In this episode, we discuss the state of the consumer and consumer spending, the decline in FedEx volumes and what it means for the recession outlook, and why the big 3 in cloud will be hard to compete with.
A transcript of this podcast, with relevant images and quotes, is available for all subscribers today just below the show notes. The episode is based on yesterday's newsletter which is available on Substack
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Show Notes
00:00:00 Introduction
00:00:12 Slowdown or Shifting Demand?
00:02:13 The State of the Consumer
00:05:34 Recession Watch
00:06:48 Energy Prices in Europe
00:08:39 Capital Intensity as a Moat
00:11:04 Frank Slootman, the straight Shooter
Episode Transcript
[00:00:00] Scott: Welcome everyone to a new episode of The Transcript. I'm editor of The Transcript along with Erick Mokaya who's our lead author. We sent out a new issue of the newsletter earlier this week.
Slowdown or Shifting Demand?
And what we saw was that there was some negative commentary from FedEx about the number of packages that they're seeing move through their network. And that was similar to what we saw from Union Pacific last week talking about a decrease in volume. And so this is a really negative macro indicator. Railroad companies and FedEx are so central to the amount of economic activity that's going on. That is a pretty negative data point, but then juxtapose that with still strong sentiment on consumer spending and consumer demand, and maybe just the hypothesis is that what FedEx is really seeing is primarily a shift from goods to services as we continue to come out of the pandemic. So those are the two competing ideas. Erick, what do you think?
"Global volumes declined as macroeconomic trends significantly worsened later in the quarter, both internationally and in the U.S -- We’re seeing that volume declined in every segment around the world, and so you know, we’ve just started our second quarter. The weekly numbers are not looking so good, so we just assume at this point that the economic conditions are not really good. We are a reflection of everybody else’s business, especially the high-value economy in the world,” - FedEx CEO Raj Subramaniam
[00:00:56] Mokaya: The title of today's newsletter is telling itself, are we in a slowdown or are we actually shifting demand in that sense? So I think what FedEx did was send a pretty strong signal, which I liked and what Walmart did a couple of is it weeks or month ago where they said that they have excess inventory and then the stock tanked. So the same thing happened with FedEx. I think they had one of the biggest drops since 198, since I think the 1980s or something like that. So I think the signal is that the demand is shifting pretty significantly downwards in certain markets. And that's what was worrying for FedEx. So I don't know how to position that in regard of some of the comments that we have in the newsletter that said, hey, consumer spending is holding up pretty strongly. And that comes from companies like Visa, MasterCard, AT&T who are all saying okay, consumer spending -- Bank of America also saying the month of August consumer spent 10% more than they spent in August 2021. So that tells you consumers are spending more slightly above the inflation rate, you'd say. So I think in terms of growth, if you compare that, I don't know how to read the tea leaves right now ahead of the Fed meeting that we are having this week also. What's your key takeaway, especially from the macro section given all this, quotes and texts of what different companies are saying.
"In the month of August 2022, consumers spent 10% more than they spent in August 2021 -- customers are spending more…So the consumer is in very good shape.." - Bank of America (BAC) CEO Brian Moynihan
“So goods and services spending continues to look very strong. The U.S. consumer continues to look very strong” - American Express (AXP) CFO Jeffrey Campbell
"So net-net here is what I would tell you, the consumer continues to remain strong. We are encouraged by what we see there." - Mastercard (MA) CFO Sachin Mehra
"The consumer has been a strong place -- in a strong place." - JPMorgan Chase (JPM) President & COO Daniel Pinto
The State of the Consumer
[00:02:13] Scott: Yeah. I think the most important data point is still what the financial companies are saying. So the credit card companies and the banks, they see the largest volume of economic activity and they're the ones who see both goods and services spending, and Visa was actually the one who said most directly, that what we're seeing is a shift from goods to services and spending is still hanging in. And so I really defer to what they're seeing. The other thing that was interesting. I can't remember which company, but one of the big financial companies was saying that they also saw regardless of income, upper income and lower income consumers, still continuing to spend strongly. We had a number of quotes that we're talking about just consumer balance sheets remaining very strong, high amounts of deposits. I still don't really know how to juxtapose the consumer section against the micro sections that we're looking at though, where we're seeing, for instance, Uber talking about 70% of their drivers who are coming into the workforce saying that inflation was a driver of them looking for a job, which to me would suggest that a lower income consumer is feeling pressured by the inflationary environment. And then the other data point that's negative in the micro sections is within the technology section. Several quotes talking about IT spending, sales cycles, pushing out which deals are still closing apparently, but you don't like to see that sales cycles are lengthening because that's a sign of slowdown as well.
[00:03:36] Mokaya: Yeah, I think it's really hard to once again, read what exactly is happening here as you as you've alluded to, the consumers still spending pretty well, the balance sheet is pretty strong, but there are pockets or spaces where you see a little bit of issues like the delinquency rates are rising slightly, not too much, they are slowing down a bit, cycles are extended a little bit. So the big question I think you would ask and then of course this past week, we also listened to Druckenmiller talk about the prospects of a recession. So his prognosis was a bit dark, but of course he gave the caveat that he’s a pretty dark person himself and he likes it. But I think his prognosis, if I could really say is with the caveat that he's been doing this for 45 years. And of course he's been seeing a lot - - he's been mostly dark during this period of time. He sees that the odds of recession and change in the macro economy are about as high and severe as I've seen them in decades. Do you share that view yourself?
[00:04:31] Scott: Yeah, I think so. The number one leading indicator of a recession is Fed monetary policy. And usually it's because the economy and capital markets specifically, aren't really responding to what the Fed is saying or trying to have happen. And so the Fed puts more and more pressure on the economy in terms of higher interest rates or more restrictive monetary policy. And then eventually capital markets in the economy catch up to what the Fed has been trying to do. That is a cycle that is highly repetitive throughout 20th century American economic history. And so you see this situation very clearly here, where the Fed seems to want to be taking demand out of the economy, is speaking in very clear hawkish terms and yet capital markets continue to seemingly ignore them. So we are in this zone where perhaps good news is bad news for capital markets, and we're not seeing signs of a slowdown, which means that the Fed may have to push even harder, which could be pretty bad for capital markets.
Recession Watch
[00:05:34] Mokaya: So a comment I saw one of the people who comes to our podcast here a lot, he’s called Alex Morris. He talks about Seth Klarman from 2010 who is saying, I'm more worried about the world broadly than I've ever been in my career. I'd be worried whether we'll have another 10 years of zero returns. So are we too dark?
[00:05:55] Scott: Yes, maybe, but. It all depends to me on what the policy response is. So if the Fed and the Federal Government decide that they want to change course and start simulating the economy, then it's very likely that we'll avoid a recession. But at this point, both the Federal Reserve and the Federal Government seem to be taking a hawkish stance. And the expectation is you get a recession. Once you get a recession, then this is the way that the US Federal Government has reacted for 60 plus years. Is that once you get a recession, the stimulus comes back. And the question on the 10, 15 year outlook is does that stimulus if they bring it back lead to more inflation or have we really actually crossed the inflation at this time? But in the near term, in the immediate term, hawkish monetary policy is not usually good for capital markets.
Energy Prices in Europe
[00:06:48] Mokaya: I think time will tell, but we surely hope that it's an episodic issue and not like a persistent niggling problem that we’ll keep having. So I think one, one of the key quotes that I also noted from the earnings this week was about the issue of deglobalization that is also continuing to happen in terms of the macro issues that we're having and inbound travel. Internationally I think what's happening is, there are two things. One is de-globalization where markets are becoming more and more segmented. And really everyone is trying to create an entire supply chain in their own backyard that they can control. And secondly, the other thing that's happening is energy prices in Europe. They're significantly higher. We have been experiencing such a tough time. And I think one of the things that happened last week was the German government seizing some assets of a Russian company that is based in Germany. So I think what you're increasingly seeing is a real worry on how this winter is going to be like for a lot of these companies. I don't know if you're feeling the same in the US, but generally in Europe, people are very worried about how this winter is going to be. We can see that already in the jump in terms of the prices that you're getting in terms of electricity and gas. And also it's a real worry heading into the winter. I don't know how that can be played around the world, but in Europe we are suffering already, even before the winter comes.
[00:08:07] Scott: Yeah. It's something that you can perceive from the US that in Europe, there's a greater focus on energy costs. And particularly this concern about what happens in the winter with energy costs. I think in the US, people are frustrated with high energy costs, specifically gas prices, but I think the conversation has died down a little bit around them. And so I don't really know that it's totally analogous to the conversation in the US and Europe around inflation.
Capital Intensity as a Moat
[00:08:39] Mokaya: Other than that, also maybe one key thing that stood out for me was the comparison between Google, Microsoft and Amazon in terms of being seen as cloud players versus the rest. So I think I like the quote where he compared the rest of the sub-20 billion revenue companies to something like mom and pop shops and then the top three are more like Walmart. So it looks like a market where the winner will take it all at the end of the day and those subpar players may not be able to survive. But also some mom and pop shops survived despite the fact that there's Amazon, there is Walmart at the end of the day though. So I think a bit of a not a complete analogy, but I think that stood out for me this week in terms of how much the top three companies at least are investing. I think something like what, some of the strategies have 42,000 people selling their cloud capabilities around the world. They're spending around 20 billion plus a year in terms of CapEx and all. So I think that stood out for me this week. Any thoughts, anything else that stood out for you?
“I think if you take your pick, whether it’s Google, whether it’s Amazon, whether it’s Microsoft, I think they’re going to outclass every one of us companies trying to run 150 countries with the data center. It’s a matter of time. So I’d much rather get on that bandwagon early, learn how to leverage their capabilities and be willing to pay the slight premium that I pay than trying to run. I think sub $20 billion revenue companies running their own data centers globally is like the mom-and-pop store against Walmart. So, I think we’ll see how this bears out over time. But these three guys have 42,000 people selling cloud capabilities around the world. They’re spending $20 billion-plus a year. I don’t have the intellectual bandwidth, the human capacity, the capital required to go beat them at running a much more efficient and much more AI-enabled data center." - Palo Alto Networks (PANW) CEO Nikesh Arora
[00:09:44] Scott: Yeah, I thought that quote was really an interesting one and I think it brings up something that's interesting, which is that capital intensive businesses can create their own moats. I think this is counter to the way that people have thought about capitalism and the industrial economy for 30 plus years now, where in the US we've gone to this extreme in terms of optimizing for returns on invested capital. And that's what you're supposed to be doing, but there still are moats around heavy capital intensive businesses.
[00:10:20] Mokaya: And I think the reason they could afford telling off the marketing is that they're really a big brand. And secondly, of course this is during the pandemic and everybody had to go do something at the end of the day. So I think for them it's coincided with that. I don't think you can do that for a lot of companies. There's a company called Corpat They invest a lot in owning big pieces of land. I think I saw a quote, that they own 16,000 acres of land in the US. And I can't remember the statistic very correctly, but their moat is actually just owning prime pieces of land in particular places where they can use them to sell their vehicles at the end of the day. So I think that dovetailed really well with what you're saying. At the end, for some companies owning physical assets may actually be a moat for them at the end of the day. See, that's a good place to maybe end.
“We are not just participants in our industry, we are stewards of it. Today, we operate on nearly 16,000 acres of land worldwide and own approximately 90% of it, controlling it in perpetuity. Over the last 5 years alone, we've invested nearly $2 billion in land acquisition and development. Similarly, we have maintained a conservative balance sheet since our founding” - Copart (CPRT) CEO Jeff Liaw
Frank Slootman, the straight Shooter
A quick one though. There's a quote you really like from Frank Slootman. Any quick comment on it? He's quite a straight shooter in earnings calls and he was being interviewed by the Goldman Sachs CEO, which is very rare, a CEO interviewing a CEO and I think the back and forth is such a fun conversation. Actually, if you have time, you can listen to it. But I think this kind of quote, in terms of quality shareholders, this was something that stood out for me. So I don't know what hit you from that quote. Anything that stood out for you there?
"...if you want to get out in 90 days and make a bunch of money, I have nothing to tell you -- We’re making sizable acquisitions. We give 10-year guidance. Why? Because we don’t want people to pick the fly shit out of the pepper, so to speak, and you have my opaque views of the quarter. But say, look, is your thesis intact over the long period of time. And those are always the questions that we try and answer. I cannot run a company on a quarterly basis. There are quarterly aspects to it. Fundamentally, almost everything that we do has a much longer time horizon. When you look at P&Ls, most of the money we spend is not related to the current period, right? And sometimes it’s hard to convey that. " - Snowflake (SNOW) CEO Frank Slootman
[00:11:32] Scott: I think you're pulling out that I took the quote of don't pick, fly shit of pepper or something. Yes, but you were the one who read the conversation. What was your impression? What did you like about it?
[00:11:43]Mokaya: He is pretty straightforward. Like he only wants shareholders who are in it for the long term. He does not want any short term shareholders. So if you're thinking like the quarterly guidance he gives is very meaningful, I think you're not the kind of shareholder that he wants for the company. So I think it dovetails really well with what Warren Buffet keeps saying about quality shareholders are one of the biggest assets that a company can have also. So he doesn't like quarterly earnings calls. So he wants to drive us out of business so to speak. But I like that. I like that perspective that he’s a long-term thinker. He gives long-term guidance and he wants long-term shareholders to be part of the journey towards creating value long term. That's the thing that stood out for me there. It's a good place to close. Thank you for joining us this week. I'll see you again next week for another session as we draw close to the Q3 earning season next month. Bye.
The State of The Consumer