Mar 17 • 14M

Structural not Transitory

Episode 53

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Welcome to The Transcript Podcast where we highlight and discuss key thoughts, ideas, and themes we picked from our reading of transcripts from earnings calls.
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Welcome to Episode 53 of The Transcript Podcast. This week we have made A transcript of this podcast, with relevant images and quotes for all subscribers. Become a paid subscriber to enjoy this every week.


Episode Summary: In this episode, we discuss the impact of the Russia-Ukraine war on inflation which has shifted from transitory to structural and the hints of a potential recession. 

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


Show Notes:

00:00:00: Introduction.

00:00:17: Impact of Russia-Ukraine War on Inflation.

00:03:26: Omicron Crisis In Asia.

00:04:53: Rising Defence Spending

00:05:45: The downtick in advertising spending in Europe.

00:08:06: Rising CounterParty Risks

00:10:25: Netflix not following Disney


Episode Transcript:

Introduction

[00:00:00] Scott: Welcome everyone to a new episode of the transcript podcast. You've got me, Scott Krisiloff, I'm the editor of The Transcript, along with Erick Mokaya, our lead author. We sent out a new issue of the newsletter a couple of days ago. We were late on the podcast this week, but never fear, we're still here

Impact of Russia-Ukraine War on Inflation

[00:00:17] Scott: The biggest thing in this week's newsletter was, continuing to watch the situation of Ukraine unfold. Obviously, around the world, everyone is watching this and everyone is extremely saddened by the humanitarian crisis that's going on there stunned that we could be in this sort of war in the 21st century seems unfathomable to me personally. It's having significant economic effects though, that we're seeing as well in the form of higher inflation around the world and I think that this is bringing us closer to just this inflationary psychology that we're seeing breakout. We saw three different quotes from three different sources, all saying that inflation is now a structural problem, which if I think back to last year when the Fed was talking about inflation being transitory, everyone was saying that if inflationary psychology took hold the Fed moved quickly and so I think we're starting to see that. I think we are starting to see people look at and have a structurally higher view of long-term inflation. And that means a potential larger change for the Fed. So any thoughts on that Erick?

"I think a good bit of the inflation that we're seeing across the country is structural in nature" - Tractor Supply Company (TSCO) CEO Harry A. Lawton

"I think we would view a lot of this inflation as structural. " - Colgate-Palmolive (CL) Chief Investor Relations Officer John Faucher

"We believe that inflation is now a structural problem. We already had an inflation problem, which the war is certain to accelerate" - Greenlight Capital Re (GLRE) Chairman David Einhorn

[00:01:23] Mokaya: My keynote is of course the change in terms of the wordings around inflation. So last year we talked about. Transitory, transitory being banned as a word and now we are into that phase of the economic cycle, we are being told that it's actually a structural problem. I was curious about the west management CEO who said that.

His statements struck me as well. So it's like we have to increase prices by 20%, but customers know that wherever they go, they will get everyone else has increased by 20%. So this means that they have no choice, but to take up that inflation. That they have to take up the prices have risen. Sadly consumers are also feeling this inflation. They are noticing it.

I mean, you can't go anywhere and not notice the price increase. Gas prices are skyrocketing over here. So food prices are rising very, very fast. I mean, discretionary spend is becoming under pressure. So I think that's what I'm noticing from where I am. So it's, it's a little worrying to be honest never really through an inflationary cycle. And, and most of us haven't at least this younger generation. So this is our first time experiencing very high inflation. So I don't know. I don't know. What's your experience? What's your experience on the ground? In the US yourself?

[00:02:37] Scott: Yeah, I mean, you're seeing gasoline prices and rising and it's definitely noteworthy. Again, you've had very strong consumers for the last couple of years, driven by stimulus as we've exited the pandemic, those things aren't there anymore. And so, you know, the increase in prices to those consumers is particularly acute. I think one, I guess, silver lining, if you would call it a silver lining is that I expect that labor shortages will probably start to improve because people are seeing their savings get eroded by inflation. They're going to need to go back to work. And so I think that, especially in the higher labor-areas of the economy, you may see signs that the labor markets are healing. So that is one potential silver lining in here.

Omicron Crisis In Asia

“Omicron in Asia is still a problem, and there is still significant hindrances to travel there, particularly internationally” - Booking Holdings (BKNG) CEO Glenn D. Fogel  

[00:03:26] Mokaya: Yep. A little worrying though, is that there is also an Omicron crisis in Asia currently. So in addition to the issues that you're having in Ukraine and Russia, I talked to a couple of friends, and actually, there is a surge in Omicron cases in Hong Kong. They're having lockdowns in Hong Kong presently. I mean, I don't think we needed war on top of a pandemic now, but it's unfathomable that we are living through such times. Geopolitics now. It's common parlance. Now, like everybody's talking about it a lot. Russia, Ukraine, China, Europe, the US, Africa, where were the stages of play in terms of where they're standing in terms of the various countries. So it's frightening times at the same time, I would say.

[00:04:15] Scott: Yeah. It's interesting what you brought up about Asia and the Omicron surge. There is obviously another layer of impact to the supply chain where a lot of inflation has been coming from. That makes from this plus war, you know, we've had two years of pretty heavy supply chain shocks. It really makes you think that the supply chain is a little more fragile than we had thought about in the decade before the last two years.

And it's something, again, this is a theme we've picked up in previous weeks. That it seems to me, there's likely to be. Some rethinking of the way that supply chains are structured and potentially more of a tilt towards economic nationalism or supply chain nationalism.

Rising Defence Spending

[00:04:53] Mokaya: And heavy investment, of course, in the defense system. I think I saw Germany has kind of scaled it. They intend on building up their arsenal in terms of arms. A lot of companies had gotten into this complacent face. I guess, going forward, this is going to take a lot more, it's going to be more serious in this regard, but something else that we noticed beyond like war and Europe was about retail comps coming back down. I think this is specifically meta platforms that noted this. So, I listened to and I looked at the earnings note, the conference call where the meta platform CFO was, and he noted that had noticed that the retail comps are slowing down. That means ad spend is also going down. So I'm not so sure like an ad spends in Europe itself is soft to me going forward. Quite significant for Facebook.

"The 3% comp that we talked about is on top of a pretty big number. We've added a significant sales volume to the U.S. over the last couple of years. Walmart U.S. is [like a] 15% 2-year stack over 2 years." - Walmart (WMT) Executive VP & CFO M. Brett Biggs

"It looks like we have reverted back to the pre-COVID trend line in terms of gradual increase that we've seen in e-commerce as a percentage of total retail. So that big surge that we saw when the COVID lockdowns went into place has pulled back to the trend as life has returned to normal." - Meta Platforms (FB) CFO David M. Wehner

The downtick in advertising spend in Europe.

"More broadly than just the Russia exposure, we're also experiencing some softness in Europe beyond that as well due to the conflict. It's hard to say whether that is temporary or will persist. But this is another challenge that we hope will be a short-term headwind to the business" - Meta Platforms (FB) CFO David M. Wehner

[00:05:45] Scott: Yeah. I think the quote about ad spending declining in Europe is really important because it helps to remind that in addition to all the geopolitical things that are going on in Europe and the surge in energy prices, that's an indicator to me that just like a general recession is coming to Europe as a result of these things. So advertising spending would usually be a leading indicator into a recession that people are pulling back on something that's a more discretionary line item in the budget. So any thoughts on that? I mean, are you seeing any signs of just general recession in Europe?

[00:06:23] Mokaya: I haven't really paid much attention to Europe, but I would say that there's been a significant impact in terms of energy prices. I read something like in, especially in Italy gas prices are super high and the Alliance, of course with Russia is impacting some of these countries very negatively. Like now that they've cut off supply from Russia in terms of oil and gas. So yeah, I think there's going to be a really significant hit to Europe going forward, given the reliance that we have on some of these on Russia and Ukraine.

[00:06:56] Scott: I think there were a few big alarm bells to me in this issue of the transcript this week and the ones we already covered. The first one was just this inflationary psychology. The second one was that downtick in advertising spending in Europe. And the third one was JP Morgan's head of global markets talking about how markets are extremely treacherous and he said the counterparty risks are growing. When you have these targeted dislocations, especially in products that are tied heavily to futures and options trading, you can often have over-leveraged players who are big customers of the financial services companies who end up causing big problems.

When you have these like extreme volatility moves, You often end up finding out that somebody is in trouble and JP Morgan's head of global markets is in a better position than pretty much anybody to notice that and understand that. And he was talking about how their clients are under extreme stress. And so we've seen a little bit of a bounce in markets in the last couple of days as we're recording this. If things get moved in an extreme negative direction, you know, by a few percent you may start to see a lot more pressure. So something to keep in mind. 

Rising CounterParty Risks

"The markets are extremely treacherous at the moment. There is a lot of uncertainty. There are a lot of clients that are under extreme stress. That creates potentially very significant counterparty risk exposure. And the movements here are extremely significant and playing out in real-time. So I would suffice to say that the full ramifications of the current conditions are still uncertain and unknown at this point." - JPMorgan & Co (JPM) Head of global markets Troy Rohrbaugh

[00:08:06] Mokaya: I would say JP Morgan was, I think they're speaking from experience because this past, I don't know if you've noticed this past two weeks, there's been a Serge in BitCoin prices. And because of that JP Morgan was the counterparty to one of the guys who shot a nickel. And because of that, they, they had to, I think that the LSC tickets, they see the. The regulator who deals with the cost, the market for nickel, because of the short position moving very badly against the player. And of course, being that JP Morgan is on the other side of this trade. I think this part, they are speaking from experience that they are actually seeing counterparty risk increased significantly.

So the guy was shot around 150,000 tons of nickel and 50,000 tons were actually held by JP Morgan. So quite significant to pay attention to, but I don't know, like in a recession, how should investors be thinking about like, it seems like we are headed into one significantly. 

[00:09:05] Scott: Yeah this is, this is really the rub because we're heading into recession with petty high inflation and usually the way that the market reacts is it will sell off into the fear of a recession. And then it will bottom once the Fed recognizes that we're in a recession and the Fed starts pumping money again, or, you know, easy monetary conditions. So it usually starts to get worried as the Fed is raising interest rates because it knows that that is a precursor to recession coming. And so we're in that phase right now. But we are down like I think like 12%, 10, 12% on the S and P 500. And in terms of the economic backdrop, relative to that, we're not really progressed in that recessionary timeline.

Like the Fed is still the Fed still hasn't raised rates and is going to just do like a small increase in rates right now. We're still pumping money out in QE and we have 8% inflation. So, the level of, you know, real monetary policy impact act that needs to be taken in order to impact the inflationary environment and all of these other cross-currents that we've got. We could still be on track for a bigger recession here.

Netflix not following Disney

"Now for us, it's not like we have religion against advertising to be clear. I mean we're -- we said we're focused is on building optimizing for long-term revenue, big profit pools. And we want to do it in a way that is a great experience for our members, great for. So we lean into consumer experience, consumer choice and what's great for our creators and storytellers. So if at some point, we determine something that we have the right to kind of player within the space and it meets those dimensions, then great. But that's not something that's in our plans right now." - Netflix (NFLX) CFO Spence Neumann

[00:10:25] Mokaya: I would say that we are recording this podcast before the fed announces rates today, they may actually have raised rates by the time the podcast comes out, I would say so. So maybe one final thought before we go about Netflix, they're not planning to have an ad-supported tier. So it's very interesting to see how that's playing out, but what Disney is doubling down and I was talking to a friend, I was actually wondering how they would do the targeted ads on Disney plus because they will only have data on the kind of movies I've watched. So I'm not so sure how precise those ads are going to be for me to actually enjoy watching them. Or I may take a break during that and not watch. I don't know what, at what point in the movie will they be putting this ad in the first place or will they be like the ones who go to the movies and they're just random at the beginning of a movie or something like that. So, pretty interesting to see.

[00:11:21] Scott: Yeah. I mean, I think it's just going to be like linear TV. I think they'll splice the band throughout the time that you're watching. I think the quote that we pulled from Disney was interesting because it gives a little bit more color on the way that Disney is thinking of the advertising inventory itself, the way that they're going to market, and having customers purchase that advertising inventory. There's a growing marketplace for people to be directly into these apps that are hosted by very large media companies, Disney is an example of it. It's really, it's a great kind of like the experience of launching those ads.

Where you're sitting on your couch, watching television. It's just like the old linear TV days, which were the most effective form of advertising, but that's where you really had people's attention. Versus like, if you're watching YouTube, you're usually at your computer or your laptop, you're like, kind of on the screen and maybe you're doing other things and stuff like that.

But this is going to create a venue for advertisers or recreate the venue for advertisers to be able to have the kind of full attention of somebody who is just watching a program. And so that I think advertisers are probably going to be pretty excited about, and because these companies are going to go direct to consumer there's more data it's much better than the linear TV experience for, for an advertiser. You might be able to charge very premium prices here.

"We have also had an incredible amount of advertiser demand ever since the launch of Disney+ and as you can see from our results in addressable advertising out of our Hulu business, we have more demand than supply.… And it's also going to be great for the advertisers because we have a very unique audience here. It is a family audience, we will be very careful about the ads we take, how we put them into our content. And we've learned a lot over the last couple of years about what kind of content lends itself to natural breaks...We're going to be very careful about making sure the -- any advertising is consistent with the content; what people are watching. So, it's not going to be something that's going to be jarring an off-topic or off-brand... I suffice it to say the advertising community was extremely pleased with this announcement." - The Walt Disney Company (DIS) CFO Christine McCarthy

[00:12:42] Mokaya: Interesting. I see a point there and definitely as Disney itself says it was that there's an incredible demand from advertisers on this end. And one thing I noticed in the conference call that they had was that they appreciate the granular data that having Disney plus affords them from the consumer. So they know how much, which movies you're watching, which are not trending, or which part of the movies you like most, where are you pausing at so that they can actually be with that kind of feedback, which they couldn't get from movie theatres. Now they can go back and make better movies for you in the future.

So I think that's something that I noticed. Well, Disney is really, really appreciating that data is actually the new gold. And now imagine before, when they had to go through Netflix to do this and they couldn't get that kind of granular data. So pretty interesting what is happening in this space going forward I would say.  So I think that would be a good place to close at for this week. Thank you so much for joining us. See you again next week, and hopefully that all of you are safe wherever you are on this planet. Thank you once again and see you next week again. Bye.