Jun 22

Uptick in Delinquency Rates

Episode 63

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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 63 of The Transcript Podcast

Episode Summary:

In this episode, we discuss takeaways from the Fed’s press conference last week, the slight uptick in delinquency rates, and the emerging opportunities in restructurings.


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

The Transcript
Don’t Stop us Now
Succinct Summary: Consumer spending has remained incredibly strong despite increasing worries about recession. This is typically a good thing; however, the Fed explicitly signals that it is concerned about overheated demand. The central bank raised interest rates by ¾ of a point last week and said that more rate increases are on the way. They seem unfa…
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This week, we have made available a transcript of this podcast, with relevant images and quotes, for ALL subscribers. Find it after the show notes below.

Show Notes

00:00:00 Introduction

00:00:11 A Hawkish Fed

00:02:30 Strong Consumer Spending

00:03:36 November Elections in Play

00:05:57 Rising Delinquency Rates

00:07:17 Supply Chains Getting Better

00:08:00 How is the supply of SemiConductors?

Episode Transcript


[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 who's our lead author. We sent out a new issue of the newsletter yesterday.

A Hawkish Fed

“As shown in the SEP, the median projection for the appropriate level of the federal funds rate is 3.4% at the end of this year, a percentage point and a half higher than projected in March, and .9 percentage point above the median estimate of its longer-run value.” – Federal Reserve Chair Jerome Powell

And what we captured last week was there was a Fed meeting. They raised by 75 basis points as I'm sure everybody's well aware of at this point. They were pretty hawkish, and the thing that stood out to me most was that Jerome Powell was resolved in his fight against inflation and wasn't fazed by what's going on in capital markets; and in fact, implied that what's going on in capital markets is exactly what the Fed is expecting to see and wants to see. They want to see tightening conditions. They want to see a decline in demand because they feel like they have to fight inflation. That's the bedrock of the economy. That's pretty bearish to me because they also said that they don't wanna declare a victory too early. So it tells me that they're gonna push until they see the data start to turn. And that turns them into a lagging indicator in a negative way this time around. Any thoughts Erick?

[00:01:07] Mokaya: Yeah, so a quick one that I picked up of course is one, they don't care about the stock markets. Actually, they expect the stock market to be doing what it's doing currently. Secondly, he mentioned that housing markets are not doing so well, and that's also what they expect and want, and of course, they mentioned that they expect more rate hikes going into the next two or three meetings. Their target is to be around 3, 4% by the end of the year and maybe 3% by the end of the year, 4% by next year. So unless things change it's a rate hike season. A statistic that stood out for me was that this is the first 75 basis point rate hike since 1994 and circumstances were kind of similar at that time. But all in all consumer spending is still holding up which is pretty interesting given the kind of rate hikes that you've had so far. Secondly, of course, that business leaders themselves don't sound very confident about heading into this season despite the fact that consumer spending is holding up well. Some of them are doing layoffs. Coinbase did a couple of layoffs. Redfin had layoffs. And of course, the main point of contention is that circumstances have changed. The markets are not the same as they were a couple of months before. They're seeing some headwinds, especially in the area of let's say crypto, of course, Coinbase is very exposed and headwinds are also in the area of housing. So I think those are key points that I picked up, especially from the macro section. Any more thoughts on that yourself?

"With May demand 17% below expectations, we don’t have enough work for our agents and support staff, and fewer sales leave us with less money for headquarters projects -- But mortgage rates increased faster than at any point in history. We could be facing years, not months, of fewer home sales" - Redfin (RDFN) CEO Glenn Kelman

"We appear to be entering a recession after a 10+ year economic boom. A recession could lead to another crypto winter and could last for an extended period. In past crypto winters, trading revenue (our largest revenue source) has declined significantly." - Coinbase (COIN) CEO & Co-founder Brian Armstrong

Strong Consumer Spending

“The general consensus, I think, at the conference so far, is that so far, consumer demand is pretty resilient, pricing is being implemented reasonably successfully and is being accepted by retailers and consumers." - Colgate-Palmolive (CL) Equity Research Analyst at Deutsche Bank Steve Powers

[00:02:30] Scott: I think the consumer spending that strengthens consumer spending is less of a leading indicator than the other stuff that we're watching and that's why you're seeing business leaders in capital markets being so pessimistic about the likelihood of a recession. We know consumers are flushed with cash still from the stimulus. So people are still feeling wealthy. But as the trends are moving downward and the Federal Reserve seems intent on restricting demand, the Fed usually gets its way. And by usually, I mean, pretty much always so I think we're on the lookout for a recession, and the quote that summed it up was, I can't remember who, but talking about feeling like the road runner or the Wiley coyote, in this case, I think where they're off the cliff and just waiting to fall and haven't started falling. That certainly seems to be the most likely scenario. Even though the politicians seem to be saying that there's no need for a recession. I mean, Jerome Powell was even saying basically that soft landing is out of our control, that those are the factors. So the Fed is trying to prepare us to accept the hard landing is what I read from a lot of that press conference.

“I don’t want to be the handicapper here. I just—that is our objective. I do think [a soft landing is] possible. Like I said, though, I think that events of the last few months have raised the degree of difficulty, and created great challenges. And again, the answer to the question can we still do it, there’s a much bigger chance now that it’ll depend on factors that we don’t control, which is, you know, fluctuations and spikes in commodity prices could wind up taking that option out of our hands.” – Federal Reserve Chair Jerome Powell

November Elections in Play

[00:03:36] Mokaya: I think a small note also is a factor that is playing into this the kind of concerns that are being played out, especially politicians and also like the Fed is the November elections. It's such a big deal. I've noticed it, especially now with the previous week's quote where the president was claiming ExxonMobil makes more money than God. I think the intention is clearly to target particular sectors, which are affecting inflation and those sectors include housing, and energy markets and also like these targeted measures towards those areas to kind of soften demand or kind of pull down the cost inflation that is happening in these markets. So I don’t know what you can say about that, given that you're in the US yourself?

"...the Fed is laser-focused on arresting the inflation problem and they’re not necessarily concerned with what’s happening to the stock market. And I think that has a lot to do with what happens as we go into November. So, Becky, I think between now and November, things are going to materially worsen." - Hayman Capital Management Founder & CIO Kyle Bass

[00:04:19] Scott: Yeah, I mean, I think we've talked about this a lot, and I think there's a resistance among fundamental stock analysts, people who really like to look at companies, there's a resistance.

Looking too much at the politics, looking too much at the Federal Reserve and the things that are going on there, but my experience in the Time Magazine Project, which we've talked about a lot, is that the real leading indicator in the economy is federal government policy. So whatever the federal government is doing, and then the Federal Reserve follows usually because the political pressure is really, even though the Fed is supposedly independent, the will of the people or the will of the executive and the Congress is really what ends up getting the Federal Reserve to move. So in this case, it's very clear that the elections are about inflation. That's the number one topic on voters' minds right now. And the voters are asking the government to control inflation and so the government is doing that via the Federal Reserve. And you know, the flip side of this is that the lower-income consumers are the most hit by inflation, and then they're most hit by a recession.

[00:05:25] Mokaya: Yeah, I totally agree. A couple of other quotes that stood out of course, one for me was that there's no rapid recovery that's going on in China. A couple of quotes that I've been picking in the earnings calls but also talking to friends in China is that the lockdowns there had a significant impact on consumer spending, on habits. I think these had a much bigger impact than the previous lockdowns that they've had. So the expectation that China would recover very quickly is not in sight. That's not something you should count on.

Rising Delinquency Rates

“One thing we are seeing is we are seeing delinquencies start to increase. It's not yet a concern for us..So we are seeing some headwinds there a little bit when it comes to delinquencies as may be a leading indicator." - Ford (F) CFO John Lawler

But also two things, delinquency rates are picking up and restructuring opportunities are available. And something else that we noted also is that activist investors are like vultures now. They're out there hunting for these companies whose stock prices are falling significantly and trying to institute a few measures to get that. Any thoughts on those two things?

[00:06:17] Scott: Yeah. I mean, these are all coincidental to like emerging indicators of recession basically. The delinquencies are starting to soften, that people are looking for restructuring, capital markets are still closed for IPOs, and things like that. You know, it makes me increasingly bearish on financial services companies, honestly. The housing stuff that we talked about as well, it seems like it's only a matter of time before housing prices start to move in the other direction, just as interest rates have changed the affordability equation. The other thing is that technology stocks have just sold off so much you're noticing that the multiples relative to some of the other sectors. I don't know how much more beaten up they can get, especially because there is still fundamental growth in technology. So like Coca-Cola I think is like 25 times earnings in Google's at like 19 or something, I think it's pretty clear, I would rather own Google than Coca-Cola in the absolute. These are things and dynamics that are important to watch.

Supply Chains Getting Better

I think the other thing that stood out to me this week was that supply chains, you're getting increasingly positive comments on supply chains and that they're starting to heal and they're still not fully healed, but they are starting to heal.

And so you do have these disinflationary forces that are starting to stack up in the economy too, which is just again, that road runner dynamic, where you're like off the cliff and it's it, you're just waiting to fall. That's the type of thing that can happen here. So I'm not personally betting on increased inflation or accelerating inflation right now. Any thoughts, Erick?

[00:07:52] Mokaya: Yeah, I think on supply chains, they're getting better. Not where they're supposed to be, but still slightly way better than let's say six, or seven months. That's what I picked up.

How is the Supply of SemiConductors?

“I do think semis are better, but I think you're now starting to see other kinds of rocks that are being uncovered in the industry, and I think you'll start to see that until we get to kind of stability in the industry where we just haven't run at 92 million vehicles in a while. And so to get back to 92 million, it's not going to be a light switch that's flipped on. It's not like if semi cons are available, all of a sudden, there's going to be 92 million. I mean you still have port congestion. You still have a lack of truck drivers. You still have a tight labor market. You still have energy constraints in Europe. And so I think there will be other things that will challenge the industry to get back to 92 million outside the semi cons even." - Adient (ADNT) EVP of Americas Jerome J. Dorlack

A debate that is currently happening, especially on financial Twitter, is about the semiconductor industry being extremely exposed to the cyclical nature of markets and all. When demand is very high supply comes up and exceeds the demand and then quickly you have an oversupply. So I think right now because we've been having a lot of shortages, people are watching out for their point in time where a supply becomes excessive and notice like Bridgewater Associates has a 1 billion bet against SML who is one of the semiconductor players. The bet here is significantly when is this going to turn? So it's a very close eye being placed on this. What we pick from earning so far is a bit mixed, from my perspective, there are a few who were saying it's getting better, but most are saying, this is very challenging heading into 2023. We are still going to have these kinds of issues. One thing I've read also is that for some of these semiconductor factories that are being set up, it takes up to three to five years to set them up completely. We are barely two years into the pandemic. So I wonder if we've ramped up production enough to be able to meet the demand. Any thoughts on that, especially yourself?

[00:09:17] Scott: Yeah. It's something that I'm looking at as well, and I'm not sure, it's balanced out to me. There's an over inventory of semiconductors. The cycle's gonna hit the semiconductor industry really hard. I think the dynamic that resonated with me more than probably applies somewhat here is in the auto industry where you're seeing that because there was such a restricted supply of automobiles, it's been hard to get over inventories, which is usually where you would get crushed in a cycle. So if the economy's moving in the opposite direction and you're over-inventoried, that's where you're cutting prices hard to try to clear the inventory. So there are some companies where we've seen that dynamic, where there's over inventory like retailers have been like this, Peloton is like this, consumer products where there was ramp-up in production. But I don't know that semiconductors are gonna have the same dynamic and Bridgewater always just brings a smile to my face with whatever they're doing.

[00:10:08] Mokaya: Would you place a $1 billion bet?

[00:10:11] Scott: I don't know that I would.

[00:10:14] Mokaya: It's quite significant though. It's the biggest…but Nvidia seems like way too high of a market cap to me and has really held on despite all of the - -you know, they're a bubble beneficiary and has held in a lot. So, the fundamentals are just too good though. They're like crypto beneficiaries and stuff like that. So - - 


[00:10:39] Mokaya: Alright. I think that's a good place to end, but maybe a quick one was also like this week I Was listening to Seth Klarman in an interview and I found very relevant quotes and we sent out some quotes this week on this.

The Transcript
Quotes from Seth Klarman Interview
Given today is a US holiday, our regular weekly newsletter drops tomorrow instead of today. Before then, we were listening to legendary investor Seth Klarman's interview at Harvard Business School with Das Narayandas last week and thought we should share a few insightful quotes we got from the interview…
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