Marching Towards Neutral
Despite the inflation, The Fed hopes to get back to a neutral rate by year end
Succinct Summary:
Inflation pressures continue to persist and aren’t showing signs of relief. The Fed is getting more aggressive and signaled that it plans to raise rates by 50 bps at a time. However, the Fed seems to have a zero-tolerance policy for recession and so they are still relatively dovish in tone even despite hawkish actions. As a result, despite 8.5% inflation they still only hope to get back to a neutral rate by the end of the year.
Editor's note: Welcome to this week’s edition of The Transcript. Parts of the quotes which have been blocked are only available to our paid subscribers.
Become a paid subscriber:
Macro:
Inflation pressures are persistent and show no sign of relief
"It’s tough to say if we’re at peak inflation, the way I think about it is that we’re seeing persistent inflation. And I think we will see, strong inflation, not only through this year but in the next year." - Tractor Supply Company (TSCO) CEO Hal Lawton
"We've seen another step in cost pressures, and foreign exchange rates have moved further against us. Transportation and labor markets remain tight. The availability of materials remains stretched in some categories and markets. Inflationary cost pressures are broad-based and continue to increase with little sign of near-term relief and have resulted in consumer price increases across CPG categories and beyond." - The Procter & Gamble Company (PG) CFO Andre Schulten
The Fed knows that they have to get the inflation out of the system
"So I'm not going to chat a box with you about soft landing, hard landing, and all that stuff. But the reality is, they've got to take the inflation out of the system. They know that." - Bank of America (BAC) CEO Brian Moynihan
They are planning to raise rates back to neutral without upsetting the economy
"I think I'm in the same areas as my colleagues philosophically. I think it's really important that we get to neutral and do that in an expeditious way. I really have us looking at one and three-quarters by the end of the year, but it could be slower depending on how the economy evolves and we do see greater weakening than I'm seeing in my baseline model. This is one reason why I'm reluctant to really declare that we want to go a long way beyond our neutral place, because that may be more hikes than are warranted given sort of the economic environment. We do need to get away from zero, I think zero is lower than we should be right now. But at the same time, we need to just pay attention." - Atlanta Fed President Raphael Bostic
"I like to think of it as expeditiously marching towards neutral. It's clear the economy doesn't need the accommodation we're providing. And so in order not to tip the economy over by reacting abruptly, we need to take a measured pace. But that measured pace still gets us up to the neutral rate, which I put at about 2.5% by the end of the year -- really to assure the American people that we're going to get inflation back down, we're going to aim for our target. That is something that, in my judgment, gets to neutral by the end of the year to get on a good path for that. Then, the tactics about: is it 50, is it 25, is it 75? Those are things that I’ll deliberate with my colleagues." - San Francisco President Mary Daly
And are preparing to raise more aggressively with 50 basis point hikes being on the table
"...at our last meeting, and this was in the minutes from the meeting, many, many on the committee, thought it would be appropriate for there to be one or more 50 basis point hikes. I don't disclose my own path. I try to leave the committee. But I think markets are processing what we're saying. They're reacting appropriately generally, but I wouldn't want to bless any particular market pricing. The thing I want to say though is we really are committed to using our tools to get 2% inflation back. And I think if you look at, for example, if you look at the last tightening cycle, which was a two-year string of 25 basis point hikes from 2004 to 2006, inflation was a little over 3%. So inflation is much higher now and our policy rate is still more accommodative than it was then -- So it is appropriate in my view to be moving a little more quickly. And, I also think there's something in the idea of front-end loading, whatever accommodation one thinks is appropriate. So that does add points in the direction of 50 basis points being on the table. Certainly, we make these decisions at the meeting and we'll make a meeting by meeting, but I would say that 50 basis points will be on the table for the main meeting.." - US Federal Reserve Chair Jerome Powell
This means rates could go much higher
"So, look, I very strongly believe that that Fed rate hike will have to go much higher due to slow down inflation. Let’s basically be still a negative 8%, right? So I think that just going up 2% or 3% and being at negative 6% or 5% is not going to be good enough. So I think that rates could go as high as 4% or 5% and we are not going to lend the money for any further down for that very, very short-term." - Interactive Brokers Group (IBKR) Chairman Thomas Peterffy
Remember, there is zero-tolerance for a recession
"My goal is to have there not be a recession while I sit in this chair, and I'm just going to do all I can to make that be true," - Atlanta Fed President Raphael Bostic
Will there be a soft landing or a hard landing?
"The question of great debate is a soft lining, hard landing, et cetera. But I think what's unusual this time is how much cash is sitting in the consumers' accounts. If you are sitting here when they start normalizing rates in the middle of the last decade, late to middle of last decade, you wouldn't have seen the consumer balances sitting with those multiples I gave you earlier in their accounts and then having tremendous borrowing capacity left in terms of unused credit lines and the same on the commercial side" - Bank of America (BAC) CEO Brian Moynihan
International:
China lockdowns are having an impact on business
"China, the lockdowns had two impacts in China for us. One, on the supply side, we have two plants in the Shanghai area and the contract manufacturer. Those obviously were shut down for now an extended period of time. So we had to activate our business continuity plans to offset as much of that production impact as we could. And we're certainly seeing a significant impact in terms of consumer demand. About 25%, I think, was the Wall Street estimates of consumers are somehow impacted by the lockdown. That is impacting our consumers' ability to reach stores, grocery stores, and department stores. Even online shopping is significantly constrained due to the inability to deliver. So we certainly see a significant impact from lockdowns. The latest read of market size in our categories over the past three months through March was flat in terms of value in China. With the continued lockdown and the difficulties in the market, we would expect April to be flat to negative." - The Procter & Gamble Company (PG) CFO Andre Schulten
"I think a separate risk is kind of the impact of logistics and supply chains as we deliver product to China and from a more macro perspective just the port closures and the broader impact that we could see in China given the degree of exports they have just generally across the economy. With respect to the China quota difficult to predict." - Intuitive Surgical (ISRG) CFO Jamie Samath
Housing demand is down in China
"Well, today, we are talking about minus 15% latest forecast on China. And the main reason behind that is that the construction industry situation has further worsened. In particular, the consumption of the housing inventory, where last time figures showed that it was still within healthy levels. And today, unfortunately, the latest figures released from China show that in Tier 2, 3, and 4 cities, the housing inventory, unfortunately, is shifting to alert levels, while at the same time, housing stats continue to fall. So the China market, which of course is large in the world, is providing itself another challenge. So this was the overall picture." - Schindler Holding AG (SHLAF) CEO Silvio Napoli
Financials:
View of private market dynamics from Silicon Valley bank.
VC investments, IPOs, and later-stage private investments slowed down in Q1
Quotes Hidden. Subscribe to Read
Too soon to assume broad pullback in early-stage financing though
Quotes Hidden. Subscribe to Read
There is still a backlog of companies waiting to go public but waiting for the environment to be better
Quotes Hidden. Subscribe to Read
The fundraising environment has become harder for smaller funds but easier for larger funds
Quotes Hidden. Subscribe to Read
Consumer:
The Housing Market is at an Inflection Point. Subscribe to read.
Quotes Hidden. Subscribe to Read
But the housing market may be different than in 2006
Quotes Hidden. Subscribe to Read
Demand for new swimming pools is still very high
Quotes Hidden. Subscribe to Read
Netflix is considering an ad-based tier for consumers
"...one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription. But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense." - Netflix (NFLX) CEO Reed Hastings
And slowing down content spend growth
"We talked about in the letter, during this period of slower revenue growth, we're going to protect our operating margins -- for -- presumably, for the next 18, 24 months, call it the next 2 years -- we’re pulling back on some of our spend growth across both content and noncontent spend, but still growing our spend and still investing aggressively into that long-term opportunity, but we're trying to be smart about it and prudent" - Netflix (NFLX) CFO Spencer Neumann
One streaming service may still be growing faster than others. HBO Max is growing
Quotes Hidden. Subscribe to Read
A catalyst for advertising-based companies.
Quotes Hidden. Subscribe to Read
Premium and luxury demand is still strong
"We are closely monitoring consumption trends for signs of changes. So far, elasticities have been in line with or better than our expectations. Demand for our best-performing, premium-priced offerings remain strong as do our market share trends." - The Procter & Gamble Company (PG) CFO Andre Schulten
“We are not even close to experiencing a luxury down-turn, we see many people that are affluent and even the middle classes want to indulge. The overall demand for luxury products and premiumized products is very high – the market is premiumizing overall,” - L'Oreal (LRLCF) CEO Nicolas Hieronimus
Technology:
There is a big gap between supply and demand currently in semis
"...the demand that we're currently seeing comes from so many places in the industry. Technology-wise, market-wise, geography-wise, it's so widespread that we have significantly underestimated, let's say, the width of the demand. And I think that I don't think is going to go away. And it just -- it's an anecdote, but I met a very large -- the executive of a very large industrial company, a conglomerate, last week. And actually, they told me that they're buying washing machines to rip out the semiconductors to put them in industrial modules. I mean, that's happening these days. Now, you could say, that’s an anecdote. But, to be honest, it happens everywhere. It is -- like I said, it is 15, 20, 25-year old semiconductor technology that is now being used everywhere --.But currently, we see no signs of any weakening in our customer base, zero. And even if the demand weakens, there's a big gap between the demand and our capacity." - ASML Holding N.V. (ASML) CEO Peter Wennink
There is a shortage of electric-car batteries that is even bigger than the computer chip shortage
"Semiconductors are a small appetizer to what we are about to feel on battery cells over the next two decades. Put very simply, all the world's cell production combined represents well under 10% of what we will need in 10 years. Meaning, 90% to 95% of the supply chain does not exist" - Rivian (RIVN) CEO RJ Scaringe
Healthcare:
Surgical procedures on the rise as covid fades
"We were pleased to see a steady uptick in surgical procedures this quarter with the easing of COVID restrictions in many parts of the world, but we recognize that the situation is fluid, which requires monitoring." - Johnson & Johnson (JNJ) CFO Joe Wolk
Industrials and Transport:
Supply chain challenges continue with only small progress so far
"Supply constraints, maybe to start at the global level, supply constraints are only present in every potential bucket that you can think through. Being able to source raw materials is still difficult in sufficient quantities. Getting raw and packed materials to the places we need to get them to continues to be costly and highly volatile. Labor availability is certainly a stretch, not for P&G directly, but more for our supplier base. And then getting finished product out to our retailers by being able to actually ship with truck availability in the U.S., for example, is difficult. So it's across all aspects of the supply chain." - The Procter & Gamble Company (PG) CFO Andre Schulten
"During the quarter, the supply chain environment continued to be challenging and remains dynamic. In Q1, we continued to experience constraints in our ability to meet customer demand, and as a result, on-time delivery performance to our customers was lower than we have experienced so far during the pandemic." - Intuitive Surgical (ISRG) CFO Jamie Samath
Travel demand has never been this strong
"I’ve never seen in my career, and I’ve been in this industry a long time -- such a hockey-stick increase of demand -- We finally reached the inflection point as we transition from pandemic to endemic, and demand is stronger than I've ever seen in my career, and that's even before business travel fully recovers." - United Airlines (UAL) CEO Scott Kirby
"In March, we saw what's possible with surging demand brought on by reduced infection rates, relaxed restrictions, and tremendous pent-up demand for people to travel -- Domestic leisure travel continued to lead the way, far surpassing 2019 levels of traffic and revenue in the month of March. In addition, we saw strong quarter-over-quarter improvement in corporate and government travel with revenue for this segment as a percentage of 2019 increasing 27 percentage points from January to March -- As for full-year 2022 capacity, we now expect to be recovered to 92% to 94% of 2019 levels." - American Airlines (AAL) CEO Robert Isom
Materials & Energy:
Food security risks are high
"...the rising threat of food insecurity. I am deeply concerned about this risk to emerging and developing countries, particularly those still recovering from the pandemic. There is a very real risk that soaring global market prices of food and fertilizer will result in more people going hungry, further exacerbate inflation, and harm government fiscal and external positions." - US Treasury Secretary Janet L. Yellen
Oil companies are getting more bullish
"...we believe that the conditions are set for long- and short-cycle to be contributing at the same time to the supply growth of the international market. And long-cycle is not only offshore, long cycle in some large capacity expansion, that national company major continuing to grow. And offshore market, we’ll also see the condition of major and international operator continue to expand the investment." - Schlumberger (SLB) CEO Olivier Le Peuch
“We expect oil and gas demand will grow over the near and medium-term, driven by economic expansion, energy security concerns, and population growth. At the same time, supply remains under structural threat of scarcity. While the war in Ukraine has created a short-term dislocation in commodity markets, the fundamental supply tightness existed before this geopolitical conflict. Current oil supply tightness and commodity price levels strengthen my confidence in the accelerating multiyear upcycle” - Halliburton (HAL) CEO Jeffrey Allen Miller
But in the long run, we’re probably not going to use combustion engines anymore
"It of necessity as well as potential pressures from Wall Street and regulators. “Most countries around the world will stop selling gas engine-powered cars. The scale of the shift is hard to fully appreciate. The challenge is whether it’s driven by policy or not. The businesses that are going to survive are the ones that recognize that the end state for combustion is zero." - Rivian (RIVN) CEO RJ Scaringe
This is creating a strong market for Lithium
"Lithium is present almost everywhere. It’s a very common element. However, you still need to take up the ore -- take up basically sludge or whatever the clay with the lithium and then you need to go through a whole series of refinement steps. And that’s a lot of industrial equipment that’s needed to refine lithium ore to lithium that can be used as lithium hydroxide or lithium carbonate in the battery cell. So, we think we’re going to need to help the industry on this front, but the industry is very fast. And I certainly encourage entrepreneurs out there who are looking for opportunities to get into the lithium business. The lithium margins right now are practically software margins. I mean, if the -- I think it’s something -- I think there’s a -- I mean, -- correct me if I’m wrong, but I think we’re seeing cases where the spot lithium price is 10 times higher than the cost of extraction. So, we’re talking 19% margins here. Can some -- can more people please get into the lithium business? It’s -- do you like minting money? Well, the lithium business is for you." - Tesla (TSLA) CEO Elon Musk
And copper too
"The case for copper as a commodity is strong. I've been saying this for 20 years, but it's never been better. Demand is growing globally. Globally, growth is no longer dependent solely on China. With COVID recovery, infrastructure spending, and the spread of electricity everywhere, it's generating significant growth in Europe. Business is strong in the U.S. and in Asia, outside China. The coming demand for carbon reduction and its impact on copper demand is truly extraordinary, and it's coming -- Higher copper prices in the future are likely," - Freeport-McMoRan (FCX) CEO Richard Adkerson
US solar panel assemblers sold out through 2024!
"U.S. solar panel assemblers are, for the most part, sold out of solar panels through 2024 and, even at full capacity, are only capable of serving 10% to 20% of the U.S. solar panel demand in the first place." - NextEra Energy (NEE) CFO Kirk Crews
Aluminum and steel prices are shooting through the roof
"...you can see in the middle chart, how literally since our session last time, the cost of both steel and aluminum has exploded, literally bringing back to record levels. Clearly, here one of the key contributors to the situation is the war in Ukraine." - Schindler Holding AG (SHLAF) CEO Silvio Napoli
Nuggets of Wisdom:
On writing annual letters
"[The annual letter] keeps forming, but that isn’t a newsletter -- It’s what I want to talk to my sisters. Well, I forged it originally in terms of my sisters who had brought me all their money and Berkshire, they trusted me 60 years ago and they just put it all in and they’re very smart -- .both of them are very smart and interested in financial matters, but they’re not a nob like me -- Once a year, It’s like I sit down with them and tell them you know, here’s what might be interesting to you. And that’s, I’m doing that all year in my mind" - Berkshire Hathaway (BRK.B) Chairman and CEO Warren Buffett