5%, maybe not materially much more, but at least hold it there is what they're still talking about as well while inflation remains above 5%. So to use your words, I think they are hellbent on getting inflation back to 2%. Or if there's a recession coming, maybe that changes the calculus sum. But until they get back to their 2% level, I think that they're still biased toward tightening credit conditions, which I think you're really starting to see a slowdown this quarter. You really are. Genuine slowdown in the economy. They could tumble into recession pretty easily, over the next three, six months.

[00:04:35] Mokaya: Then maybe an additional point was from FOMC minutes that actually, they start themselves as seeing is it a mild recession in the second half of the year. So I think it ties back to what you're saying that maybe the Fed is actually given the subsiding risks of banking crisis and that banks are now stable, they're a bit more prepared for higher rates and the fact that's not maybe trickling down to any parts of the economy as they had hoped after the March raise. So I think going into May, it looks like another raise is in the works. And this has to go on until the inflation actually comes down to 2%, or at least we feel like a recession is coming through. So I think that's why I think JP Morgan and Bank of America both have, as their base case, a mild recession in the second half of this year.

Is The Banking Crisis Over? 

"We're not through with bank failures. But we're through the depositor, depositors haven't had a crisis. The owners of banks may have lost a hell of a lotta money. The people who bought the debt of the holding company may they may lose a lotta money. People can lose a lotta money. But the depositors aren't gonna so you don't need to turn a dumb decision by managers into a panicking the whole citizenry of the United States about something they don't need to be panicked about." - Berkshire Hathaway (BRK.A) CEO Warren Buffett

And if you look at a few of the other things that we picked up in the newsletter it seems like several parts of the economy are actually slowing down as they respond to the rate hikes that have happened so far. So I think that's a key takeaway to keep an eye on. But also something else that Warren Buffett also said that there could be more bank failures. What did you make of that statement that there could be more?

[00:05:45] Scott: I don't know. It was an interesting one because both Jamie Dimon and Warren Buffett had kind of signaled that the banking crisis isn't over, but at the same time signaled that it was over.

So it was a little bit surprising, but Warren Buffet in saying that, I think was mostly just talking about...He said that the deposit outflow should be done because he would bet that nobody's gonna lose money as a depositor in a bank. I think he was talking about really on the asset side of balance sheets banks have gotten overextended in certain areas really with respect to duration, I think. This commercial real estate thing is coming into play. More and more recently, but to me that feels more like people grasping to fight, like to justify what just happened on the banking side with something new. That's not to say that it can't spiral into something. Certainly, people could start to get concerned about commercial real estate. Certainly, delinquencies could go up, but it feels, at least to me, more like when people were talking about all day after subprime, like there was a whole period after the financial crisis in 2008, 2009, where you would see these charts of all of the all day mortgages that are coming due and all the refinancings. And those big bad things frequently don't materialize. And so I guess I would be more surprised than not if this one did on commercial real estate.

The Car Market

"Our diversified business model delivered total sales of $5.7 billion, down 26%, compared to last year, driven by lower retail and wholesale volume and prices. In our retail business, total unit sales declined 12.6% and used unit comps were down 14.1%. Average selling prices declined approximately $2,700 per unit or 9% year-over-year." - CarMax () CEO William Nash

[00:07:03] Mokaya: I think that one takeaway is that this is one of the most anticipated recessions ever. It's like we've been waiting for this for almost half a year or so, and of course, there's a couple of signals that we also picked up in the newsletter. And I think one which you also emphasized a lot was CarMax. What were your key takeaways from their kind of assessment of what the economy is doing apart from some of the negative trends they're seeing in the auto market?

[00:07:25] Scott: Yeah, I think it's the commentary on the consumer that CarMax is seeing that stuck with me on that earnings call which first of all, their numbers are down like their sales are down 26%. So like big declines in comps, which you're not seeing in other parts of retail. Like those are big numbers, bigger numbers than we're seeing in other places. But then also talking about dynamics like consumers coming into the showroom thinking they want to buy, but then getting sticker shock, basically, once they see what the monthly payment is going to be with interest rates and wherever car prices are right now, and deciding, eh, maybe it's not a good time to buy a car. So that to me is again, indicative of real deterioration in consumer balance sheets and real deterioration in consumer psychology that would be easy to transfer to the rest of the economy. Just happens to be in larger ticket items right now.

[00:08:17] Mokaya: That's a bit concerning, given that for a long while during the pandemic, consumers really really wanted to buy cars. And what was happening during the pandemic is that there was more demand than supply. And now the demand seems to be pulling back and now looks like some auto companies may actually be stuck with a bit of more inventory if consumers are actually getting that sticker shock or looking at some of the items and wondering whether they're going to be able to pay.

Buffett and AI

"I don't really understand it. I think it's an incredible technological advance in terms of showing what we can do. But I don't know whether we know what happens. And I was listening who was it the other day that knows a lot about technology? He just says that it scares him. Well, if it scares him, it scares me in terms of the possibilities of I mean, we've done amazing things, like we figured out how to create an atomic bomb back in 1945. I didn't know what an atom was or anything, but then Einstein told me it was gonna change the world, and it changed the world. So I don't wanna change the world too many times without knowing or having some idea of the consequences of it. And this, I think this is extraordinary, but I don't know whether it's beneficial." - Berkshire Hathaway (BRK.A) CEO Warren Buffett

So beyond the consumer, maybe one more thing before we close; AI and Buffet. Buffet thinks AI cannot be able to make jokes for him. So that was an interesting perspective from him. This is an incredible piece of technology, but he is not convinced or doesn't know yet whether AI is good or bad so to speak. And of course, also an interesting perspective of him investing a lot in Japan now is very geared towards, he's invested in the top five companies. I think in the last three years he's raised from 0% to 7.4% owning some of the companies there. Any takeaways from Buffet on AI and also on investing in Japan?

[00:09:22] Scott: No, I think I love Warren Buffet as much as the next guy, but he's got his shtick and he sticks to it. So technology, he's never gonna understand. And the US is always gonna keep growing and life is always better than it was. And I don't disagree with any of that, but it's striking to me the extent to which, how much economic value you could extract from planning ignorance of technology when technology's been such a huge growth driver of the economy for the last 35 years, 40 years, 50 years. It seems like a massive miss to me, but I'm not sitting with Buffet's billions. So what do I know?

[00:10:00] Mokaya: One thing before you go, something to do with the Meta. I'm surprised that Meta has completely shifted now to focusing on AI and of course, they seem to have recognized that maybe AI is bigger than the metaverse. Is that a good takeaway from that?

[00:10:12] Scott: That what? AI is bigger than the metaverse? I actually think they come together, honestly, like there's generative AI. If you want to create an immersive media experience with AI, that happens in the Metaverse, right? Or it can happen in the metaverse. It can really uplevel the metaverse, so to speak. So I don't think that the two are totally unrelated, which means that the Metaverse to me is still like an undervalued thing probably, but I'm recognizing that I'm very wrong right now along with Zuck.

[00:10:47] Mokaya: But since I mean the company's doing well so far, I think at least in the stock market since it hit some lows last year. Seems like people are aligning with this vision going forward.

Conclusion

That being said, I think it's another big week in earnings. Thanks for helping us reach episode hundred on The Transcript. Looking forward to another week of earnings. So I'll see you again next week for more content from us.

The episode is based on yesterday's newsletter which is available on Substack.

The Transcript

The Transcript Q4 2022 Letter

Summary: We summarize our key learnings from the Q4 2022 earnings calls as we prepare for the Q1 2023 earnings calls that start next week with bank earnings results. Macro For most of the first quarter, the economy appeared to be performing surprisingly well. Consumer spending remained strong, and inflation remained stubbornly high. Just a few weeks ago the Fed appeared to be readying a more hawkish turn. However, the collapse of SVB has changed this calculus some…

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3 years ago · 19 likes · The Transcript

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

Give a gift subscription

Show Notes

00:00:00 Introduction

00:00:07 The Banking Crisis

00:02:55 Consumers Are Still Spending

00:04:22 The Era of AI

00:08:40 Earnings Season Begins Soon

00:10:11 Conclusion

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript, along with Erick Mokaya, who's our lead author. 

The Banking Crisis

We sent out our quarterly letter last week, so each quarter we like to do a letter where we synthesize the things that we've been reading throughout the last three months and think about where we are relative to the economy and catalysts, and then also look forward to the things that we're looking for in the next earning season, which is coming up soon. And so we wrote this letter. I think the biggest takeaway from me in the macro section is just the uncertainty that was created by the financial stress that happened around SVB and First Republic and Credit Suisse, et cetera in the last few weeks. And then the way that impacted the Fed. The uncertainty makes it so that we don't have as much visibility into what the Fed is planning to do from an interest rate standpoint which could affect financial markets. So I think everybody's in a bit of a wait-and-see mode which is what the Fed also talked about at their last meeting. Erick, any thoughts or new things that have come to you in the last week?

[00:01:05] Mokaya: I think we are where we were last week. Nothing much in terms of new data. I mean as we're doing this quarterly letter, I go back until January to date, just see where we are in terms of how the newsletter has developed over time, looking at the quotes and stuff, and this is very interesting to see how much stuff we covered at The Transcript and how themes have developed from January to February to March. So in January, everybody was worried about how high inflation is. In February, still a bit of inflation, but it was coming down. But then suddenly in March, the bank situation heightened the whole conversation shifted to ‘Have we raised rates a bit too much to break the system?’. I think you captured it well. They're still waiting for more data. I think this earning season that starts with banks next week will be very key in terms of seeing where some of the banks are in terms of what happened in the last bits of the quarter. So I think that's my key picking that we still don't have enough data to see which side now is more overwhelming. Is it the inflation side or the banking stress side and what the Fed is going to do about it? So I think that's something I picked up. Any other thoughts from the newsletter at least?

[00:02:15] Scott: Yeah, it certainly doesn't feel like the banking stress is as prevalent now as it was a couple of weeks ago. It feels like it was a hurricane that kind of blew through and passed through. I think that people still remember Bear Stearns in 2008 was just the beginning of the financial cascade, not the end of it. And while it feels like things are a lot better now, there's certainly the chance that we could get a second wave of financial stress. It's not clear to me what the catalyst would really be in order to create that financial stress in the system or perpetuate a second wave of banking stock declines or anything like that. 

Consumers Are Still Spending

And so really it's relative to that, it's what's the underlying inflation trends, and that goes back to what we were observing at the beginning of the year where you had goods inflation coming down. You have services inflation that was still persisting. But you have some cooling trends in the economy. You have labor markets that weren't quite as tight as they had been, and so that may make it so that inflationary pressures are starting to come off. So I think the other thing that we wrote about in the letter is that consumer spending has stayed really strong throughout the year.

[00:03:31] Mokaya: On consumer spending, I think it's the same thing I noticed also. I think there's a quote there, which you referenced JP Morgan talking about cash buffers, at least for the lower-income consumers starting to fall back to the pandemic levels by Q3 this year. I think what we're seeing so far in terms of reading through from January to March is that the consumer is still spending. They're still tapping into these cash savings that they have saved during the pandemic. They're still spending, especially on services still, things to do with travel and entertainment. They are a bit pressed. I think we've seen a couple of retailers mention that but they're still spending nonetheless. The banking stress has so far, and as you say, maybe it blew up too quickly. The consumer didn't even notice or feel it especially since depositors were met whole. So I think generally consumers are still spending and spending well, so generally, I think that's key picking from the consumer side.

“...recent data suggest that consumer spending isn't slowing that much, that the labor market continues to run unsustainably hot, and that inflation is not coming down as fast as I had thought." - US Federal Reserve Governor Christopher Waller [March 6th: Waiting for More Data]

The Era of AI

I think one of the things that also came up in looking at the last three months of our earnings calls transcripts is the pick up in terms of the language in AI in terms of the large language models and how they're being applied to search, to various products around the world in terms of companies like Microsoft and Google picking up a fight. So I think AI is one key term that has come up in the past two or three months and is expected at least to be one of the highlights in terms of discussion points in this earnings season. Do you agree with that? I think you're very close and you're very excited about this too. So maybe you have more points to add to that.

[00:05:01] Scott: Yeah, I'm honestly finding it a little bit difficult to focus on macroeconomic trends outside of AI. I know that we're in this really choppy economic environment where we may be headed towards a recession and there's dynamics in monetary policy and financial stress and all that. But all of it seems somewhat unimportant compared to what's going on in AI right now and the impacts that could have on the economy. Much more positive than negative to me, I think. But it's mostly just displacement in terms of opportunities. If these large language models just get marginally better, honestly, even where they are right now they can be very helpful in understanding pretty much most things that you require learning. Things that you don't understand right now that you need to understand better. I was doing a research project last week and the first place I went to was chatGPT and started asking questions about this particular subject that I needed to have a better understanding of. And it got me up the curve much faster and much more tailored than Google would've done if I would've done that in the past. And chatGPT for most of us is still not even connected to the internet. Like most people don't have access to the plugins yet. And once you have the plugins and you're connecting to the internet and you're able to interface with this large language model that's chatting with you it can really suck the gravity out of certain things that touch the internet, historically, up until six months ago the parts of the economy that were the premier parts of the economy. What happens to Facebook in a world where you're mostly interfacing with a large language model? What happens to Google? What happens to Amazon? These companies are fundamentally web browser companies. What happens if the way that we interact with the world changes away from the web browser, changes towards some sort of more natural language interface? There's massive displacement and economic value that can come from that.

[00:06:58] Mokaya: Definitely, and I think every company for the last two or three months, ever since chatGPT was launched and then Bing launched its chatGPT-powered new Bing, what you've seen is that every company is taking time to actually analyze what does chatGPT and AI and GPT4 mean for me as a company? What parts of our company can we make more efficient? I've been spending a bit of time also in chatGPT Plus myself the past couple of weeks, and I was just testing it and it wrote up an entire piece of code on Python for something I wanted to do. I imagine that would've taken me a lot of time back and forth in terms of writing the script, going online, searching for a small solution to a really particular problem that you have for yourself. But now by interacting just with chatGPT, I was able to create an entire code and plug it into Python and I'm done with all the work that I needed to do at the end of the day. So I think that kind of efficiency, that's what you're looking at a lot of companies doing. One of the other gleanings that you get from reading the transcripts is that companies are investing more in AI. Even tech companies, even though they're cutting every other aspect of their growth, one area they're not cutting on is the investments in AI and especially investments in the kind of things they need to be able to work out AI. And I think that's one of the things that you noted there is that one of the winners in the public markets appears to be Nvidia, and Nvidia is actually the best-performing stock in Q1 2023 so far. Very interesting development and one that we'll definitely be watching this earning season. But beyond AI, and I'm sure that you want to discuss more on AI, is there anything else that you are tracking as we start the earning season, especially for banks? Anything that you're watching?

"Believe me, I’ve been at it for 20 years, and I’ve been waiting for it. But look, at the end of the day, they’re the 800-pound gorilla in this. That is what they are. And I hope that, with our innovation, they will definitely want to come out and show that they can dance." - Microsoft (MSFT 0.38%↑) CEO Satya Nadella [Feb 13th: Let’s dance]

“...we're on the verge of launching a number of LLM-based products and services, you can think of it as a portfolio." - Alphabet (GOOGL 1.55%↑) CFO Ruth Porat [March 20th: Run on the Bank]

Earnings Season Begins Soon

[00:08:40] Scott: Yeah, I think it's what you mentioned earlier on the banks, it's seeing to what extent the hurricane that blew through the financial system ended up impacting them and the quarterly numbers. What happened to the deposits at a bank like First Republic, for instance? I think it was well understood which banks were under attack, so to speak, but how it leaves their balance sheets looking and what sort of impairment and whether or not there would be further surprises for equity markets in terms of how impacted they were, those are the key things that we're looking for in earnings calls over the next couple of weeks. And then what's going on with the consumer? Is the consumer starting to spend less? Then they were as judged by whatever the credit card companies are seeing. Those would be big data points for me. How about you?

[00:09:26] Mokaya: Same. I think this quarter you expect investors to pay more attention to available for sale and held-to-maturity securities more than usual. I think they have become the lingua franca now, the common talk in earning calls now. So you expect more questions in that regard. Of course, you also want to see how supply chains are developing so far. I think they've been easing, so I think a bit of a continuation of that. In the international markets, of course, the deglobalization, seeing how companies are adjusting to that in terms of where they're placing their factories and all. So a couple of things to watch here and there. And of course, how the labor markets are developing in different pockets of the economy. Any thoughts on that?

[00:10:05] Scott: No. 

Conclusion

[00:10:11] Mokaya: It's ok. On that note, I think we can close there for this week. Thank you so much for joining us. It's Easter this weekend. So we'll have a newsletter next week on Tuesday and our podcast again on Wednesday. So thank you so much for joining us. See you again when the season starts and we are pumped up for this one because it's a very exciting one ahead.

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The episode is based on yesterday's newsletter which is available on Substack.

The Transcript

Fire and Ice

Succinct Summary: The world has changed a lot in the last week. Markets are still trying to understand the impact of the run on Silicon Valley Bank. It’s not clear how wide the contagion will spread. For now, the consumer seems to continue to spend, so the Fed is stuck between trying to cool inflation and support the financial system. How will the Fed b…

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3 years ago · 1 like · The Transcript

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

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Show Notes

00:00:00 Introduction

00:03:51 The Role of Small Banks

00:05:00 What will the Fed do?

00:06:35 Deglobalization Continues

00:07:09 The Consumer Keeps Spending

00:08:19 Leading and Lagging Indicators

00:09:44 Conclusion

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript, along with Eric Mokaya who's our lead author. We sent out a new issue of the newsletter yesterday and the world was still grappling with the Silicon Valley Bank failure and really not necessarily even the Silicon Valley Bank failure itself, but the contagion that's spread within the banking system from that failure. And so I think a lot of attention on First Republic, on Credit Suisse around the world. There were rescues of both institutions last week and going into this week, First Republic is down, the stock is down as we're recording this on Monday morning. And so people are still trying to figure out, how much farther does this spread? Is this a financial crisis? And what are the impacts on the economy and Fed policy with respect to interest rate increases in the economy? Because the focus had been on inflation up until about two weeks ago. Erick, any thoughts on what's going on?

"Yes. I think if you'd asked me this question last week, you get a different answer than what you get today because I do think the world has changed quite a bit in the past 7 days...I would say that the events of the past 24 hours continue to add some of that extra volatility into the mix." - Affirm Holdings CFO Michael Linford

[00:00:56] Mokaya: Yeah, I think it's a tough time, especially for the Fed, which is also meeting this week.

So lots of stuff to consider. Lots of banks are in crisis. I think First Republic is like the poster child now for what will happen in the markets. I think, as you say, it's down significantly today. Lots of bankers asking whether this is a repeat of 2008. Jefferies CEO was saying that this is not. And then another thing that I picked up, at least from earnings calls throughout all the earnings calls or conferences that are this week, the first question every analyst or every CEO got asked was, what's your exposure to SVB and how safe are the deposits? And then one of the questions of course Wise in London was talking about even customers now want to know where do you keep my deposits? So they had to actually put out a blog to explain okay, we bank with this one and this one. So I think it's a bit more scrutiny around banks and right now the worst the bank can do is for something negative to happen about any bank in the system because it's so fragile that if something happens, everyone focuses on that bank very quickly. Those are some of the key pickings. What's your perception from where you are at?

[00:02:04] Scott: I think it is legitimately pretty bad for the banking system right now. One thing that's really stuck with me was the conversation that we had with Mark on our Twitter spaces last week and really driving home that this is a question about uninsured deposits around the banking system. Deposits obviously are core and fundamental to banking as a business model generally. And so if we have questions around the safety of deposits that's really dangerous for banking as a business model in general. And so this is something that is very concerning and uninsured deposits specifically, like as we're seeing it at First Republic, I don't think there's anything necessarily wrong with having uninsured deposits, but it isn't totally rational as a banking customer to have uninsured deposits. It actually makes much more sense to have any deposits that are over the FDIC threshold in money market funds or where there is exposure to more counterparties, not concentrated counterparty risk in a single bank. And there is a rational reason for anybody who had uninsured deposits to be moving them away from a direct deposit banking institution and into more of a money market fund. And that in the longer term could end up restricting credit availability, especially in real estate segments and for small and medium-sized industrials who bank with these small and mid-sized banks. If those banks don't have the deposit, the non-interest-bearing deposit basis that they used to have, it will be hard for them to be able to stay in business in the same way, even over the medium, longer term. I don't want to be bombastic. But yeah, this is a tough one.

The Role of Small Banks

[00:03:51] Mokaya: It is a tough one. I was looking at some statistics last week about small banks, especially in the US which are most vulnerable at this point in time, and which I think were asking the Fed through a letter this past week that they can have all their deposits be backstopped at the Fed. So generally like to be deemed insured. So I think the statistics will include banks with less than 250 billion in assets. They account for around 50% of commercial and industrial lending, 60% of residential real estate lending. 80% of commercial real estate lending and 45% of consumer lending in the US. So it's pretty a substantial part of the economy. And this past week, I think there's been a huge focus on what their role is in the economy and what exactly would happen, especially if people pull deposits from them and then take them to the JP Morgans and the Bank of Americas of this world. So think, are you going to have risk more concentrated, this seems at the end of the day, again, and then that also raises the risk that if one of these falls it's actually going to be much worse for the economy. So I don't know what that means for the ecosystem as a whole.

If all the money moves towards the big banks. It's a bit of a challenging time. Any other picking that you had maybe from the action?

What will the Fed do?

Do you think the Fed this week could be inclined to raise rates now that they've seen the totality of what is happening in the ecosystem?

[00:05:05] Scott: It's a big question, right? This is what we're all waiting for this week to get some sort of signal from the Fed and Powell as to how they are balancing inflationary forces against what's going on in the financial system.

What's going on in the financial system is potentially very dangerous to the economy. Obviously, this is a huge part of the Fed's mandate is financial stability and it's just there's still a visceral response and emotional reaction and memory to what happened in 2008, and so I think that nobody at the Fed is going to want to see a repeat of the financial crisis.

That's said, on the other side inflation it's definitely moderating, but it's still there in a big way. I think we see companies on the good side say moderating it's the services side, which the Fed was really honed in on and had been communicating the markets that they were honed in on that isn't really going away. CPI, even 6%, yes, that's down, that's lowest in many months, but that's still extremely high, way outside of their 2% target. Psychologically, the whole banking crisis, this mini-crisis or whatever we're in I think that psychologically is weighing more heavily just on the zeitgeist than inflation right now. And so maybe that impacts the Fed this week.

[00:06:21] Mokaya: Yeah. Yeah. I think from earnings calls, you can definitely tell. All the talk this week was about banks and the banking crisis. Inflation took a back seat for once in quite a year. It took quite the force, kind of banking crisis to make people forget a bit about inflation.

Deglobalization Continues

But from the pickings that we had, from the few pickings here and there in terms of inflation still there subsiding. Beyond maybe the banking crisis, I think some of the things that we noted were obviously deglobalization continuing in manufacturing. I think for me the quote that stood out was NXP Semiconductor saying, we have customers who have told us point blank if we cannot manufacture certain products for us here in the US, don't even bother bidding on the program. That sounds very forceful in terms of where people want their manufacturing to be located. For me, that's something that stood out. Anything that stood out for you?

The Consumer Keeps Spending

[00:07:09] Scott: I think just this stuff that's going on in the banking system is overwhelming. It's the banking system offset with Fed policy. It's just so central to what's going on in capital markets that it's hard to really focus on anything else and think that anything else is super important. I think the inflation side, which we've been following for a long time, is gonna be heavily driven by what's going on with the consumer. And I think there was one quote in the consumer section, which we held for premium subscribers that was from Kroger, talking about how consumers really are starting to trade down using coupons, more trading at a private label. And then I think it was Dollar General as well, that was saying that they're seeing pressure in their consumers. And Kroger was also saying people are eating at home more. And I think that this is something that really is starting to happen. I think consumers are really starting to feel pressure. I think inflation really is starting to become a bit overwhelming for the consumer. And we know that excess savings is starting to get depleted from basically the covid era stimulus. And so I think there are real changes going on in the consumer and this banking crisis probably doesn't help impact psychology, all that. But there's still just this inertia to inflation.

"The news is full of bank noise today. And so there's plenty to be paying attention to. But our view on our industry is travel will be very strong and travel continue to move. We expect consumers' desire and demand for travel to continue to build this year. We're seeing that, as I said at the start of the year." - Samsonite International SA CEO Kyle Gendreau

Leading and Lagging Indicators

[00:08:19] Mokaya: I think it's a rough time. Generally. I wouldn't want to be Jerome Powell this week. You're facing for the first time reporters this week and have a barrage of questions about what's happening in the markets, and then how that factors in into your inflation data. The back of mind as you say, like our data is showing us clearly the consumer is still spending. And then there's a banking crisis that you have to deal with. So you have to kind of balance because increasing rates would mean a bit more pressure on the banking side. At the same time, increasing rates would also put a big pressure on inflation over here. So it's a tough one.

[00:08:50] Scott: It's a question of leading and lagging indicators. The Fed is actually one of the biggest laggards in the economy in terms of the data that they look at in order to adjust their monetary policy in terms of inflation and the state of labor markets and unemployment, are really the things that really get them to respond to a crisis. And so you've got down on the one hand and you've got leading indicators. Capital markets have been shut and selling off for over a year now, and you're seeing a banking crisis, and the Fed is still stuck behind these lagging indicators that haven't moved. There's a good case to be made that there's this big earthquake that's just rumbling underneath the economy that the Fed is not seeing yet, not picking up in their measures. And by the time they do, it could become really big. I really hope that's not the case. Hopefully, this resolves without something like that.

Conclusion

[00:09:44] Mokaya: Hopefully it does. As it continues, it’s going to be a bit of a dance of, as you say, fire and ice, as our newsletter indicated this week. So let's hope it doesn't break a lot of stuff as they keep raising rates. And let's look out for the earnings calls this week, and definitely also the press conference of Jerome Powell this week. We'll definitely be taking a few notes from that. So on that note, we close for this week.

[00:10:06] Scott: I think that sounds good.

[00:10:09]Mokaya: All right. Thank you. Thank you for joining us. See you again next week for another edition of The Transcript podcast. Keep following us, keep sharing us and keep it locked here. Bye for today.

The episode is based on yesterday's newsletter which is available on Substack.

The Transcript

Run on the Bank

Succinct Summary: SVB failed last week. Before Wednesday, it was perceived as one of the highest-quality banks in the country. But in the course of one trading day, it effectively vaporized. The bank’s issue was that it grew deposits too quickly and improperly managed duration against its leverage. The bank didn’t fail because of credit risk, it failed …

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3 years ago · The Transcript

A transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

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Show Notes

00:00:00 Introduction

00:00:07 The Rapid Fall of SVB

00:02:14 The 3 Banks That Failed

00:05:12 Contagion Effects?

00:09:15 Goliath is Winning

00:12:2 Conclusion

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got Mace Scott Krisiloff, I'm editor of The Transcript, along with Erick Mokaya, who's our lead author. 

The Rapid Fall of SVB

This was one of the stranger issues of the newsletter that we've sent out because I think up until Friday of last week, we really had one newsletter that was written, and then based on Friday and even based on Sunday as I was editing, the message of the newsletter was changing rapidly. Early in the week, it was still about chairman Powell's testimony to Congress and talking about persistent inflation and strong labor markets and what the Fed would do relative to that. And then obviously everyone knows Silicon Valley Bank collapsed in a bank run. Basically from Wednesday evening to Friday morning, it was like about 36 hours and the bank was gone which was a crazy thing to see especially for someone who started his career as a bank analyst in small and mid-cap banks and knows what a respected institution Silicon Valley Bank was. This is something that's very crazy to watch. In some ways was more surprising than things that happened in the financial crisis with the speed with which it happened but in other ways, it's just reminiscent of some of those things that we lived through not too long ago, 15 years ago now. Erick, any thoughts?

[00:01:12] Mokaya: So much to talk about. First of all, this is actually my kind of first real experience with bank runs. I think in the 2008 crisis I was pretty young. I was in my first year at the university, so I hadn't really truly experienced what it was to experience a bank run. I read about it, but it wasn't like practically seeing it happen. So this one was different. It happened on social media. Twitter was not there in 2008. This time it was there. A lot of information was flowing around Twitter. This is the 16th largest bank in the US going from being number 16 to zero. And then this is the second biggest bank to fall since the financial crisis. That's a mild way to put it, but it's pretty huge whatever happened this week. But again, digging into it, what really went wrong with this bank because from the last couple of years, it seems like it's been doing well for many years. It's been here since 1983. So they must have been doing something right for those 40 years to survive that long through the different crises through 2000 and now the 2008 crisis, and now finally actually being wrecked post the pandemic.

The 3 Banks That Failed

[00:02:14] Scott: Yeah. I think at the highest level, just as Silicon Valley Bank is an institution, again, as a bank analyst starting in 2008 and throughout this 15 years as I've been watching public markets, Silicon Valley Bank is viewed as one of the top banking institutions in the country, like one of the great growth banks in the country. And the other two that I would put in that list as well is Signature Bank New York, which is now also shut down and First Republic, which is now under fire as well. These three growth banks which if you look at their stock performance relative to the KBW Regional Bank Index, everything up until last week, these banks had just trounced that index.

[00:02:54] Mokaya: If I may ask, what do you mean by they are growth banks? What's the essence of them? What have they performed? A lot of people know the big banks, the JP Morgans, the Goldman Sachs, and those are the ones which are pretty much involved in the 2008 crisis. But now you have these banks, which are smaller banks, First Republic, Silicon Valley Bank, what makes them distinct from the rest and why is it that there is a bit of a crisis in these three banks specifically?

[00:03:18] Scott: Silicon Valley Bank and First Republic I know really well. Signature Bank less well, and the quality of their client base is really the thing that differentiated them from the rest of the banking arena. But I think this is missing the point as to your question of what happened, which I think what happened is really a very different thing than 2008 as well in that this is not credit driven, this is duration driven. Where in 2008 we were talking about loans going down. In this cycle, what we're seeing is really just mark-to-market losses and long-term government-backed securities. So it's not a question of whether these are money good, it's just a question of whether they're matched duration to the deposit base which is a totally different issue here.

[00:04:01] Mokaya: So if I may add, then I think the issue from my reading at least of the bank, and since I've been examining it, at least in the past week or so, I think it's what happened is that they grew very fast in the past two, three years. But then what happened is the rate hike, and I think the rate hike, there's a saying in the market that the Fed hikes until something breaks. We've been seeing a bit of signs that some parts of the financial systems are under stress, and then the past week or so, suddenly something broke, and that was Silicon Valley Bank because customers wanted their deposits back, but now they've invested in some long-term assets, which they can't sell very quickly to be able to fulfill the demands. And then everyone tells everyone, hey, this duration mismatch is a big issue. Pull out your money. And then in a week they had 40 billion worth of deposits that were taken out. And then that at the end caused the bank run. But from where you're sitting now, what's the perspective of the people around you in terms of how quickly this happened? And do you think this changes also the perspective of the Fed more moving away from fighting inflation now to containing a system-wide kind of contagion that may be happening because of Silicon Valley Bank?

Contagion Effects?

[00:05:12] Scott: Well, it could, It could, that is definitely the question that we'll be watching and assessing in the next several weeks. Obviously the Fed meets next week to set interest rate policy and there's already articles in the Wall Street Journal talking about them maybe not raising rates as quickly or leaving rates unchanged next week as they assess the impact of this stuff. But yeah, the way that changing narrative often happens is that there's some big event like we just went through with Covid that changes is the frame of reference that everybody is analyzing the world through. And the Silicon Valley Bank collapse last week feels like one of those, maybe not as large as Covid, but it certainly feels like a firing gun on something changing for the narratives here. And that was again, part of the reason why it was tough to write this week's issue is because we saw some big change right at the end of the week and it's unclear how things were going to evolve based on that. But whether or not this is a longer-term thing that changed or a shorter-term thing, I've been thinking, is this the sign that we're actually finally at the start of the recession? Is this the firing gun for the recession? Even if it is, a lot of times, that just means that it's time for the bull market to start when a recession starts, sometimes bull markets just start because the Fed comes in and starts easing monetary conditions as well. But the Fed is really walking this odd barbelled economy where you've got potentially financial risk building among regional banks and potentially spreading, and then you've also got their mandate of inflation pushing down on them. I don't know how they're going to necessarily square those two here. Probably bias towards not letting financial contagion happen. So that may be the winning factor here or the big change.

[00:07:00] Mokaya: I think that's a bigger risk because it has a contagion effect, not just within the US financial system, but it's global. This morning, we are recording this on a Monday. So this morning the UK financial system had to deal with the same issues the US was dealing with. There was a bit of a bank run that was almost going to happen in the UK branch of the Silicon Valley Bank, and in the end HSBC had to step in, buy it for one pound and then take over its operations and allow it to continue to flow smoothly. So what you can sense is that once something like this happens, it's a regional bank in the US that this is happening at, then its fall raises issues about the entire financial system because everyone is asking, is my bank safe? And someone else is in a different part of the world in Africa, he's also asking the same question, what does that mean for me, where I am?

[00:07:47] Scott: Yeah. This is the fundamental thing that's different about this time than 2008 that I don't know that markets are fully appreciating quite yet is this actually just flies in the face of the regulatory regime that was established really prior to 2008, but especially reinforced post 2008, which is that you are supposed to hold capital against risky assets and government backed securities are not risky assets, so you can have high tier one leverage ratios, which are adjusted for zero risk weighting to government securities and you can go as far out the duration curve as you want on that. And then on the other side, remember in 2008, the problem was viewed as not having enough of a core deposit base funding basis for investment banks. That's how the investment banks failed because they were short-term funded through commercial paper markets, not through deposit markets. And that's why they were deemed to be unsafe. So in this case, you're a company that basically only had held zero risk rated assets and was core deposit funded and still was basically caught up in this very fast-moving world of the internet that we have now. And it may just be the case that fundamentally, high-leverage banking models are not sustainable in a world where you can pull all of your deposits overnight, 200 billion worth of deposits just out the door. The regulatory regime is not prepared for this sort of dynamic.

Goliath is Winning

[00:09:15] Mokaya: Significantly think of it. Somebody was able to pull out 40 billion from a bank last week over one or two days last week, and managed to actually run down a bank or cause a bank run at the bank. That tells you a lot about how this kind of modern digital kind of banking has also influenced a lot. So in the old days, you had to actually go to the bank to make a bank run. Now you can just switch on the phone and switch very quickly and send money, wherever it is that you wanted to send to. But then I think one of the other things that I've also noted now, one of the banks that was up on Friday when everyone notice there was JPMorgan. Seems like Dimon the too big to fail banks are actually going to get even bigger because they're going to get more people wanting to put their money in banks that are actually safe at the end of the day. So I think another thing that people are paying attention to a lot is the level of uninsured deposit that you have. Silicon Valley Bank had almost close to 90% of its deposits uninsured. That was not an issue back then, but now I think everyone is paying attention to it. Is my money insured? Is it not insured? And some of the banks are actually performing poorly in the market today, have to do with having very high uninsured level of deposits. I think there's a lot of mistrust suddenly in the market, which wasn't there before.

[00:10:33] Scott: Yeah, again, the deposits are insured in a way. All deposits especially in this case of Silicon Valley Bank. The assets that were backing deposits were government guaranteed securities. What was the problem was they had duration risk to them, right? Because as interest rates change the current market value of those changes, but the fundamental cash flows backing those securities are guaranteed by the US government already. So I guess what the US government would need to do and really shouldn't have that hard time of doing through the Fed, is just guarantee the duration risk against those assets to the extent that they want to guarantee all deposits across the banking system. If I'm looking for somebody to lend to you long term as a government, I guess that's what you need to do.

[00:11:23] Mokaya: Which way from here now, because there's a bit of stress in some of the other financial institutions in the system except the big banks. There's going to come regulations once more because Silicon Valley was on the verge of becoming one of the big banks. It was moving from regional to being one of the big banks. It hadn't been done on liquidity tests on it for a long time. Somehow theY escaped kind of federal regulations and all. So I bet there will be regulations on this kind of banks going forward again. So the response is most likely going to be more regulations for the banks. And more requirements maybe to keep insured deposits and all. What do you see from your end in terms of going forward on the implications of this?

[00:12:08] Scott: I don't know. It'll be interesting to see. It depends how crazy this little mini-banking crisis that we're seeing right now is. I don't think there's necessarily political will to change any regulations based on anything that's happened so far. But if it gets a lot worse, there probably will be.

Conclusion

[00:12:26] Mokaya: Alright. There's a lot to speak about, we probably should have a Twitter space this week or next week on this, depending on how things move. Anything else that may have caught your eye in the market this week?

[00:12:36] Scott: Hard to focus on much of anything besides Silicon Valley Bank and the regional banking space. 

[00:12:42] Mokaya: Alright. To keep track of what's happening in the market, especially key quotes from earning calls and from key leaders, just follow us on Twitter. We're very active there. Keep up with us on Twitter @thetranscript_ and of course, keep it here for another podcast next week as we try to discuss and unravel what happens about this Silicon Valley Bank collapse. Bye for this week.

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The episode is based on yesterday's newsletter which is available on Substack.

The Transcript

Feelin’ Fine

Succinct Summary: Most people thought that the economy would be in worse shape than it is but things, honestly, still seem fine. The consumer continues to spend and capital markets are beginning to look past inflation. It's hard to believe that the Fed could tighten as aggressively as it has and not cause a recession, but there aren't many signs of rece…

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3 years ago · 3 likes · The Transcript

This week, a transcript of this podcast, with relevant images and quotes, is available for all subscribers after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.

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Show Notes

00:00:00 Introduction

00:00:13 Consumer is Still Partying

00:01:31 Service Inflation Still Sticky

00:02:45 No Hurricane Yet

00:03:22 UID 2.0

00:05:44 ChatGPT Attracting Criticism

00:08:15 Back to Office at Amazon

00:09:27 Conclusion

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript, along with Erick Mokaya, our lead author. We sent out a new issue of the newsletter yesterday, which is President's Day, a holiday, but we still had it out there.

Consumer is Still Partying

And what we found last week was that similar to what we've been seeing, the consumer is resilient and really just positive sentiment generally from CEOs, especially some of the banks who were speaking. Brian Moynihan said that, of middle market clients, they were saying that overall they thought things would be much worse now than they are, but when they look around, they're feeling fine. So that was the title of our newsletter this week, Feeling Fine. Erick, any thoughts?

"On the credit card side, we're up at almost 20% in the month year-on-year...So the consumer side, people are out there still spending, and you can see that in your day-to-day life. Try getting a restaurant reservation in most cities these days, right? It's really hard if you want to do something last minute. And so I think we're seeing people out there." - Wells Fargo CFO Michael Santomassimo

[00:00:44] Mokaya: I smiled when I saw the title Feeling Fine. I think it really represents what we've been capturing in earnings calls. We didn't do a podcast last week and the title was Let's Dance, so it's Let's Dance and Feeling Fine. So it's good times for the consumer generally. There's not a lot that has changed ever since banks reported last month. So I think it was banks having conferences last week. More CEOs, including a Goldman Sachs CEO, are saying okay, the consumer is still strong. So the argument is about whether we are having a soft landing or no landing at all. So I think that's the main argument. But generally, the consumer is feeling okay. But I think the key picking this week is that try to get a restaurant reservation or hotel room, both of those are unavailable right now. People are still maybe enjoying the experiences of post-pandemic pleasure having been holed in during the pandemic. 

Service Inflation Still Sticky

And if you combine that with what the Fed chair said a couple of weeks ago about service inflation being sticky, I think it looks like this is not going down, or at least we may need to readjust or be a bit more comfortable with a bit higher inflation going forward. Now, what's your take on all that?

[00:01:47] Scott: Yeah, I think it's interesting. Last week we got CPI and PI data which was a little bit hotter than expected, especially on the core side. There still seems to be like 4% plus inflation underlying core inflation that's in the economy, and that's obviously running a full, that's double what the Fed would want at 2%. And so we got actually some pretty negative inflation data points last week, but still the tone of this newsletter this week was very positive. And even with respect to inflation, I think Goldman Sachs's CEO was talking about how investors feel like we've conquered inflation at this point and they're looking past inflation. And I don't know if this is a circumstance where people feel like we've gotten farther ahead of inflation than we really have, and the Fed is going to come in and continue to pump the brakes on the economy, or if we really are headed for this soft landing or no landing situation that people seem to be expecting now. That's the outstanding question.

No Hurricane Yet

[00:02:45] Mokaya: I think going back six or seven months ago when the JP Morgan CEO talked about there being a hurricane on the horizon, my conclusion now is that given how the sentiment has changed, especially the bank CEOs, it could be that they were expecting something much worse and now whatever is happening is actually a bit benign. If you look beyond just the macro section, the financials, and capital markets activities are starting to pick up, meaning that people are becoming a bit more confident. Or at least that the range of expectations is narrowing to such an extent that they're more confident about the future, so they're able to put out a bit more capital to work in the markets. Anything else you may have picked?

UID 2.0

[00:03:22] Scott: Yeah, I think going into the more company-specific areas in the consumer section, we had a few different quotes from Trade Desk, and there was one that really stuck out to me, which was them talking about the uptake of UID 2 being much faster than expected and having 75% market share, which UID 2 is something honestly I need to understand a little bit better the mechanics and who benefits. But my understanding is that for social media companies like Snap and Meta, the lack of being able to target consumers after Apple made its privacy moves has been a major headwind for their ability to grow advertising revenues. And the Trade Desk was saying that with UID 2, this problem of cookies and user identification has now been solved, which seems like it could be a big positive catalyst for those social media companies. Do you have any additional insights in the UID 2, or what's going on there?

[00:04:17] Mokaya: So I think last time I checked, which was a while back, I need to update my knowledge on it. Think of this as having two parties involved so one is a consumer and then there's a publisher who wants to serve them ads. They have this thing in common. They both want relevant ads, for the consumer because they bought them to get things that they really want to buy and then they are able to maybe get them at a discount or something. And to the publisher, they want to put out relevant ads so they can be able to increase the ROI. So the solution that you UID 2 provides is to be able to do both of these things without compromising on privacy. So UID 2 is more of an open-source solution to this problem. So what happens is the consumer shares an email or phone number that is hashed out and encrypted and then shared with both of them. And then the consumer can be able to change some of the details that they want to attach to them. And the publisher is able to get some of these details and be able to deliver relevant ads and increase this ROI at the end of the day. So the uptake has been a bit surprising even the CEO of Trade Desk said that around 15% of the third-party data ecosystem was already on UID 2. And then they expect that to increase to around 75% by the first half of this year, meaning that this solution seems to be very relevant to the ecosystem and as such the uptake is surprisingly good. And I think that then becomes a huge catalyst for growth for companies that are involved in this area, like the Trade Desk themselves. Maybe I can read a bit more and next time we can have a proper, deeper conversation.

Source: Rise Interactive

ChatGPT Attracting Criticism

So beyond that though, I wanted to also touch on a few takeaways maybe from the tech section. It's about chatGPT. It's been the front and center of activities in the past two weeks. And last week we didn't have the podcast, but I think Let’s Dance was all about Microsoft CEO Satya Nadella calling Google to come dance a little bit in the world of search engine. It feels like we're in the new face of search wars and all that and browser wars are once again reactivated. And there was a bit of a reference to Netscape. I don’t know, what's your takeaway from that in terms of the relationship between those two and Netscape and AI and chatGPT and all that?

"I think the marketing moment offered by ChatGPT is incredible. We’ve seen these moments before: a company called Netscape brought the web browser to everybody’s attention. I mean Netscape was not an eventual winner but the internet certainly was. I think what ChatGPT has done [is] helped make AI real to lots of people who kind of were aware of it but didn’t maybe quite see what the power of AI would be. So full credit to what they did there." - IBM CEO Arvind Krishna

[00:06:19] Scott: Yeah, I think it was interesting. You're really seeing, this was IBM CEO speaking and you're seeing competitors to open AI really coalesce around the idea that chatGPT is inaccurate or presents inaccuracies, and that's becoming a brand identity that competition is pushing onto chatGPT, I think. And so it's interesting that's a vector of attack that they're coming at. And you saw IBM's CEO pushing that as well. Also, he was saying that basically the Netscape OpenAI chatGPT comparison was obviously meant to show that hey, yeah, somebody launched this game-changing technology 30 years ago now, and it didn't end up winning the day, somebody else won the web browser wars. So it was to remind people that there's still a big industrial competition that's coming in this, and just because chat GPT launched to the war doesn't mean that they're going to end up winning. I think it's particularly interesting that IBM's CEO is talking about this because of IBM's complete irrelevance to this conversation so far. Obviously, they made a big first-mover push with Watson, but that has not materialized into much economic value. I would put more stock into this I think if it were Google CEO or somebody from the Amazon team talking about this, but IBM is irrelevant it seems.

"The use cases we work on are not consumer, so consumer is a lot easier to explain: they type in something and, some number of times out of 10, you get an interesting, intriguing, and in the right ballpark answer. What nobody can quite say is how likely is it to get a completely incorrect answer, as at least one of the two demonstrations has shown. If you’re using it for consumer search, fine. If I’m using it to answer a question on somebody’s financial transaction, that’s actually quite a problem. Or, if it’s being used to answer somebody’s question on what healthcare treatment they might seek. So, for enterprise use cases, I still think that there is a massive opportunity that is outside the pure consumer space." - IBM CEO Arvind Krishna

[00:07:38] Mokaya: One of the questions fronted to him was why IBM did not launch ChatGPT and the reasons he gave, I don't know what’s your take from them. One was that they focused on very black box kind of experiences they didn't want where the user interacts with the AI like now on ChatGPT and quickly gets the answers themselves. And then the second reason he gave was that they focused on very niche areas like health, where they didn't have the expertise and that's why they failed in that. He himself acknowledges that what ChatGPT has done is to actually bring to the forefront the conversations around AI and its usability among people. You can feel like across the landscape ChatGPT is causing such a massive reawakening among companies. 

Back to Office at Amazon

Anything else that you took away? Perhaps one of the most surprising was Amazon calling people back to their offices and the impact that would have maybe on office leasing and commercial real estate. Any takeaway from that?

"Ultimately, they’ve led us to conclude that we should go back to being in the office together the majority of the time (at least three days per week)...Of course, as there were before the pandemic, there will still be certain roles (e.g. some of our salespeople, customer support, etc.) and exceptions to these expectations, but that will be a small minority. We plan to implement this change effective May 1." - Amazon CEO Andy Jassy

[00:08:27] Scott: Yeah, I definitely see more in-person work happening these days. It feels like the pandemic is very much in the rearview mirror now, and people are going back into offices. Really just feeling the need for social connection, I think in work. And I think even though we're still very productive in a remote work environment there's more gravity pulling people back into offices. So I don't know, I still don't know whether it balances out in a hybrid situation or not. But there is definitely more momentum for its office.

[00:08:58] Mokaya: Yeah. Six or so months ago, it's very few companies that dare say what Amazon is saying right now, but I think like with the post-pandemic life happening, layoffs happening, I think companies are taking advantage of this to really restructure a lot of the things that they wanted to do, really thinking keenly how to right-size their workforce and how to make workforces more efficient and one of the things is definitely bringing people back into the office. And a key reason they give is culture. It's really difficult to embed culture in new recruits if they're working from home. 

Conclusion

So we've covered a lot in the newsletter, so I guess that would be a good point to end this conversation.

[00:09:31] Scott: I think that's a good place to stop.

[00:09:33] Mokaya: Maybe I would close with the quote from Charlie Munger who said “Go all in on good bets”. I think our good bet is The Transcript and we really love it. Thank you for joining us this week. Bye from us.