End of an Era?

Forecasters are bracing for the end of the low-interest rate era

May 09, 2022

Succinct Summary: The Federal Reserve raised interest rates by 50 bps last week and signaled that more 50 bps hikes are on the table for at least the next couple of meetings. Monetary policy is still far from restrictive though. These rate increases are only enough to bring interest rates back to a neutral level. The Fed is hoping to avoid a recession but it will probably be tough to achieve that. Many forecasters are bracing for the end of the low-interest rate era and warning that we’ll all have to unlearn some of the lessons that we’ve been taught over the last 15-40 years.

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Macro:

The Fed raised interest rates by 50 bps

“Inflation is much too high and we understand the hardship is causing, and we're moving expeditiously to bring it back down. Against This Backdrop, today the FOMC raise its policy interest rate by 1/2 percentage point and anticipates that ongoing increases in the target rate for the federal funds rate will be appropriate. In addition, we are beginning the process of significantly reducing the size of our balance sheet.” - US Federal Reserve Chair Jerome Powell Press

They plan to raise by that much at the next couple of meetings

“Assuming that economic and financial conditions evolve in line with expectations, there is a broad sense on the Committee that additional 50 basis point increases should be on the table at the next couple of meetings.” - US Federal Reserve Chair Jerome Powell Press

They recognize that they may have to move to a restrictive stance

“So I think it's certainly possible that we'll need to move policy to levels that we see as restrictive as opposed to just neutral. We can't know that today. That decision is not in front of us today. If we do conclude that we need to do that, then we won't hesitate to do it.” - US Federal Reserve Chair Jerome Powell Press

They are willing to accept some pain

“Ultimately, getting supply and demand back, you know, back in balance, is what gives us two percent inflation, which is what gives the economy a footing where people can lead successful economic lives and not worry about inflation. I mean, so, yes, there may be some pain associated with getting back to that. But, you know, the big pain is in not dealing over time, is in not dealing with inflation, and allowing it to become entrenched.” - US Federal Reserve Chair Jerome Powell Press

But they don’t think that we have to see a recession

“The labor market is, as I mentioned, very, very strong. And so it doesn't seem to be anywhere close to a downturn. therefore the economy is strong, and is well positioned to handle tighter monetary policy…I think we have a good chance to restore price stability without a recession, without, you know, a severe downturn without materially high, higher unemployment” - US Federal Reserve Chair Jerome Powell Press

The economy remains very strong

"...look, the month of April so far, consumers stronger than it was in March. And so the consumers continue to spend money and so people say, well, they’re spending more because inflation has raised prices. The reality is that transaction volume is rising 10% over the last year, which means they’re doing more." - Bank of America (BAC) Chairman & CEO Brian Moynihan

“Even though we saw a pretty tough GDP number come out recently, I think the factors behind it really point to actually a pretty strong economy. You've got really strong job additions in the U.S. You've got generally 2 jobs available for every person that's looking for a job. You've seen greater participation rates in chunks of the population. You've also seen that consumer spending continues to be really strong.” - Marriott International (MAR) CFO Kathleen Kelly Oberg

There’s not enough capacity to meet demand

We've been unable to meet the relentless demand we're seeing in our U.S. stores as seamlessly as our customers and partners expect and candidly deserve. Simply said, we do not, today, have the adequate capacity to meet the growing demand for Starbucks coffees." - Starbucks (SBUX) CEO Howard Schultz

I mean it's been fairly consistent on our largest customers' earnings releases that they know there is unmet demand. Our largest retail customers are still saying they hit large out-of-stock conditions. All of our larger customers have said they can sell more if they can make more. So that hasn't changed. I think consumer demand in retail was recently quoted as being remained at elevated levels versus food service. So it has not changed in the last quarter." - Americold Realty Trust (COLD) CFO Marc Smernoff

Rates are definitely going higher

"I think there’s no question the perception of how aggressive the Fed will be in 2022 has changed over the last few months and certainly prospective at the beginning of January is difficult from the perspective today. But rates are definitely going higher. When rates go higher, it tends to have an effect on the dollar and on asset prices. And so we’ll have to watch that very closely. But the path of all that and whether or not it can be navigated in a way where we kind of land softly and we don’t have a serious recession is hard to predict." - Goldman Sachs (GS) Chairman & CEO David Solomon

The Fed has a tough job

"Central banks have a little bit of a credibility problem - - Taking the optionality of 75 basis points off the table was an unforced error the Fed didn't have to do. The Bank of England making a similar mistake the next day caused the market to become a bit unhinged." - Appaloosa Management Co-Founder David Tepper

Question: "I’m curious if you could either be a fly on the wall but maybe more importantly a whisper, a Fed whisperer. What would you be telling Jay Powell right now? (CNBC Anchor Andrew Ross Sorkin)

Response: Oh, I’d say looking for, look for another job. I think this is one of the most challenging periods ahead for the Federal Reserve Board in its history." (Tudor Investment Corporation Co-Founder Paul Tudor Jones)

Is it the end of an era?

"The age of yield curve intervention has ended. Since 2008, the Fed has basically controlled not only the short end of the yield curve but also the entire maturity spectrum in the fixed income markets….unfortunately, the Fed kept the proverbial punchbowl out for so long that there are no easy solutions to the inflation problem that the Fed is currently trying to fix. The market now is in the beginning stages of a big adjustment as investors, and not the Fed, determine term interest rates…As a result of the high inflation and the Fed no longer controlling the yield curve, the Fed put, which basically guaranteed that the stock market would not decline by unacceptable amounts, is now gone." - Loews (L) CEO Jim Tisch

"We’ve been accustomed to 40 years, basically, of one cycle, the whole cycle that we covered in the last quarterly review. Declining interest rates, declining tax rates, all these trends - - it’s all come to an end. Not just an end, it’s actually changing. But people haven’t wrapped their heads around that yet. It felt normal because there was 40 years of it. If you’re 50 or even 60 years old, in terms of being conscious about economics, that’s all you knew. But it’s going to be different now. There’s going to be a new cycle" - Horizon Kinetics (INFL) Co-Founder Steven Bregman

"An entire generation of entrepreneurs & tech investors built their entire perspectives on valuation during the second half of a 13-year amazing bull market run. The "unlearning" process could be painful, surprising, & unsettling to many. I anticipate denial. Some thoughts: Previous "all-time" highs are completely irrelevant. It's not "cheap" because it is down 70%. Forget those prices happened. 2) Valuation multiples are always a hack proxy. Dangerous to use. If you insist, 10X should be considered AMAZING and an upper limit. Over that silly. 3) You may be shocked to learn that people want to value your company on FCF and earnings. Facebook trades at 14X GAAP EPS, & is growing 23%. What earnings multiple are you assuming? 4) Revenue & earnings QUALITY matter." - Benchmark Capital General Partner Bill Gurley

“Most people dramatically underestimate the remarkableness of this bull run. Such things are unstoppable … until they aren’t.Markets teach. The lessons can be painful” - Amazon (AMZN) Former CEO Jeff Bezos

International:

EMEA and European travel bouncing back after being hit by the war in Ukraine

"We also then were hit with the war in Ukraine, which did have some impact on the EMEA markets. But again, the market – the consumers seem to absorb that information and now EMEA is back to its highest levels since COVID hit. So again, we have seen these impacts." - Expedia (EXPE) CEO Peter Kern

Stagflation in Europe?

"Tensions have become persistent and more acute: inflation is rising while economic activity is showing signs of slowing - - The European economy is de facto stagnating. Growth in the first quarter was 0.2% and would have essentially been zero without what may have partly been one-off spikes in growth in certain countries. The major economies are suffering - GDP growth has slowed in Spain, halted in France, and contracted in Italy. In Germany, growth momentum is low and has been weakening since the end of February, which is the point when everything changed. Inflation is rising and GDP is at a standstill. A nasty situation, with divergent threats" - European Central Bank Executive board member Fabio Panetta

Hundreds of Millions of people are currently locked down in China

"...the situation in China is unprecedented. Shanghai, a city 4x the size of New York City, is completely locked down. Other major cities, including Beijing, are experiencing new COVID outbreaks and implementing new mobility restrictions pursuant to China's strict zero-COVID policy. Conditions in China are such that we have virtually no ability to predict our performance in China in the back half of the year...China continues to battle COVID resurgences and navigate through prolonged lockdowns" - Starbucks (SBUX) CEO Howard Schultz

"We are battling the most severe outbreak since COVID-19 first emerged 2 years ago. The challenges we face are unprecedented. The case count, duration, geographical coverage, and restrictive measures are far more extensive than in previous outbreaks. Shanghai, Tianjin Jilin, and Guangzhou were among the places to experience extended periods of lockdown. Shanghai, one of the most impacted cities, has been locked down for more than a month now - - Hundreds of millions of people across China are currently under some level of restrictions." - Yum China (YUMC) CEO Joey Wat

“Our prevention and control strategy is determined by the party's nature and mission, our policies can stand the test of history, and our measures are scientific and effective. We have won the battle to defend Wuhan, and we will certainly be able to win the battle to defend Shanghai - Relaxation will undoubtedly lead to massive numbers of infections, critical cases, and deaths, seriously impacting economic and social development and people’s lives and health" - People’s Republic of China President Xi Jinping

The Chinese economy and global supply chain are getting hit

"If you think about our 20 manufacturing facilities that we have in China, about half of them are operating more or less normally and the other half are kind of impaired, to some extent, by either supply chain challenges inbound and/or the operation itself. But we do expect that to improve in May and get back to normal with normal production certainly in June with a steady improvement in May." -Honeywell International (HON) Chairman & CEO Darius E. Adamczyk

"As I said in the script, we had a strong start to the year going into Chinese New Year. But the lockdowns, particularly Shanghai, took the steam out of things, and we ended the quarter negative. It's -- the key factor will be the degree of mobility...The lockdowns, as you can read in the newspapers, are still in full force, so to speak, in those cities where they're locking down. And I think that's going to remain the biggest factor." - Coca-Cola (KO) Chairman & CEO James Robert B. Quincey

“At the same time, there are new tough COVID lockdowns in China, which have put a lot of pressure on our supply chains...COVID in China restarted in March again. Production slowed down, with temporary production stops towards the end of the quarter at suppliers and our joint ventures. By now production has resumed, however, at low levels. Although predictability of the situation is limited, we will try to make up for the loss of production in the course of the year as much as possible." - Volkswagen AG (VOW3) CFO Arno Antliz

Although China's comparable store sales improved sequentially in January, traffic lessened considerably in February and March as Omicron cases surged and lockdowns were implemented, leading to a comparable store sales decline of nearly 50% in the last week of March as we exited the quarter." - Starbucks (SBUX) Executive VP and CFO Rachel Ruggeri

Financials:

Financial conditions are tightening

"If you look at how much Financial Conditions Index is tightened just in the last month, the only other times that it’s tightened this much and just to remind everyone Financial Conditions Index is a composite of the stock market, the dollar, credit spreads. And it’s a very good indicator of the general strength of the overall economy, a good proxy for it. So it’s moved so much in the last month, the only other two times I think it exceeded it were in Lehman Brothers in 2008, as well as in March of 2020." - Tudor Investment Corporation Co-Founder Paul Tudor Jones

It’s tough to make money in this environment

"You can’t think of a worse environment than where we are right now for financial assets..I think we’re in one of those very difficult periods where simply capital preservation is I think the most important thing we can strive for. I don’t know if it’s going to be one of those periods where you’re actually trying to make money." - Tudor Investment Corporation Co-Founder Paul Tudor Jones

You just don't want to be owning anything

"Clearly you don’t want to own bonds and stocks. You start with that. It’s going to be very, very, a very negative situation for either one of those asset classes. Right? You can’t think of a worse macro environment than where we are right now for financial assets. And, again, one of the reasons I think maybe the biggest differentiator between now and those other periods over the past 40 years is to look at the level of overvaluation that we were both in rates as well as in stocks. So that’s one reason why even with this tightening in financial conditions, we’ve still, the Fed still probably has to raise rates to get inflation under control." - Tudor Investment Corporation Co-Founder Paul Tudor Jones

The game is changing on high growth high valuation tech companies

"We are keenly aware that the market is placing a high value on companies generating and expanding profits as interest rates rise. We are leading the industry in this respect. Our focus over the past two years on profitable growth has resulted in the strong top and bottom lines that we delivered in Q1." - Uber Technologies (UBER) CEO Dara Khosrowshahi

Retention issues are cropping up as valuations decline

"Even after dramatic declines, it is difficult to call a bottom in the high-growth, high-valuation end of the tech sector, especially given that many of these companies relied on stock-based compensation and controversial accounting and reporting techniques. It appears that many of the companies Page 3 which used this type of compensation to attract employees may have retention difficulties, leading to increased dilution for future stock grants or increased cash wages, which could weigh on margins for analysts who rely on adjusted measures rather than old-fashioned GAAP" - ThirdPoint CEO Daniel S. Loeb

Consumer:

Summer travel is expected to be robust

"So despite the usual caveats for COVID, now a rising inflation to worry about and of course, the geopolitical situation, the pent-up demand that’s out there for travel seems to be outweighing anything the market can throw at it and we continue to be feeling very good about a summer recovery that should be very robust." - Expedia (EXPE) CEO Peter Kern

...guests are booking more than ever before. In Q1 gross nights booked grew 32% compared to Q1 2019. And this is despite the pandemic, the war in Ukraine, and macroeconomic headwinds. People are also more confident booking travel further in advance. And we're seeing strong demand for summer bookings and beyond." - Airbnb (ABNB) CEO Brian Chesky

"We'll probably have the biggest leisure summer we've ever had, only to surpass last summer, which was the biggest leisure summer we had ever seen, prior to what I think we'll see this summer." - Hilton Worldwide (HLT) CEO Christopher Nassetta

Labor issues are easing slightly

"On the labor front, there are still significant issues that we're seeing, both in what we manage and as we talk to our franchise community, what they're seeing. Over the last 6 months, we've seen a very significant increase in labor coming back into the labor force and our ability to get folks in the hotels, which obviously are needed, given the demand profile and the increases in demand across all segments, as I already described. So we're not all the way anywhere near where we want to be, but the issues are not -- they're not as extreme as they had been at other points in the pandemic, including recently." - Hilton Worldwide (HLT) CEO Christopher Nassetta

Housing markets are showing signs of moderating

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Technology:

The PC market is soft

"...the PC market is experiencing some softness coming off multiple quarters of near-record unit shipments. We have taken a bit more of a conservative perspective on the PC market. Again, I think the softness is in certain parts of the market, it’s not in all parts of the market and our focus is on where we add the most value in the market and that is in the premium segments." - Advanced Micro Devices (AMD) CEO Dr. Lisa Su

AMD seems to have hit an Inflection point

"In summary, the start of 2022 is a significant inflection point for AMD, marked by record top and bottom-line financial results. We now expect annual revenue to grow by approximately 60% year-over-year, up from the approximately 31% growth we guided at the beginning of the year - - in summary, the start of 2022 is a significant inflection point for AMD, marked by record top and bottom-line financial results" - Advanced Micro Devices (AMD) CEO Dr. Lisa Su

The US doesn’t have the workforce to compete in semiconductor manufacturing

"There’s a lack of manufacturing talent, to begin with. I don’t really think it’s a bad thing for the United States actually, but it’s a bad thing for trying to do semiconductor manufacturing in the U.S. We have actually had a manufacturing plant in Oregon for 25 years, and 25 years, that’s a long time. We sent all kinds of people, we changed the managers, changed the engineers, we used both American local engineers and we also send engineers from Taiwan to Oregon to try to improve the performance. Improvement in its performance has happened, however, the cost difference between Taiwan manufacturing and Oregon manufacturing has remained about the same. For the same product, the Oregon cost is about 50% more than the Taiwan cost. Well of course for us the Oregon product is still profitable — although not nearly as profitable as the Taiwan product — so still we have maintained it...we think that the recent effort of the U.S. to increase onshore manufacturing of semiconductors, right now you are talking about spending only tens of billions of dollars of money of subsidy, well it’s not going to be enough. I think it will be a very expensive exercise in futility. The U.S. will increase onshore manufacturing of semiconductors somewhat, but all that will be very high unit cost, it’ll be non-competitive in the world market when you compete with factories like TSMC. Right now I think the U.S. has a very good position in semiconductor technology design." - TSMC (TSM) Founder and Ex-CEO Morris Chang

GPU prices moderating

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Healthcare:

Steep decline in COVID vaccines usage in 2022

We expect now about 18 million vaccines for 2022, including the provision for the fourth booster for the defined populations. This would be a decline of about 70% versus 2022. Testing, excluding OTC, is expected to be down 50% plus or minus. And the OTC test will be in the same neighborhood, maybe a little bit higher. But overall, that’s going to probably produce a contribution year-over-year. That’s down 60%, 65% on COVID." - CVS Health(CVS) CFO Shawn Guertin

Industrials and Transport:

Some companies are reporting that lower demand is helping to improve supply chain dynamics

"...what's happening now is, as you mentioned, inventory is recovering. Not only is it recovering, it's starting to recover aggressively because demand has actually fallen some from a macro perspective. Well, we were already benefiting just as availability was getting better. Now availability is getting better at a very fast rate. Our speed of delivery has started to get better at a fast rate. Those manifest with sharper retails. We see customers respond. Then as you mentioned, some suppliers having an excessive amount of inventory relative to what they want. What happens is our competitive retailers, what they've done is they've bought their inventory for the next few months already, and they bought it at a certain price. They've locked in that price. They're now low to discount because they could put them in a bad cost position on a retail relative to cost." - Wayfair (W) President & CEO Niraj S. Shah

“I think I feel better that we can see the light at the end of the tunnel because the consumer generally is challenged. And as that demand is lower, it actually solved the supply chain issues to one extent. It solves ultimately the pricing issues that we're seeing. We're seeing container costs down in some places over 50% from the peak already. And although that takes time to flow through the P&L. I think that that's a very different trend than we've seen over the last couple of years” - Franchise Group President, CEO & Director Brian R. Kahn

People are going back into the office more

"Our attendance across the United States is, is pretty good. It’s between 50% and 60% I’d say. Pre-COVID, it was probably 80%. When you look in Europe and in London, it’s actually higher. When you look in Asia, it’s 100% when offices are open, so you know, think about our business as a big global business and it’s different in different parts of the world." - Goldman Sachs (GS) Chairman & CEO David Solomon

Materials & Energy:

Capex picking up pace in oil and gas

"The CapEx is quite something, if you add up the CapEx of just the majors, it’s north of $120 billion for this year, just with Chevron, Exxon BP, and Shell. And then that jumps up a little higher in 2023. If you look at the CapEx numbers for our big customers in traditional oil and gas, their CapEx numbers are continuing to increase and with the new landscape in energy, and energy security and energy challenges in Europe a lot of work going on there." - Fluor (FLR) CEO David Constable

Nuggets of Wisdom:

Mental models ought to evolve with the environment

"To be an investor is to live constantly at the intersection of story and uncertainty. We build our mental models, frameworks, and processes to try to accurately price securities and overlay them with a story about the economic, geopolitical, and psychological factors that frame the backdrop to value them. We create data-driven stories to explain our differentiated view of a security that is out of balance within its sector or asset class to justify a variant perception that we think will generate alpha. Sometimes, however, investors might create a framework that seems sound only to discover that the method is actually no better than a system to “win” at Russian Roulette. The key, of course, is to change your framework when the environment changes - - Since I started Third Point 27 years ago, I have seen many investors (including myself) stumble after years of success because they did not adapt their models and frameworks quickly enough as conditions shifted. I have said before that they don’t ring a bell when the rules of the game are changing, but if you listen closely, you can hear a dog whistle. This seems to be such a time to listen for that high-pitched sound." - ThirdPoint CEO Daniel S. Loeb