The Transcript

In this special episode, we host tech/semiconductors analyst Eric Jhonsa to discuss key takeaways from earnings for the semiconductor industry. Eric writes columns for Real Money and live-blog earnings at The Street and was previously at Seeking Alpha focusing on tech news coverage, and a writer for The Motley Fool.

This week, we have made available a transcript of this podcast, with relevant images and quotes, for ALL subscribers this week. Find it after the show notes below. Become a paid subscriber to support our work.

Show Notes

00:00:00: Introduction

00:01:32: Mapping the Industry

00:03:33: Industry Cycles

00:07:30: Takeaways from this Earnings Season

00:11:21: Semis’ Earnings Reports

00:15:33: Geopolitical Risks 

00:17:21: Intel’s Turnaround Strategy

00:20:35: Recommended Resources

This week's episode discusses key takeaways from the Fed’s press conference, how companies are preparing for a recession, and the big tech earnings.

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

This week, we have made available a transcript of this podcast, with relevant images and quotes, for ALL subscribers this week. Find it after the show notes below. Become a paid subscriber to support our work.

Show Notes

00:00:00 Introduction

00:00:15 What is a Recession?

00:02:40 Debt markets are reeling

00:04:29 COVID-era trends are reversing

00:05:57 Some Early Recession Indicators

00:07:22 Meta: From Social to Interest Graphs

00:11:17 Conclusion

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 editor of The Transcript, along with Erick Mokaya who's our lead author. 

What is a Recession?

We sent out a new issue of the newsletter yesterday and last week was a heavy earnings week. And it was in addition to a Fed meeting. I think in the macro section, the biggest thing was that the Fed raised interest rates by another 75 basis points, signaled to the market that they may slow the pace of increases a little bit, but still sounded very committed to large, significant, additional tightening going down the line. That was one of the biggest events of last week. Erick, any thoughts?

[00:00:39] Mokaya: I think that was the biggest thing last week, that and the GDP and the fact that the US is now in a technical recession. But then like the day before the Fed chair himself was saying that there is no recession. And the next day the technical recession numbers came in. A question I wanted to ask you was why is it that the current administration they're very keen, especially on the definition of a recession, is it because there are elections coming up? And by the, what's the definition of a recession in the US? Who defines it? NBER right?

“The NBER's traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months. The committee's view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another” [NBER]

[00:01:07] Scott: Yeah, exactly. It's an interesting question. I think in my experience, it's a relatively modern concept that two periods of negative GDP growth equals a recession, a technical recession. At least as it's been defined in the United States or the historical bookkeeper of recession is the NBER. They decide what is the recession and what isn't the recession based on our databases. And my experience is that it's most strongly correlated with a rise in unemployment. So if you start to see a rise in unemployment, then typically the NBER will term that period of recession. But if you don't see any rise in unemployment, I've seen multiple times where there were weak cycles and the NBER didn't term it a recession, I think 1966 was one that comes to mind where you actually had a pretty strong financial storm blowing through. And I don't think that there was a recession during that time or at least one that was recorded.

“Most of the recessions identified by our procedures do consist of two or more consecutive quarters of declining real GDP, but not all of them. In 2001, for example, the recession did not include two consecutive quarters of decline in real GDP” [NBER]

[00:02:02] Mokaya: What's your call here?

[00:02:04] Scott: Well, I think that's what we should talk about next. The rest of the newsletter this week picked up a lot of early recession indicators. So the one that's probably the most important to talk about is credit markets where you have Lazard, Moelis and Aries Capital, a BDC company. All three of them were talking about dislocations in credit markets. And the quote that really stood out to me was Lazard saying everybody went from being laser-focused on rising interest rates to people are now laser-focused on recession. And so credit markets are usually more savvy when it comes to recession than equity markets. And there seemed to be signs there that I was reading that credit analysts are concerned about a recession. Any thoughts on that?

Debt markets are reeling

[00:02:40] Mokaya: Yeah, I think one of the things that stood out obviously was the fact that debt markets are heavily challenged and right now it's actually easier to raise equity than debt. So I was wondering is that also an early indicator of recession and before that also as regularly as we've been noting the past couple of weeks, demand is still strong. But companies are preparing. And my favorite quote, I think from that part, was the one from Spotify who said it's only the paranoid that survives. So yes, everything may be going on well, but you look ahead and you're like, okay, let's prepare for as tough times as possible. So that if those tough times don't come, at least we are prepared for it. And that I think was the tone I got from the Facebook earning call that I read this week. So any thoughts, especially on the fact that they can raise equity faster than debt, is that usually an indicator of recession?

[00:03:27] Scott: Yeah. In some ways, the data that we're seeing now is more consistent with classic early recession data. And so, as we're talking here, I'm wondering if maybe what we have been seeing in terms of the bear market was really like the post-COVID recession era, like the return to some sort of normalcy and increasing interest rates. And now what you're seeing is the classic yield curve inversion, classic credit markets starting to lead, consumers starting to trade down, advertisers pulling back. Those are all pretty classic early recession indicators. Which would say to me that maybe the recession, I mean, the title of our newsletter this week is what's priced in. And I think that's the most important thing because clearly, the Fed is signaling it's still planning to tighten. It's not getting looser. And then you have these recession indicators coming. So, did we price it in a pretty nasty recession? Or did we price it in a recession at all? I think to some extent we did, but would equity markets be surprised from this point if economic data begins to soften? I think the answer is maybe.

COVID-era trends are reversing

“We bet that the channel mix - the share of dollars that travel through e-commerce rather than physical retail - would permanently leap ahead by 5 or even 10 years…What we see now is the mix reverting to roughly where pre-Covid data would have suggested it should be at this point. Still growing steadily, but it wasn’t a meaningful 5-year leap ahead" - Shopify ($SHOP ) CEO Tobias Lütke

[00:04:29] Mokaya: Interesting. I think when you talk about some of the early indicators of the recession, I think that the pattern which I noticed last week was obviously the ad markets. The ad markets are really heavily challenged starting from Facebook. They see a really tough time ahead. Shopify, eCommerce was the biggest trend in the pandemic. It's retracing its roots back to normal levels in terms of growth. I don't know if you've seen the chart it’s like it went up and then it's back down to the normal trend where it could have been had COVID not happened.

Source: Shopify

So I think some of the other trends that we're noticing is that also people are eating out a bit more. They're going back out. In terms of people ordering online, it has also gone down significantly. And obviously, across some of these companies, they're all preparing for the tough times as we’ve said, from Facebook to Google themselves freezing hiring to Shopify themselves firing around 10% of the workforce. So you feel like all these companies, they're big companies, they are actually preparing for the worst ahead for them. Apart from that also, you see Cloud is still a very strong part of growth which can also be an indicator of recession time because that's when companies are cutting down on costs and seeking efficiencies and one of the most efficient ways to actually do business might actually be putting your business online, and maybe storing that data in the cloud. So that's why you saw a cross-board for Microsoft, Amazon, and Google, all of them posting strong, double-digit growth in terms of cloud revenues and Google search. Those are some of the things that I picked up across tech and tech earnings this past week, anything that stood out for you?

Some Early Recession Indicators

[00:05:57] Scott: Yeah, I think the consumer section is what stood out for me. And as we were talking, the early recession indicators, things like multiple companies talking about consumers trading down to more private labels. And then another comment by Moelis stood out to me was he was talking about the credit markets tightening and he was saying capital markets have been prepared for a hurricane and the only segment of the economy that hasn't really been prepared is the consumer. And so you have had this long period that we've been watching, where consumers have been spending and spending and spending, and they've had all of this extra spending power from all the stimulus that came through during the COVID era. And there are some signs where it seems like consumers may be reaching their limits of the ability to sustain these sorts of inflation rates, and then also their ability to spend into those inflation rates. So, the counterbalance of that is unemployment is still very low and there's still pretty strong labor shortages.

[00:06:55] Mokaya: It's a tough thing to read, to be honest, because unemployment's very low. A lot of companies are saying hiring is still such a challenge. I certainly think McDonald's CEO was saying something like they have a lot of new people and because they've had to keep hiring a lot. And right now, one of their challenges is efficiency. The lines are not moving as fast as they would expect in normal times when you have employees who know their job and all. So I think hiring is such a challenge for some of these companies and unemployment again is still pretty low. Yeah, that's what I would say also.

Meta: From Social to Interest Graphs

But one thing that I wanted to discuss a bit is your favorite company, Meta. I mean, they had a really tough quarter. But it seems like the challenges of TikTok are slightly behind them. They're moving to replicate TikTok. They were the same way they did, I think three or four years ago with Snapchat. Snapchat launched stories, and then they took it, replicated it, it boosted their growth in terms of Instagram, and then they put it to Facebook, and now Instagram is becoming their test ground also for a feed that looks more like TikTok. And there's been a lot of resistance from users who don't want Instagram to look like TikTok.

Source: Stratechery

But again, the statistics show that people are enjoying the reels that are being posted. They're sharing them on DMs. The monetization is not as strong as it was, but it looks like it's better than it was for stories back in 2018 when they started it off. I think it looks like a company and one of the quotes from the wisdom section that stood out for me was him saying that what they do now is trying to iterate it as fast as possible to try as many things as possible. He's saying a lot of that going ahead, the company is going to be focused on increased intensity in terms of focus, doing more with less. So what's your takeaway from Facebook, Meta right now? I'm not sold on the metaverse myself. I'm just impressed by the execution, especially in terms of dealing with TikTok as a challenger.

"Right now, about 15% of the content in a person's Facebook feed and a little more than that of their Instagram feed is recommended by our AI, from people, groups, or accounts that you don't follow. And we expect these numbers to more than double by the end of next year. As our AI finds additional content that people will find interesting, that increases engagement and the quality of our feeds." - Meta Platforms ($META ) CEO Mark Zuckerberg

[00:08:38] Scott: Yeah, I think the biggest thing I'm taking away from what's going on at Meta right now is the growth in short-form video across most social media platforms. So anybody who is engaging with those platforms from a business growth standpoint, using these as major channels for customer engagement should be aware that the algorithms are changing. And Facebook and Instagram are pushing more short-form video. I've noticed it in my Twitter feed as well. Just more short-form videos popping up. We had a quote from YouTube talking about short-form video. And so the algorithms which are extremely powerful on these platforms are actually actively promoting short form video because there's higher engagement rates and greater opportunities for monetization. So one of the things that Facebook said is I think they said only 15% of content right now is from third-party content generators. And they're going to be bringing that to 30% over the next, I think it was about 18 months and you've gotta believe based on everything they're saying in the strategies, that's gonna be predominantly short-form video. So for people again, who are engaged with these platforms, use them as an important outlet for advertising, for content growth, whatever it is, be making more short-form video. I think it is something that you need to think about. So The Transcript, Erick, we need to figure out what's our short form video strategy.

"Taking a closer look at YouTube. YouTube Shorts are watched by over 1.5 billion signed-in users every month with more than 30 billion daily views. In Q2, YouTube TV surpassed 5 million subscribers, including trialers. There's also a lot of potential for shopping on YouTube. Just last week, we announced a partnership with Shopify - Alphabet ($GOOGL ) CEO Sundar Pichar

“Reels engagement is also growing quickly. I shared last quarter that Reels already made up 20% of the time that people spend on Instagram. This quarter, we saw a more than 30% increase in the time that people spent engaging with Reels across Facebook and Instagram” - Meta Platforms ($META ) CEO Mark Zuckerberg

[00:09:56] Mokaya: I think we should, we should actually be having a short form video. We used to have those short clips, I think it's time now to revive ourselves in that direction because we probably need to, I think we do. What I've noticed a lot also on Twitter is that a lot of short-form videos, because they're short, it's like one minute long, you find like they have a million plus views sometimes. And it's shocking how fast these videos go. You don't need to engage with them for very long. Short and straight to the point. That's kind of what is taking off on most social media platforms. Again, a core thing, which you've mentioned, Facebook themselves, they're changing more from you seeing content from your friends only. Now they're moving from the social graph to the interest graph, where they want to link you to interesting stuff across the platform, which you may like, which are not necessarily from your friends. There will be a little bit of resistance, especially from the core audience of let's say Facebook, could be boomers mostly I would say who may not be interested in social interests across platforms and all, but the younger generation is more oriented towards good content that is flowing from across all these other social media platforms. It doesn't matter where it comes from, as long as it's good they want to see it. I think that's what Facebook is tapping into and they're really known for tapping into current trends to grow and to keep monetizing. I would not bet against Zuckerberg after reading the latest earnings call. That's what I'd say. I dunno if I can bet with him, but I can't bet against him.

Conclusion

We can close there for this week. Thank you for joining us. Once again, keep subscribing to a newsletter. We'll keep giving you the best quote calls each week. See you again next week and thank you.

Episode Summary: In this week's episode, we cover CEOs not seeing a downturn as imminent from their data, the challenging ad environment for Snapchat, and look at the week ahead in tech earnings. 

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

This week, we have made available a transcript of this podcast, with relevant images and quotes, for ALL subscribers this week. Find it after the show notes below. Become a paid subscriber to support our work.

Show Notes

00:00:00 Introduction

00:00:15 CEOs not seeing a recession

00:02:40 Not as bad as expected

00:04:26 Tech earnings ahead

00:07:14 Conclusion

Episode Transcript

CEOs not seeing a recession

[00:00:00] Scott: Welcome everyone to a new episode of The Transcript podcast. You've got me, Scott Krisiloff, I'm editor of The Transcript, along with Erick Mokaya who's our lead author. We sent out a new issue of The Transcript yesterday and last week was the first really big part of earnings season.

CEOs not seeing a recession

And what we saw was really positive commentary, pretty much across the board from companies saying that they don't see any signs of recession out there. So when they're looking at what's going on with their customers, with the consumer, spending seems to be strong. People seem to be confident. People are concerned about a recession. They say I've seen this quote probably half a dozen times now that everybody's reading the same headlines and people are concerned about recession, but when you look at what's going on at our company we're not seeing it. So that is probably the biggest story of the week. What do you think, Erick?

“We’re not seeing the stress. And when we talk to our customers, they’re not seeing the stress in their business models yet” - Bank of America ($BAC ) CEO Brian Moynihan

"We're acquiring spending and we see future travel bookings [strong] so I don't see it [a recession] in my numbers at all. It's really hard for me to get my head around that in quarter three or quarter four we're going to have a big slowdown." - American Express ($AXP ) CEO Stephen Squeri

[00:00:51] Mokaya: The standout quote was the American Express, who were saying that they're acquiring spending and seeing future travel bookings. They're seeing them as very strong currently. I think in the last part of the quote, he says it's really hard for me to get my head around that in Q3 or Q4, we are going to have a big slow down. It's in the same vein as a Citigroup CEO the previous week who said something like in the data currently, at least they're not seeing the signs of a recession. So the Fed is meeting this week. So I'm not so sure if they're also seeing the same data. Spending is still strong, everything seems to be doing well. So it feels like… it gives the Fed a little bit more leeway to raise rates again. What do you expect going into this week looking at the data that you've been seeing at The Transcript so far?

"If you look at our customer base, the consumer is posing the greatest benefit to the fed and the greatest trouble in that they're employed, they're earning money, spending money, have lots borrowing capability and they have more money in their accounts at the end of June than they had at the end of May, multiples of what they had pre-pandemic. So that makes the Fed's job tough because they're trying to slow down this wonderful thing we have called the American consumer, whose spending helps drive our economy and it's going strong right now. up double digits for the month of June and frankly double-digits for the first few weeks of July over last year's July” - Bank of America ($BAC ) CEO Brian Moynihan

[00:01:37] Scott: Yeah, I mean. We've talked about this for the last few weeks on the podcast, that the data that we're seeing that companies are seeing or is really coincidental data. And yes, the economy is strong right now. This was Jamie Damon’s thought really that even though the economy is strong right now, and there are leading indicators that suggest that a recession may be coming. I've tended to agree with that sort of thinking. Most specifically, because the Fed has been tightening and has signaled that it's continuing to tighten. This week I started to think maybe this isn't really as much of a coincidental indicator as the market not really seeing the picture fully that the economy really is strong. And that that may be able to persist rather than turn into a recession.I don't know. I'm still not fully resolved on this, but this week was really a striking consistency of quotes and clear message that was being sent by the companies, which I usually try not to ignore.

Not as bad as expected

[00:02:40] Mokaya: Yeah. I mean. Across the board, you see a lot of companies saying that they're doing well. And one of the surprising one I think for me this week was Blackstone, which is also in the middle of fundraising and it's raising money at a really incredible pace. And they say that from what they're seeing, there's a lot of dry powder even in venture and the PE world, so to speak. We may be wishing a recession on ourselves at the end of the day. From what you read in the transcripts so far, it feels like most companies are doing well. Unless you are a company like Snap or Netflix that is losing consumers. Maybe a quick one on ad spending and the Netflixes of this world, they reported last week. And I think the theme was that they lost fewer subscribers than expected. They were supposed to lose, I think, 2 million and they lost a million and that was better. And the stock price rallied on that results. So I kind of feel like for some of these companies, this quarter is - - if it's not as bad as we expected, then the market's going to be really happy for you. So any thoughts on that, Netflix, Snapchat, especially that reported last week?

"...we're talking about losing 1 million instead of losing 2 million. So, our excitement is tempered by the less bad results. But looking forward, streaming is working everywhere. Everyone is pouring in. It's definitely the end of linear TV over the next five, 10 years, so very bullish on streaming…So, tough in some ways, losing 1 million and calling a success. But really, we're set up very well for the next year." - Netflix ($NFLX ) Co-CEO Reed Hastings

[00:03:41] Scott: Yeah, I think that that's a really good point that we're seeing in earnings season here is that even if companies are reporting pretty negative numbers, the pessimism has been baked in for many companies, especially in tech. And so for Netflix to report a million lost subscribers, but have the stock still rally is a pretty strong signal about where we are with respect to the decline in prices. That said, Snap obviously was down 35% or more with its earnings released on slowing advertising and growth. So it'll be interesting. You know, Facebook is really the bellwether to me here. And so watching what happens with that stock this week also, I'll be watching Apple very closely.

Tech earnings ahead

Obviously, we've been seeing signs of decline in PC and smartphone sales. We've seen many indicators of that. And so whether or not that's appreciated by the market right now is another place I'm watching closely this week actually.

"Within the legacy market, revenue was $489 million, down 24% sequentially and 43% year-over-year. The decline was most pronounced in the client PC end market, which now represents a mid-single-digit percentage of our overall revenue. Consumer demand also deteriorated more than anticipated, reflecting the sharp rise in inflation impacting consumer discretionary spending" - Seagate Technology ($STX ) CFO Gianluca Romano

[00:04:42] Mokaya: Yeah, it's a pretty big week in tech earnings this week. Of course, what we've been seeing the past few weeks is that obviously, the PC market is slowing down. I saw a headline on Bloomberg that said it's something like Apple may be thinking of having discounts on some of their devices in China. That ties into what we've been seeing lately, in terms of slowing down demand for PCs and smartphones. That may actually combine to make up a tough quarter. They're trying to tap into discounts and that's something that you rarely, if eve,r hear Apple talk about. What's your feeling going into this tech week?

“The 4 megacap companies reporting this week [Google, Facebook, Microsoft and Amazon) comprise 20% of the SP 500’s market cap as of July 22, ’22, and probably close to 13% – 14% of the benchmark’s earnings weight, so the coming reports this week are a big deal” - Fundamentalis

[00:05:21] Scott: Yeah. I mean, there's a lot of data points that are not super positive data points that we've been picking up around this one of which again, on Snap, the advertising spending is slowing. I think this has been a long time in the making that we've seen for social media platforms having a harder time targeting customers or targeting users for advertising with the changes that Apple made to its platform. There's a lot of headwinds that they're still working through. So we'll see how it goes this week. But then the flip side of that is there's a lot of pessimism that's already baked into some of these stocks. So Facebook, you know, is like 12 times earnings or something like that right now. So they're cheap relative to historical earnings. There are also pretty high operating leverage businesses. So if there is a decline in advertising spending, for instance, based on it being a macroeconomic cycle, which advertising is cyclical you would expect earnings to fall for a company like Facebook, for instance.

"I think it's probably a good opportunity to step back and discuss how the overall demand environment is materializing. As you noted, we have seen a pretty good deceleration over the last 90 days. And as we noted in the shareholder letter, we've seen that across our DR and brand businesses as well as a number of sectors. But over a longer trajectory here, we've observed a fairly steady deceleration in demand over the last year." - Snap ($SNAP ) CFO Derek Anders

[00:06:20] Mokaya: So then again, the same thing will continue then. If you're not as bad as we expect, we'll be happy. If you are worse than we expect, definitely the market is ready to beat you down.

[00:06:33] Scott: Yeah. And I mean, again, I think that's been the striking thing for me this quarter is that even though earnings have been pretty negative the market has reacted somewhat positively to the news. And so we certainly reached the spot of extremely heightened pessimism sometime about three weeks ago now, probably maybe even four. And we are either maybe just rallying off of that pessimism and still planning, you know, and still potentially falling back down or, you know, this could be a longer-term bottom. I think a lot of that will depend on Fed policy again and whether or not the Fed is really moved from being a put to a call as we've talked about in the past as well.

Conclusion

[00:07:14] Mokaya: So interesting week ahead with tech earnings and the Fed. So be right here at The Transcript to have a look at it. We should end there for this week. See you again next week as we continue with the earnings season. Bye from us.

[00:07:25]Scott: Thank you. Bye.

Episode Summary:

In this special episode (Episode 67), we host former hedge fund manager Marc Rubinstein to discuss the key takeaways from Banks' Q2 22 earnings calls. Marc is the author of Net Interest and writes for Bloomberg Opinion. He covers financial sector themes.

Show Notes

00:00:00 Introduction

00:01:30 What Happens During Earnings Season? 

00:04:25 The US Banking Industry

00:07:16 Key Takeaways from Banks this Earnings Season

00:16:22 Rising Rates and The Banking Industry

00:18:44 Banking Sector Outlook for Q3 22 

00:21:13 How to Analyze Banks

00: 26:32 Fun Takes: Mike Mayo Vs Jamie Dimon

00:30:12 Conclusion

Episode Transcript

Introduction

[00:00:00] Mokaya: Welcome to the Transcript Podcast. This is a special episode where we'll be focusing on banks' earnings. We are privileged to have Marc Rubinstein. He's a former hedge fund analyst and he focuses now on writing on financials, mostly. Welcome, Mark. Maybe you can tell us a little bit about yourself and maybe add a little bit of a thumbnail sketch of your career.

[00:00:18] Marc: As you said, Erick, I'm a financial analyst with an explicit focus on financial companies; banks, insurance companies, asset management companies, and so on. I did that as an investor in a hedge fund for 10 years. I was a partner in a London-based hedge fund called Lansdowne Partners. We ran a fund that launched before the financial crisis, invested during the financial crisis and then we ultimately wounded up a number of years after the financial crisis, focused exclusively on banks and insurance companies, and asset management companies. But my history with them goes back even further than that because I was a sell-side analyst. I worked at Credit Suisse for a number of years looking at European banks. Actually, my very first job you will be interested to know was as a Swedish banks analyst. I used to make regular trips between London and Stockholm looking at Swedish banks as they privatized, as they came back out of government hands after the nationalization of them in the 1990s.

What Happens During Earnings Season?

[00:01:30] Mokaya: That makes sense because in one of the latest articles that you wrote about Klarna, I noticed you linked to the board meetings of companies in Sweden, and that was in Swedish. I was a bit surprised that someone had such refined knowledge about Swedish companies. For those who don't know most minutes of board meetings for Swedish companies are available online for download at a small fee. So earnings season, you spent a lot of time as an analyst and as a hedge fund manager, maybe can give us a quick overview of what happens during earnings season for analysts.

[00:02:01] Marc: It's a great tradition, the earnings call, it used to be going back many, many years before telephony democratized earnings calls, that analysts were called into a room and the CEO, Head of Investor Relations, and the CFO would present the quarterly results to a room full of analysts. Clearly now, initially because of conference calls and then because of Zoom, you don't physically have to go to a room anymore, but once a quarter, the bank, any company will present its earnings to its shareholders. Actually, there were some exceptions within the banking sector, Wells Fargo up until relatively recently dispensed with the idea, they released alongside their financial report and accounts, a kind of a transcript. And that was it. There was no recourse for analysts to ask questions. That was it. Actually, Berkshire Hathaway is another exception. They don't do a quarterly call with analysts but most financial companies do.

One reason why there's a heavy focus, I think on banks, earnings is because they're early in the season and possibly set the tone. And secondly is because they're a good window into the economy.

For banks, it's particularly interesting for two reasons. Firstly, they are early in the earnings cycle. Banks, I think traditionally actually, U.S. Bancorp has been the first US company to report. But JP Morgan comes pretty soon afterward, usually kind of the 14th of the month, two weeks after the end of the quarter, which is quite an achievement for a large complex organization, such as a bank, with trillions of dollars of assets, to be able to turn its books around in the space of two weeks and report to the market what those numbers are. It is quite an achievement, but they come quite soon. One reason why there's a heavy focus, I think on banks, earnings is because they're early in the season and possibly set the tone. And secondly is because they're a good window into the economy. Banks will go in and talk about some of the detail later. Bank of America has got 35 million accounts across the US, so unique access to what's going on in US households. And they even gave a July update when they reported really kind of, almost like a real-time update window into what's going on in the economy.

Bank of America has got 35 million accounts across the US, so unique access to what's going on in US households. And they even gave a July update when they reported really kind of, almost like a real-time update window into what's going on in the economy.

Mapping the US Banking Industry

[00:04:25] Mokaya: I'm actually very impressed that the US banks get to report two weeks after the end of the season. For comparison, I would say Kenyan banks, where I come from, take like two months to actually report earnings. All these entities, JP Morgan, and Goldman Sachs, they're very big, so to get them reporting that soon after the end of a quarter, it's quite impressive, so to speak. But then I would come back and maybe ask you then, you've talked about JP Morgan, you've talked about Goldman Sachs and Wells Fargo, but what are the big banks in the US that people pay attention to most? Maybe you can map for us what the US banking industry looks like from your perspective.

[00:05:01] Marc: And actually just to back up, you make a really interesting point. It's a good reflection on risk management. One would hope as an outsider, that banks would have real-time valuations of all of their assets and liabilities, and converting that to reporting for external consumption shouldn't be too laborious a process. So they should be able to do it pretty quickly. And I would be nervous about a bank that isn't able to report as quickly. Of the big banks in the US, there are five of them that dominate. They are Bank of America, Citigroup, JP Morgan, Wells Fargo, and PNC as well. And then you have those with more of a capital markets focus that would include Citi and JP Morgan as well but we bring into that Goldman Sachs and Morgan Stanley.

Jamie Dimon of JP Morgan attracts a lot of publicity. He's an excellent CEO. He has longevity. I think he's the longest-serving CEO of a bank globally…So he has longevity. He's seen cycles. He speaks very well and he obviously sits on top of one of the largest, if not the largest bank, in the world and they report early. So multiple reasons why market participants would listen to Jamie Dimon.

Jamie Dimon of JP Morgan attracts a lot of publicity. He's an excellent CEO. He has longevity. I think he's the longest-serving CEO of a bank globally. The CEO of HDFC Bank in India was around for a while longer, but he retired just over a year ago. I think Jamie Dimon now might be the longest-serving CEO in public banks globally. So he has longevity. He's seen cycles. He speaks very well and obviously sits on top of one of the largest, if not the largest bank in the world and they report early. So multiple reasons why market participants would listen to Jamie Dimon.

Bill Demchak, who is the CEO of PNC sits not far behind. Actually, he has a background in capital markets, so he is able to talk about capital markets as well as retail banking. PNC through a series of acquisitions is now kind of the largest super-regional bank alongside USB. We didn't mention US Bankcorp is another one, two of them are the largest super-regional banks in the US. Much more domestic than the others. Much more focused on retail banking than the others. Bill Demchak is excellent. We can go in later to some of the things he said on his call, but definitely another one to listen to.

Key Takeaways from Banks this Earnings Season

[00:07:16] Mokaya: And then you have the Bank of America who has a finger on the pulse of the consumer in the US. I think that's one of the biggest strengths because when you listen to the earnings call their perspective on a trillion dollars moving through their banks every quarter almost. Perhaps, you can give us a bit of a flavor of this earnings season and how you've seen it so far. What's the feel about the globe, about the economy when you look at it from the perspective of the bank.

[00:07:41] Marc: I think the concern going into this earnings season was that recession was a risk. And banks given the window they have into household finances would give a there on that. And actually, it looks okay. One of the features of these bank results is that although earnings revisions are skewing downwards, we are seeing some downgrades, I think the performance of bank stocks in a run-up has been so bad that there was a kind of a relief rally subsequently. And the stocks in the week or so subsequent to the earnings season are up kind of 6, 7% something in that order of magnitude. And that's largely because there was concern about the consumer feeling the pain and so far, and clearly, these things can change very quickly, but we've seen no evidence of that. 

And the consumer, I feel like a broken record. The consumer right now is in great shape - JPMorgan Chase (JPM) CEO Jamie Dimon

Jamie Dimon of JP Morgan, for example, said, consumers are in good shape. He said they're spending money. We heard the same from Citi. Citi has said that consumers are spending well above pre-COVID levels. We heard from Bank of America, I talked earlier about the 35 million checking accounts that they have. They said US consumer remains quite resilient and that the word resilience was mentioned a number of times across these calls. Bill Demchak, who I said is definitely worth listening to, pushed right back. He said, And I'll quote this one. He said:

"Investors are completely wrong about the banking system right now. If you look at the market cap that's been pulled out of the banking system and take your worst-case reserve to build and charge-offs, it's just wildly wrong. Yes, we'll have increased losses, but not anything close to like we put in during COVID." 

And then he went on to talk about the specific competitive opportunities for PNC. Things can change, overall I think one highlight was resilience, but actually, things can change. And another highlight is uncertainty and the capital markets banks emphasized uncertainty a bit more. So Goldman Sachs, for example, spoke about a cautious tone because the environment's uncertain, very uncertain. We don't have a crystal ball to tell you exactly how military policy will navigate the inflationary environment that exists, they said.

Again, back to JP Morgan, so Mike Mayo is an analyst who has a long history with Jamie Dimon and he was pushing back on Jamie Dimon about this point Jamie Dimon had talked about a hurricane. He talked about the recession using the analogy of a hurricane and yet was talking nevertheless about investing for the future. So my push to this analogy talking, "If there's a hurricane on the horizon, why are you waxing the surfboard?" Jamie Dimon's response was again, there's a lot of uncertainty, there's a range of potential outcomes. He said from a soft landing to a hard landing. We are pointing out that the probabilities and possibilities of events are different. But he said he's waxing a surfboard because it's not going to change how we run the economy over a 10-year view. Its not going to change how we run the company over a 10-year view. The economy will be bigger. So I think two real themes, one this notion about resilience to the consumer, no evidence yet, and that goes right down into delinquencies debit and credit card spending. No signs of consumer stress yet, but two that there is uncertainty because the range of outcomes is complex.

Could you help me reconcile your words with your actions? After Investor Day, Jamie, you said a hurricane is on the horizon. But today, you’re holding firm, which you’re sending $7 billion expense guidance for 2022. I mean, it’s like you’re acting like there’s sunny skies ahead. You’re out buying kayaks, surfboards, wave runners just before the storm. So, is it tough times or not? - Mike Mayo from Wells Fargo Securities.

[00:11:31] Mokaya: Definitely. That's why he moved from saying storm clouds are coming, the hurricane is coming, and now I think in these earnings calls, from what I could read, he had toned down a bit on that, but he says that currently there are two perspectives, the first perspective is currently as we see things, the data. I think it was Citigroup CEO, Jane Fraser who was saying, the data as we see it currently, we don't see issues to do with delinquencies increasing or charges-offs increasing or anything like that. But when you look ahead a bit into the future, we are a little worried about that. That's what I could pick from my perspective on the banks. Would you agree on that? And also maybe to add on that I wanted to ask, they say that things are looking okay right now, but then JP Morgan cut off buybacks a bit. I think also Citigroup is doing the same and you could sense it from the other teams, they're trying to shore up capital in that regard. How do you think they reconcile these two views so that they're able to handle the next couple of months and quarters?

[00:12:26] Marc: Okay. So I make two comments. The first one is that banks earning statements are quite unique. They reflect because of an accounting standard called C-E-C-L (CECL) because of an accounting standard that was introduced at the beginning of 2020 called CECL, they reflect the future. When a bank makes a loan, it has to provide for the possibility of loss embedded in that loan upfront. And if a scenario changes, they take a kind of weighted average. They look at different future paths and they take a kind of weighted average of where the economy may transition to, and they disclose actually all the underlying assumptions. And all of that percolates down into a single number, which is the provision they put against that loan at the point in which they make it. 

Now, if they get a little bit more bearish on the economy and Jamie Domin JP Morgan did, not in the second quarter, he did actually in the first quarter, did that one quarter ago. What he did was he nudged up the kind of the tail risk of a worst-case recessionary scenario. I can't remember the exact numbers, maybe from 10% to 20%, but he nudged up that weighting and that had an impact on provisions, and we saw that in the first quarter. It's a really important point because a traditional earnings statement reflects the past. It's the earnings the company made last year, a balance sheet reflects the present, but a bank's earning statement actually kind of reflects the future because within that there's this one line, this provisions for credit losses line which embeds a view on the future. So that's kind of already in there. It's already in the earnings. So that's one point. 

In the second point, you make a point about buybacks, which is a good point. They froze buybacks. The reason for that I think is less around, well, it kind of comes to the same point, really, which is that in addition to that forward-looking earnings point, the Fed does a stress test of all banks once a year. And it can put in there, whatever it wants, it can put in there the most wildly bearish stress tests, which it has done. Again, Jamie Dimon, I come back to him a lot because he's so vocal, he pushed back on that he says, you know, the Fed does want stress test, he does a hundred stress tests, but the Fed's stress test is bearish. Actually, he said COVID proved that because he said the Fed's stress test says that when we're in a kind of recessionary environment, then trading activity declines as well. 

And he said actually in COVID that wasn't the case. We saw trading activity increase, and the capital markets business did okay. So there was a kind of an offset there, a hedge almost between those two businesses. But he said under no circumstances, wasn't the case in 2008, and it wasn't the case in 2020 will earnings develop in the way the Fed anticipates in their stress test, but nevertheless, banks go through the stress test that defines the capital they have to hoard against those potential stresses. And they, therefore, have to flex their capital position according to that. And so they froze their buyback because they're kind of running up against the top end of that kind of capital buffer. That's basically that second point. As I said, Jamie Dimon pushed back, he said there are ways around that, you know, a capital ratio is also a function of the denominator of the balance sheet size. And he said there are ways of reducing that. There are various mitigation techniques they can employ. So that's a possibility that they could do in which case they'd be able to turn the buyback back on but it was, I think, a feature less of the company's view of the prospects and more on the Fed's view of how the bank is exposed to those prospects.

“And we don’t agree with the stress test. It’s inconsistent. It’s not transparent. It’s too volatile. It’s basically capricious arbitrary. We do 100 a week. This is one. And I need to drive capital up and down by 80 basis points. So, we’ll work on it. We haven’t made definitive decisions” - JPMorgan Chase (JPM) CEO Jamie Dimon

Rising Rates and The Banking Industry

[00:16:22] Mokaya: Yes, I noticed from the earnings call Jamie Dimon was really furious about the stress tests and would love them gone as soon as yesterday. So maybe talking of the Fed, what impact is the raising of rates, and of course, the recession risk having, especially on banks. So far, I know that some banks have benefited from higher rates. Some have been hit pretty hard, less like Wells Fargo in terms of their mortgage business. You'd expect banks to benefit from higher rates, but it's not always necessarily the case. What's your perspective on that?

[00:16:52] Marc: It's a fascinating tension. I wrote a piece back in January, a net interest piece on this point about banks' sensitivity to high rates. It's fundamentally a positive. They have huge deposit books. Deposit books grew through the pandemic. Actually, one of the reasons banks are now saying that consumers are resilient is because consumers have built up quite large liquidity buffers to protect themselves from a downturn and banks benefit from that through their deposit holdings. As rates go up, then the value of those deposits goes up. A bank's deposit franchise is a low-cost source of funding, and the advantage of that is higher when market rates are higher. And banks talk about kind of a beta. If rates go up a hundred basis points, deposit rates don't have to go up a hundred basis points. Maybe the beta’s 25% deposit rates only have to go up 25 basis points. 

A bank's deposit franchise is a low-cost source of funding, and the advantage of that is higher when market rates are higher. And banks talk about kind of a beta. If rates go up a hundred basis points, deposit rates don't have to go up a hundred basis points. Maybe the beta’s 25% deposit rates only have to go up 25 basis points. 

So, banks are big beneficiaries of higher rates, but there's tension because higher rates normally come alongside a deteriorating economic environment, and detest a deteriorating economic environment. And at the same time, it's difficult to disentangle the two credit losses gap. So it's very difficult to disentangle them. There's a tension there. There's a benefit in net interest income. And certainly, JP Morgan actually upgraded its estimate for net interest income, but the flip side is credit losses might go up and that's kind of the tension. And clearly, investors don't buy a single line of the earning statement. They're buying the entire earning statements in aggregate, and that's the tension that's going on right now in stock markets.

Banking Sector Outlook for Q3 22 

[00:18:44] Mokaya: So from your overall perspective, are there any other key points that we may have missed, especially to do with banks from Q2 going into Q3?

[00:18:52] Marc: I think the focus will still be on them. I think maybe what's special about this, we haven't had a recession since 2008 or, maybe we had one in 2020. But we haven't had an unmitigated recession since 2008 and the playbook that investors have reached for when looking at banks ever since 2008 has been that 2008 playbook. This is why Demchak in this quote I talked about earlier talks about it's not going to be that bad which is why Jamie Dimon always rallies against the amount of capital that he has to have, which is much higher than banks had in 2008. Banks have been trying to make this argument since 2010 and 2011, coming out of that last financial crisis that they deserve a lower cost of capital, and a higher stock market rating because they're more resilient. And the market, frankly, hasn't believed it and they sold off hard in 2020. They recovered, they've sold off hard again, now it could be, they almost need a recession to prove that they are resilient. And that's ultimately what could lead to some kind of a rating. So some banks they're not actively wishing for it, some on calls have hinted at that. Certainly, they've talked about the competitive advantage that such an environment would give them, which is also true, but that's one thing to look at going forward. And then the other things are things that we discussed. I think the second is consumer resilience we get a snapshot once a month from credit card trust data, from securitization data, and how credit card trusts are performing. So we get that data and banks talk intra-quarter at conferences, so we get consumer delinquency data once a month, quite a good data series.

We get spending data actually kind of real-time now. JP Morgan, Bank of America, and Citi, they've got the biggest credit card businesses in the US, and a huge amount of data there that we get. So we get that in real-time. So right now things are looking okay, but we'll know when that turns. And then the final point is this point about uncertainty, which is more of a capital market point. Goldman Sachs actually said that 2022, won't be as good as 21 because, in 2021, he says we saw opportunities to deploy resources, serve our clients and expand the revenue opportunity. There was so much liquidity in the system, clients wanted to do things and that's not as much the case in 2022. So those are the three points. I think uncertainty, actually on that final point, I can't remember which call it was, whether it was Morgan Stanley or Goldman Sachs, there was pushback on this analysts often talk about when looking at capital markets business, kind of good volatility versus bad volatility. Good volatility, a little bit of volatility, which gets clients trading helps trading activity, widens spreads on that trading activity. Bad volatility and everyone's caught on the wrong side of it and there's almost like a trading strike. And what we've seen recently has been good volatility. I can't remember whether it’s Morgan Stanley or Goldman Sachs that's one of them pushed back on that phraseology. But it could be, that no one wants a liquidity scare, which would be very negative, but a little bit of volatility is quite good. I think those are the things to look for. We look at volatility, we look at consumer spending, and we get those both in real-time. And that's, what's going to feed into earnings as we go into the third quarter and beyond.

[00:22:16] Mokaya: Speaking of volatility and its impact, I think this quarter has also been the quarter when across our banks, investment banking revenues have been hit pretty hard because people are not trading, markets are closed, no IPOs, investment banking deals are pretty low, what's your take on that? Is investment banking revenues, such a significant part of these banks, especially the major banks and their revenues? What's the exposure to that, and what's your take on the decline? Does it have an impact say on, would you perhaps then foresee layoffs in these kinds of markets, especially in this segments that are heavily impacted, or are they keeping the employees now and perhaps preparing for better times hoping that this is a mild recession? I know BlackRock is very clear that they're cutting down on hiring especially on the senior level. So they're okay with recruiting at the junior level for now. Are they hunkering down for a recession is about to happen?.  

[00:23:08] Marc: On the investment banking side, banks are not especially exposed to pure investment banking revenues, M&A, equity, debt, and underwriting, and we saw record earnings in those segments in 21, anyway. It is inherently a very cyclical business, so downturns are to be expected. Trading activities actually have held up quite well. Again, it was a record last year, but trading activities have held up quite well. The more exposed to that segment would be the pure play, smaller kind of investment banks which just do advisory work. So that's kind of less of an issue, I think, but certainly, it's a source of less capital-intensive revenues which will go into reverse. On the layoffs, to be honest, I don't know. It's a good question. I'd have to go and check actually to see. I wouldn't think it would be on a par with the tech sector, which was really at the forefront of that cycle, but for sure there was additional recruiting but I'd have to go back and have a look to see what extent that actually took place.

How to Analyze Banks

[00:24:13] Mokaya: What are the key things you pay attention to when you're analyzing banks?

[00:24:17] Marc: Well, there are some classical ratios to look at depending on the type of bank. If we're looking at traditional lending bank, then the net interest margin is the spread they earn off their balance sheet, principally the loan book funded by the deposits. So we look at the net interest margin, but what's different about banks is that the earnings they book or the revenue, the net interest income, they book in a single period isn't the end of the story because the loan loss, that cost of doing that business can come many quarters down the line and correlation can go up to close to one across what may appear to be uncorrelated lending assets in the event of a recession or something like that. The two ratios would be net interest margin, and we'd look at that against the cost of risk, the provisions, and the loan losses, you can generate a high net interest margin, but the cost of that will be high loan losses. 

I wrote last week about Klarna and in the context that it was looked at by tech analysts as a tech company who looked at it on the basis of price to revenues and just its revenues, but the cost of those revenues come through loan losses, which have to be taken into account, so I adjusted for that in my analysis. So those are two ratios to look at. You can look at efficiency as well. People talk about the cost-income ratio or the efficiency ratio. So those are the three ratios on the income statement. And then you'd look at the capital ratio, which is kind of a way of looking at leverage. There are various regulatory capital ratios to look at. So we look at those four ratios and then the way to tell a good bank again, a lending bank is really to go through its history and look up historically, has it priced credit correctly? I don't just look at the net interest margin versus the cost of risk today. Go right back through history to see if they've been able to sustain a high-risk-adjusted margin over time. And that's a good way to understand a good bank.

Fun Takes: Mike Mayo Vs Jamie Dimon

[00:26:32] Mokaya: One of the things that I've enjoyed in reading your letters is the exchanges between Mike Mayo and Jamie Dimon. Just before we talked, I was looking at one exchange, I think back in 2013, where Jamie Dimon tells him "I earn more money than you." I think you have a very nice front-row seat to this kind of banter between Dimon and Mike Mayo. Any quick takes or fun takes on this?

[00:26:55] Marc: It's very good. It's very funny. It's almost like the meta play within the earnings season. So Mike Mayo, for those who don't know is a banks research analyst, currently at Wells Fargo Securities, where he covers the big banks. Doesn't cover Wells Fargo, covers the other banks. But prior to that, he was at CLSA and he's been in the past at Credit Suisse. He's been at Deutsche Bank. He's been a Prudential, he's a long-time banks analyst. He's written a book and actually, he refers to the earning season as Kabuki theater, where this kind of dance takes place between the analysts and the management for air time. Often the analysts want to look. They want to often ingratiate themselves with management. They want to give the appearance of doing so in front of the investors who are their clients who were listening to the call. There's a kind of a meme Twitter account called great quarter guys. Just the concept of a great quarter. In the piece you're talking about, there was another analyst who, on the fourth quarter, 2021 Morgan Stanley call was kind of praising the company, praising their strategy, saying if more investors knew about this, there'd be a rerating and the CEO comes back, oh, it'd be a $200 stock, my friend, all very charming, all very close. 

Mayo takes a totally different stance and sees this as being one of his jobs. And I should say I've written another piece on equity research, the whole idea of equity research, and what these analysts actually do. And it doesn’t boil down to a simple task, you know, the kind of jobs to be done by an equity research analyst. It's about 10 different tasks and each of them weighs them differently. The one, Mike Mayo rates very highly is management accountability, you know, traditionally investment firms haven't paid for that. Why would they, it's not their kind of job to do. It's a public good, but Mike Mayo nevertheless views accountability as being what he strives to do. And so he asks some tough questions and he did it again, as we said earlier on this earnings call where he pointed out the inconsistency, Jamie Dimon talking about the hurricane or the storm on one side, and yet his heavy investments spend on the other. Look, I should say I've known Mike Mayo for a number of years. I used to be a client of his. There are lots of great analysts out there but for anyone kind of cold to the earnings season, who's reading transcripts, then there is a history between him and Mike Mayo. Great to go straight to his questions, partly because of the accountability issue, but partly because of that testy relationship he has with Jamie Dimon.

[00:29:33] Mokaya: Feels like friendly banter. At this point, they should be friends.

[00:29:37] Marc: I would think so. Actually, there was another case. Before Wells Fargo, Mike Mayo lost his job at his previous firm and nevertheless, he's covered I think 120 different earning seasons, you know, four a year for many, many years, 120 different earning seasons. So addicted is he and compulsive is he to earning seasons that even when he lost his job, he turned up on the calls as an independent analyst and he asked Jamie Dimon a question and Jamie Dimon to be fair was very encouraging. Probably gave him a good reference.

Conclusion

[00:30:12] Mokaya: Nice. That's why we love earning season at the end of the day, it's a time to get a good feel of how the economy is doing. And again, just before the rest of the company's report, you can get a bit of analysis on how the consumer is doing and fairing. So for me, I think this earnings season the question is “recession”? That would be the theme of this earnings season. And the other thing that I've also noticed so far is that, if things are not as bad as people expected, then your stock will rise. That's happened to a lot of the big banks. So if you're not making as many provisions as people expected, or if you're Netflix and you lost fewer customers than people expected, then your stock will definitely be positively received at the end. My take on this earnings season is it's not going to be as bad as expected. I think that would be my takeaway, any closing thoughts for today?

[00:31:01] Marc: No, that's good, Erick. It's great work that you are doing at The Transcript because as you say, the companies now are so polished in terms of the way they present their earnings. There's been lots of talk, and it kind of came to our head with community-adjusted earnings with WeWork. The way they actually present and market their earnings, so polished, so tailored, so staged, and also with their prepared remarks on these calls, where clearly they've rehearsed, but it's through the Q&A where they're not reading off a script where, you know, they'll say something like Demchak said this time around the environment and the way he thinks the market is valuing banking stocks as Jamie Dimon has done. That's when some of the interesting nuggets come and it's great work that you do, actually bringing that to the fore.

[00:31:50] Mokaya: Yeah, we really enjoy the Q&A section. Always like it when let's say companies like Netflix, jump straight to the Q&A, their prepared remarks are in their quarterly letter and then the Q&A just gives you a flavor of exactly what they're thinking. And occasionally they slip up and actually tell you what exactly they think about a lot of things. We do enjoy that. Thank you also for joining us. We hope we can do this again next quarter when the banks have another great quarter, hopefully. So thank you Mark and it's a pleasure.

[00:32:19] Marc: Thanks, Erick.

Episode Summary:

In this episode, we are joined by special guest Sam Ro to preview the Q2 earnings season that starts this week. The episode is also partly based on yesterday's newsletter which is available on Substack.

This week, we have made available a transcript of this podcast, with relevant images and quotes, for ALL subscribers after the show notes below. Become a paid subscriber to support our work.

Show Notes

00:00:00 Introduction

00:00:24 Demand Still Strong

00:03:47 Is a Soft Landing Possible?

00:06:50 The Consumer is Feeling it

00:09:48 China Reopening, Supply Chains Easing, and Weaknesses in PCs and Smartphones

00:15:34 Previewing Q2

00:20:38 Conclusion

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. You've also got Erick Mokaya who's our lead author. Today we're joined by a special guest who's Sam Ro, someone who's been a good friend of The Transcript podcast and we've known for a long time. Today, we will go through the newsletter that we sent out last week. And we'll also preview the earning season for Q2, which is starting up this week as well and so Sam will be helping us with that. 

Demand Still Strong

[00:00:24] Scott: In terms of what we saw last week, I think the theme of the newsletter was that demand is still very strong. We're seeing a lot of quotes from people saying that demand is strong in that there are no signs of consumer weakness. But the issue with this of course is keeping inflation expectations higher, especially at the Fed. And the Fed is indicating that it'll be aggressive in continuing to raise rates and trying to fight inflation and inflation expectations. So this is despite all of the concerns about the recession that we're seeing. We're not seeing any data to support recession now, but the Fed very well may push us into a recession anyway, as it is aggressive. Sam or Erick, any thoughts on that?

“Sector by sector, we’re seeing a varied picture of how inflation is impacting essential vs discretionary consumer spending. One notable highlight is that travel sectors such as airlines and lodging continue to show signs of strong demand.” - Mastercard (MA) Senior Advisor Steve Sadove

[00:01:03] Sam: Yeah. I think that's sort of the tragic irony of the state of the economy right now, where when it comes to demand, is exactly the kind of thing that's fueling inflation because of persistent supply chain constraints on limited capacity and all that kind of thing. So yeah, I think this is gonna be a hot thing to pay attention to especially with the earning season kicking off. To what degree, do our businesses and consumers continue to pay up for what's been higher-priced goods. It's because of the sort of the financial strength of businesses and consumers that so many businesses have been able to increase prices and that's the inflation that we're seeing. So yeah, it's a bizarre problem. Economic strength is causing this problem and the Fed has been very explicit about wanting to cool that demand off.

“We’re starting to see those first signs of a slowdown, which is what we need because what we have right now is a great imbalance between supply and demand that’s driving the inflation that we’re seeing." - Atlanta Fed President Raphael Bostic

[00:02:02] Mokaya: Yeah. To chip in there, I think my stand-out quote from the week is that demand is still holding up pretty strong and the Fed wants the economy to slow down so I think they may have to do a lot more to slow down the economy. Perhaps raise rates higher than they expected going forward. But then of course, on the other hand, they don't want to slow it down too much that it turns into a recession. And of course, the worry this week is and has been the past couple of weeks; Will this slowdown lead to a recession so far, it seems likely not. I think that's a key takeaway. I also wonder from the jobs reports, because you guys are more in the US. What, exactly was your takeaway? Some of the quotes that we see show that the labor market is still doing quite okay.

[00:02:50] Sam: It's all confirmed by the same things that you guys have been writing about that demand is strong. There was, I forgot exactly what the number was, but it was over 300,000 jobs created in June. And this is going on four or five months of rate hikes now. So as the Fed has been increasingly tightening monetary policy and sure everyone's concerned about recession and demand and all this stuff, the hard data is saying that employers are continuing to hire at a very healthy clip. And so, what does that mean? It means businesses are essentially investing in their own businesses and they're expanding their capacity. And as they bring on all these people, that's a lot more people who now have the income to go back and spend that in the economy. So yeah, underlying strength from a fundamental perspective. But yeah, that's exactly the problem that the Fed is running into from an inflationary pressure perspective.

Is a Soft Landing Possible?

[00:03:47] Scott: Yeah, I think the demand that we're seeing, look at it as a coincident indicator, not necessarily a leading indicator, and that's where some of my concern comes from especially to the extent that a strong employment environment and strong demand environment give the LA Fed more cover to raise more aggressively. And I think that this is a period, In a potential transition to a recession where the coincident economic data doesn't necessarily show where the ball is going. And, that is my concern. Of course, it's atypical dynamics that we're seeing from an inflation perspective anyway because you've had supply changes that were heavily impacted by COVID and you're starting to see commodity prices coming down pretty rapidly as well. This could be one of the rare circumstances where we do get some sort of soft landing, so to speak where the inflation numbers just start to peter out and the Fed can then maintain monetary policy at a more neutral rate. But as we've talked about on other podcasts, it's that it has typically not been the most likely outcome, to have that soft landing. So I think personally, I am still concerned about the recession. Like everyone else, it just may not be Materializing quite yet.

[00:05:07] Sam: Yeah. I think you're right. That's the problem with so much of the data that we get is that it's lagging, right? I mean, just this morning, Monday morning the New York Fed released its monthly survey of consumer expectations, and there one year ahead consumers, one year ahead, expectations for inflation jumped to another new record high. However, this survey was conducted, in mid to late June when gasoline prices, at least in the US, were still hovering at record highs. More current data from organizations like AAA and the EIA will tell you that the national average gasoline price has been declining for the last, three or four weeks. And that's not to mention the fact that, there are all these studies, I'd say that things like monetary policy and higher interest rates filter into the economy and cause a lag. So, we have all these lagging indicators, we have coincident indicators saying all these different things.

And then, in a couple of weeks, everyone's expecting the Fed to contain a hike rate at an aggressive pace based on a lot of this information that could be on a lag. So yeah, there, I think it, definitely raises the risk of a recession happening. But there are also some pretty good leading indicators too, that I think to suggest that any kind of landing doesn't have to be a hard one. Right. Yes, the jobs data comes on, is co or is on a bit of a lag. But there are still 11 million job openings. And to me, that's a pretty decent leading indicator of sort of unmet and pent-up demand. So I think that's gonna continue to put a floor on things like the labor market as the Fed continues to tighten.

The consumer is feeling it

[00:06:50] Mokaya: So a quick question I mean, some of the calls that we picked up indicate that the consumer is feeling the pressure. What are some of the areas perhaps you guys check out in terms of leading indicators? Anything that you're watching?

[00:07:01] Sam: Yeah, I could start, so the last is a personal income and spending report that also came with the core PC price index report. There are a couple of things to be said here, the core PCE price index has not established new peaks, kind of like how the CPI report, the Last month which many sorts of the blame for, the fed getting increasingly hawkish. So there are some measures of inflation that are coming up. They're still very high and certainly not anywhere near a place where the Fed gets comfortable, but, there's evidence that those prices are coming up from the consumer perspective which, you know, 70% of GDP is personal consumption expenditures that may be showing some cracks, but it's ambiguous at this point. So the last personal consumption expenditures read for. The month of June showed that nominal spending continued to increase, but on a real basis decreased. So maybe a few cracks are showing up there when it comes to the consumer. That said, the more anecdotal evidence does not seem to be in line with what you would expect in terms of consumers concerned about their own. Concerned about the economy, concern about their job, and concerned about their finances.

“In the quarter, there was an acute shift in customer sentiment and, since then, pressures have materially escalated. This includes steep inflation and fluctuations in purchasing patterns” - Bed Bath & Beyond (BBBY) Interim CEO Sue, Gove

It's enough to just turn on the news and see how much to what degree everyone continues to travel and does a lot of vacation spending. It's not a huge part of consumption expenditures, but it's somewhat. Discretionary type of spending. And there was another recent report that came out from Bank of America that did some analysis on their consumer behavior based on their card, spending data, debit card, and credit card spending data. They did some historical analysis and found that during recessionary periods, Consumers tend to trade down when it comes to the types of restaurants that they go to. So if you're a fine dining person, you go down to sort of casual dining restaurants. If you're a casual dining type of person, then you're spending more time at quick service, fast food types of restaurants.

They're not seeing anything like that happen. And I think that was confirmed recently by the Darden re. Earnings, where they were noticing that their high-end restaurants, like capital grill and the restaurants of higher price points, have outperformed some of their more modestly priced offerings. So it's just a really strange situation where consumers will fill out a survey and say that they feel the terrible state of the economy. But they're gonna do an upgrade to what they order at the steakhouse they go to next week.

[00:09:43] Mokaya: Yeah. So beyond the consumer stuff, any other quotes that maybe stood out for you Scott this week?

China Reopening, Supply Chains Easing, and Weaknesses in PCs and Smartphones

[00:09:48] Scott: I think one of the things that stood out to me is the quotes that we had about the situation in China of seeing reopening happening in China that Chinese domestic travel is rebounding strongly, even faster and above levels that it was in 2019 already. I think China is reopening, not only is it a significant global economy, but it is also a significant global economy to the supply chain. And so, especially some of the inflationary forces that we saw that was built at the beginning of this year were due to China closing down for COVID. So again, it's another healing step in the supply chain. That should be theoretically a deflationary force or disinflationary force rather than an inflationary force. So that's another one that's stacking up in a positive route. How about you, Eric? Anything you. I think

"A number of factors have impacted consumer PC demand in various geographies. As a consequence, our forecast for calendar 2022 PC unit sales is now expected to decline by nearly 10% year-over-year from the very strong unit sales in calendar 2021. This compares to industry and customer forecast of roughly flat calendar 2022 PC unit sales at the start of this calendar year..." - Micron Technology (MU) CEO Sanjay Mehrotra

[00:10:37] Mokaya: The PC and smartphones have learned to be a bit more co-like to pay attention to it. Especially since last time we also noticed something to do with PC weaknesses and then the same quarter, Apple reported a slump in terms of their sales in this area. So I think this is a very important one. I think it's micro technology that says that they're seeing weaknesses in PC demand and also like smartphones. Because of that, they're actually reducing their forecast for 2022 by 10% year-over-year growth. So I think that's a small thing, but it may actually have an impact across the makers of phones and PCs and something like that should be paid attention to, I would say. And beyond that, of course, the other thing is the retail, which is stuck with a lot of excess inventory. Demand has dropped, especially for, I think, goods switch to services, of course. And because of that, then they're stuck with a lot of inventory. Helen of Troy was very specific that they may check them a couple of quarters to actually go through some of theirs because they don't want to sell it on markdown. So I think that's something that is to be paid attention to. Comment?

[00:11:43] Scott: I mean, I think those two data points are on the PC decline and also the bloated inventories, both actually dovetail with the consumer questions that we were asking as well, where, we're trying to see discern where is their weakness in the consumer? And, we've Puts forward some hypotheses that we've seen on the transcript, that the lower-income consumer is getting hit harder than the high-income consumer. I think that's certainly one thing that's happening, but another thing that's definitely happening on a big scale is just the shift from goods back to service consumption. And I think so you're seeing, over-inventories, where there were goods being purchased in furniture and in fitness equipment even PCs. And then you're seeing strength again, where Sam was talking about at Darden. People are going out to restaurants and they're ordering, the biggest stake that they can, or people are splurging, Bing on travel, et cetera. And so that is probably explaining some of the dynamics in the consumer as well. As we're talking about this, but any thoughts, additionally, Sam.

"So I feel like the supply chain issues are starting to get worked out a little bit, and we’re starting to see some relief. There’s a light at the end of the tunnel.” - Stew Leonard’s CEO Stew Leonard Jr.

"The opening of new locations, which reached 47 in the second quarter, remains under pressure due to supply chain and construction issues. There are, however, encouraging signs these matters are beginning to subside, particularly in the U.S" - MTY Food Group (MTY) CEO Eric Lefebvre

[00:12:43] Sam: Yeah, That hits the nail on the head and I think, this sort of ends up becoming one of the big wild cards of earning season and just, generally speaking, the next couple of months. And I think I actually had a newsletter titled” the bullish wild card scenario”. And, people can debate whether or not it's considered bullish or, not, but this whole matter of the so-called bullwhip effect in inventories. This idea that there might be, an overcorrection going on, maybe not across every single segment of business in the economy. But we've heard about certain retailers saying certain categories now have too much inventory. There are these anecdotes about certain types of electronics where we suddenly have plenty of chips for certain kinds of electronics. And then the shift to, from goods to services you know I think prices for durable goods and that kind of thing starts to cool off., yeah, getting back to what you were saying, Scott, about China and the reopening over there everything from the ISM surveys to a lot of the regional Fed surveys. Manufacturing surveys in the last month have all noted that supplier delivery times have improved significantly. Like we’re basically going back to levels last seen in 2000 before anybody was complaining about supply chain delays and stuff like this goods are getting delivered, Pricing might be lagging a little bit, but for many categories, people have stopped complaining about this idea that they can't get something in a store, all the store shelves now appear to be stocked. Maybe the pricing is a little bit high and that's lagging a bit. It's gonna be an interesting thing to be paying attention to is. Yes, we know about China and yes, we know about these surveys about, delivery times improving. The question becomes what do inventory levels look like for a lot of the companies that are gonna start announcing earnings. And even Nike was saying that there are some areas where inventories grew a lot faster. Then sales ended up lagging the inventory growth. So, and, and all, this stuff, ordering inventory and stocking your shelves. Like this is all planned months and ahead, right? And so companies are receiving good that they ordered during a time when everyone started cutting their estimates for GDP growth. So I think this is gonna be probably the other really big thing to follow in the coming weeks: To what degree did and what industries and what categories of goods and services have there been an over-correction when it comes to inventory?

Previewing Q2

[00:15:34] Mokaya: Yeah. And Scott, maybe to pick up on what are your keys things that you're watching as we go into the earning season. I know you watch a lot of the bank earnings, which are starting this week. Are you hoping for profits or a bit of cutback going into the reception?

[00:15:49] Scott: Yeah. I mean, I assume that the earnings season is going to be rough on a lot of companies this quarter, and what I'll be looking for is the extent to which earnings are being impacted by the inflationary forces. So just margin declines in general, and then one kind of the really bare hypothesis that I'm just tracking, I'm not sure I subscribe to it though, is; As you're seeing, there was so much stimulus that was put into the economy in 2020 and 2021 that it really ramped up earnings in such an extreme way, relative to anything that I've really seen before. And I'm wondering as this stimulus has come out, did it impact earnings so much that you're actually gonna see an earnings decline from it that we actually have this inflated earnings Honestly, the only time in history that I can think of that you have like a protracted earnings decline was, the depression.

During world war II, we had a big surge, in inflation, and this was really at a GDP level. We had a surge in GDP, and then everybody said, oh, well, you're, the stimulus is getting pulled out. You're gonna go back to GDP. That's like 70% of where it was because just based on the stimulus. It turned out that inflation kept GDP down. Plus the productivity gains kept GDP where it was basically. And so that's my actual base case on earnings, but it would be just like an unprecedented thing to see earnings ramp up and then come back down from the actual fiscal stimulus that we had, not to mention the monetary.

[00:17:19] Mokaya: So, yeah, for me, perhaps to add onto that save some on tracking inventories, very keenly to see how they're doing. We've seen some quotes about supply chain easing as some also have pointed out. So mostly still watching out for that. there are some pockets as some of the semiconductor companies are saying there are some pockets where you still have some shortages, so you want to track them. And something I've learned this week is that it's really good to be early with identifying when some industries have an oversupply, and one of the industries, of course, they're paying very keen attention to is semiconductors heading into these earning seasons, how that impacts OEMs and all these other companies around them. So definitely going to be a very exciting annex season. Any closing thoughts from either of you.

[00:18:00] Sam: I just wanted to follow up real quickly on Scott, what you said about the sort of bear case scenario of earnings potential or even revenue declining because of the sort of lapsed effect of the stimulus. And, I guess it is also one of these weird iron of supply chain constraints, right? Where in many ways sales and earnings could have been a whole lot higher in recent quarters. And, I think we've heard this in at least the last two quarters' worth of earnings calls, where companies were actually complaining about the fact that because demand was outpacing supply, that they didn't have the workers, that they didn't have the stuff to sell, that it is still a matter of pent-up demand and then just from a strict government transfers the financial component of that. The conversation is concerned, There's still a lot of evidence out there suggesting that consumers are sitting on at least we consumers, are sitting on a decent amount of this so-called excess savings, in addition to what they would've saved based on trend rates there's evidence that savings are being tapped. But that's another one of those sorts. Weird wild cards in that, Maybe the remnants, the unspent portions of fiscal stimulus from a year or two ago because that's still sitting on, some people's bank accounts sort of end up becoming like a lagged stimulus. If there is a slow down that's coming.

One thing that I don't think we've mentioned, and I think it was sort of implied was the impact of foreign exchange You know there's been a lot of like notes circulating today about the impact of, a stronger dollar relative to a lot of non-dollar currencies and how that could impact I guess sort of any sort of revenue and earnings that, that ends up getting repatriated into the US. I think the dollar index is up like 16% since the beginning of the year. And it was about a month ago that Microsoft filed an 8K and actually cut their Q2 revenue and earnings guidance because of foreign exchange. I think it was really interesting that no other major companies followed up and said the same thing. They've been pretty quiet. So that seems to be something that would be of interest. I don't know, maybe it turns into one of these one-time items that, gets full, you know added back in. But I think there'll be a lot of interest in that, especially since. A strong dollar is part of this whole tighter financial conditions thing that the Fed is aiming for in the context of trying to slow the economy. So, yeah, to what degree is a stronger dollar actually eating into earnings? I think will be really interesting.

Conclusion

[00:20:38] Mokaya: That would be a good place to close the earnings season preview this week. Thank you, Sam, for joining us, and thank you, Scott. So we continue following up on the rest of the earnings season on the transcript and also on some rose stickers. See you again next week, guys. Bye for now.

Welcome to Episode 64 of The Transcript Podcast

Episode Summary:

In this episode, we discuss the Fed call, whether demand is really softening and Facebook taking on Tiktok.

The episode is based on yesterday's newsletter which is available on Substack: The free version is available here.

This week, we have made available a transcript of this podcast, with relevant images and quotes, for ALL subscribers this week. Find it after the show notes below. Become a paid subscriber to support our work.

Show Notes

00:00:00 Introduction

00:00:15 Demand Softening? 

00:02:27 The Fed Call

00:04:30 Brakes on the Housing Market

00:06:20 A Lot of Talk about Oil

00:08:11 Facebook Takes on Tiktok

00:12:37 Conclusion

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 editor of The Transcript, along with Erick Mokaya who's our lead author. We sent out a new issue of the newsletter last week, and we saw some signs that demand may be slowing. 

Demand Softening? 

For the past several weeks, we've been talking about how, even though markets have been getting concerned, we haven't seen signs of demand slowing at all. I'm still not totally convinced that this is a clear signal, which is part of the reason why we put a question mark in the headline if demand's slowing. But nonetheless, we did see some quotes that were suggesting that demand has slowed. Erick, any thoughts on that?

"We are, again, starting to see some signs of demand softening, which is exactly what we want. We don't want it to crash. We want to bring the economy into a safe position and in balance with supply and demand." - Federal Reserve Bank of Philadelphia CEO Patrick Harker

“Our ability to pass pricing on to the market as an example, because of inflation, continues to be more challenged, obviously, with consumer demand softening significantly today versus a year ago” - Winnebago Industries (WGO) CEO Michael J. Happe

"We got sequentially better on comps throughout the quarter, which is encouraging, but that being said, I think the consumer is softer," - CarMax (KMX) CEO Bill Nash

[00:00:38] Mokaya: I'm curious to know what makes you think demand is not softening . If you look at all the transcripts that we've seen in the past two weeks, I would say like 10% of them say that there's demand softening. Most of them are [saying] everything is okay, everything looks good, our pipeline is strong, backlog very heavy. So I get why you could put a question mark on it. I'm a bit convinced that there could be some demand softening actually. Maybe they're a bit too reluctant to say it. 

[00:01:06] Scott:  Yeah, I mean, I think anecdotally demand is definitely starting to soften, but I think in terms of the quotes that we pulled out, it doesn’t seem definitive to me. And I think part of that is probably the source of the quotes. Like the main quote that was saying that demand slowed was from S&P Global Market Intelligence, the chief business economist, which as an economist, I just automatically discount economists. Like part of what we do at The Transcript that I think is so powerful is that we actually are gathering quotes from business leaders, people who have actual data on the economy, aren't just looking at the secondary data or the echo data. I haven't seen in any of these quotes that we pulled out there, a clear important note of the economy from a business standpoint that was saying that they saw demand softening. I think CarMax was the closest to a company that has a lot of touch points that says there is some softening of demand, but they said sequentially better comps throughout the quarter. So it was kind of a half in half out comment on demand being softer. But that said, it's hard to believe that demand couldn't be softening given what's going on in the stock market, given what's going to interest rates. I think that it's starting to soften probably.

The Fed Call

[00:02:27] Mokaya: Yeah, I agree. The Fed chair had two meetings last week and was talking to the Senate committees which was really interesting. What I noticed is the intention to really -- he emphasizes the intention to bring down inflation at all costs. One of the researchers that I've read this past week also suggests that that could be a switch from maybe having a Fed put to actually having a Fed call. Any thoughts on that yourself?

"At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so…Over the coming months, we will be looking for compelling evidence that inflation is moving down. We can’t fail at that task.” - US Federal Reserve Chair Jerome Powell

[00:02:52] Scott: We've talked about the Fed call. Six months ago, we started calling it a call instead of the put. So I'm glad that somebody is adopting our language at least, but the main thing I've actually been thinking about this week is that usually my expectation is that a stock market would bottom when recession is clear and the Federal Reserve then starts to loosen. In this case, in the last week and a half it's very clear that a recession is/was coming or that's at least where the mindset is. But it's not so clear that the Fed is ready to start loosening. There's nothing that I've seen, that the Fed is ready to come in with looser policy. That's why I personally still tilt a little bit bearish here on when is the Fed really going to get rattled by markets selling off? And at this point, Jerome Powell and the rest of the Federal Reserve representatives who have been speaking have been very clear that the market is reacting exactly as they would expect it to. They don't seem the least bit rattled. What do you think about that, Erick?

If the Fed does not see evidence that inflation is turning, it may not welcome unwinds of the tough financial conditions stance that it has advocated so strongly. It may fear that an unwind in equity market weakness before clear evidence of a turnaround in inflation will reduce pressure on spending, slow the closing of the supply-demand gap, and help keep inflation undesirably high. This is the opposite of the Fed put and basically suggests that the Fed may push back against equity market gains until it is comfortable that disinflation is a lock - in other words, a Fed call." - Standard Chartered

[00:03:57] Mokaya: I mean, it's pretty interesting. Clearly what you can see is that the Fed are unbothered by the market. And in fact, they would expect the market to continue being rattled. Their focus right now is inflation. They would not want to cushion the market in any way. So no expectation of the Fed jumping in to help out. So going forward, I would say they're really intent on raising rates until a point where from the words of the Fed chair, that they definitively see some conclusive evidence that inflation is slowing down. And of course with November elections around the corner, they really want that down as much as possible.

Brakes on the Housing Market

The Fed's stated determination to curtail inflation through interest rate increases and quantitative tightening has begun to have the desired effect of slowing sales in some markets and stalling price increases across the country. While we believe that there remains a significant shortage of dwellings, and especially workforce housing, in the United States, the relationship between price and interest rates is going through a rebalance." - Lennar (LEN) Executive Chairman Stuart Miller

Something else that I also noticed, which is one of the things they've been focused on is the housing market. The housing market is slowly shutting off. It's actually becoming easier for people to rent than buy now because the mortgage rates are significantly up, I think around 6% now. And that's putting huge breaks on the housing market and that's a market that the Fed is watching very closely. Do you think that can change their mind in terms of how they're doing rates, especially the spike in mortgage rates?

[00:05:04] Scott: I don't know if it's gonna change their mind immediately. It probably has to get a little bit more painful in the housing market before it really changes the Fed's mind. Housing is clearly softening. Housing markets are slower than they were, and it certainly feels again, like we talked about last week, like the road runner on the edge of the cliff ready to fall, but it certainly hasn't quite gone yet. I think another quote that you picked up that was really interesting with respect to housing was from Lazyboy talking about furniture sales slowing. So this is not just the housing market for homes themselves, but all of the retail and items that go along with the house that were so hot during the pandemic. The other thing I was gonna point out on the housing thing was that obviously if housing starts to soften, then you start to see bank softening. So that's something that really starts to hit the financial sector because our money center banks are so levered to the housing market. And so, depending on the way that this all unfolds, you can certainly start to see some of the impacts that could make its way through those sectors, which are early recession indicators. These are leading sectors of the economy because they're so interest rate sensitive.

A Lot of Talk about Oil

[00:06:20] Mokaya: Another market that has been impacted this past few weeks and which has been the focus of the administration is of course the energy markets. Gas prices are significantly up. And we picked a lot of quotes from the energy markets that supply is real tight and it will be for a couple of years because CapEx or at least investing in this area -- we've been under investing in this area for a couple of years, especially the pandemic the last two years. The ExxonMobil CEO was saying that it may take up to three to five years to rectify the situation as it is. What's your take on the energy markets, especially because they seem like a very significant political play going into the election season? And at the same time, they're significant in terms of the global markets. It's one of the areas that impacts inflation a lot directly or indirectly.

[00:07:12] Scott: Yeah, it's interesting because obviously there's so many components that affect inflation. And in fact, the Central Bank says that it looks at core inflation, which is excluding energy, but from a psychological standpoint, energy and oil prices specifically are still the psychological driver of inflation. It was interesting to read that Citigroup quote, especially where they're forecasting $140 barrel oil, because you have an additional demand that's still coming online that was offline with the China lockdowns, and you don't have supply being able to rise fast enough to meet that demand.

It should not be a surprise or shock if what we're looking at are oil prices of $140, a barrel or somewhere around that range within the next three to four months going into the future." - Citigroup (C) SVP for Global Energy & International Affairs at S&P Carlos Pascual

From an inflation standpoint, you and I have been looking and seeing a lot of indicators that inflation is going to start to peak and come down. But if energy prices can't come down because of structural reasons, then it's going to be hard to see inflationary psychology come down along with inflation numbers coming down, which again would keep the Fed tighter, more hawkish for longer.

Facebook Takes on Tiktok

"We're basically shifting from having most of the content that you see in Facebook and Instagram come from your friend or follow graph, to now, you know, over time, having more and more of that content just come from AI recommendations. And as the AI recommendations get better, you get access to, you know, not just the content from the people who you follow but the whole universe of content that's out there. Our AI system can choose based on what it knows about you and what you personally are going to be interested in and learn about, what you want to see." - Meta (FB) CEO Mark Zuckerberg

[00:08:11] Mokaya: Yes, definitely. So something that I wanted to maybe close on is Facebook and TikTok. You're a big fan of Facebook, but increasingly Facebook is turning. There is something I've been reading also this week about them changing from being focused on the social graph now to the interest graph, which is very similar to what TikTok is doing. So it's like Facebook is changing the entire business to become more like TikTok in order to beat TikTok. So normally, yes, it's okay to copy. They've copied a lot of stuff from [each other], but this one is like a change of the entire business model. What's your take on that?

[00:08:54] Scott: This is why I still think Mark Zuckerberg is one of the top five CEOs in the country and should not be underestimated because literally last week we pulled a quote that was from TikTok, talking about how they have this structural advantage over Facebook because they're an entertainment platform and Facebook is a social platform and I think that that resonated really true to me because ultimately people care about the entertainment value of these things. They don't care about necessarily the social value except to which it is entertainment value. And that is TikTok’s actual competitive advantage here. And so not a week removed from that, all of a sudden we're picking up quotes from Facebook saying it's not about being a social platform, it's about being an interest graph, which is about how do you make our product even stickier? How do you make it more than our entertainment product? Which I just think Facebook's ability to reinvent itself, to continue to evolve, to look forward and hit new modalities of which the metaverse may not come to pass, but it definitely could totally displace the entire world. It's something I really admire about Zuckerberg and Facebook and I think it makes it a formidable competitor that shouldn't be discounted certainly. Probably shouldn't be 12 times earnings, but any thoughts, Erick? 

[00:10:13] Mokaya: Yeah, I agree. This is a significant change and as I was listening to you, one of his commencement addresses at the Harvard  Business School, and you could tell the way he talks of the journey from the dorm room to actually becoming - - he didn't intend to build a company that would be the networking site for a lot of people, for around a fifth, actually is it a third of the planet logging into one of the Facebook apps. So I think what you see is definitely that ability to reinvent itself when needed. When there was a shift towards mobile, they shifted and now that the world is obsessed with TikTok, they want to take on TikTok. They're not scared. They also, at the same time, have the ability to build a metaverse and also to be part of that, if it works out. I'm not convinced it will. I'm very skeptical about the metaverse and its ability to change the universe, I would say, but I mean, they're trying, and they're investing as much as they can to make sure that they have their hands and feet at all places where there's potential that they could be places where people connect to in the future.

“…the social graph was just a poor substitute for the interest graph. All people are looking for from their so-called “social” media is just media they are interested in.  Now Meta has realized their error, is burning the social graph boat, and is going all-in on being a “discovery engine..This isn’t just adding a new way to display content to friends. This is an abandonment of the idea that, until now, has defined Facebook: the social graph. It represents a shift in how we should think about social media products” - Napkin Math: Facebook’s Capitulation

I log into TikTok and once you scroll down, they try to predict what you want. And that's where I think the world is at now. People are less about finding out what their friends are up to. They just want to know what's funny, what's interesting to them that if you can predict that I liked the last football video, or at least I enjoyed it, then you can serve me more of this. Depending on the time I'm spending on that video, that would actually give you a better clue than looking at my friends, because my friends also have their own interests that I don't want to keep updated with. In fact, you go to Facebook to check out birthdays only. Other than that, TikTok is where you go for entertainment. So I think he has a case to make in terms of him trying to replicate TikTok. And I saw some statistics that TikTok is actually where people are spending a lot of time presently. I think we’ll include that graph in The Transcript to this podcast, but definitely, TikTok is a formidable opponent and they're taking them on. If you're an investor, you want to see them do that more often. You don't want them relegated to the island of irrelevance I would say. Any thoughts or should we close there for today?

Conclusion

[00:12:37] Scott: I think that's probably a good place to close.

[00:12:39]Mokaya: All right. We'll be off next week. We'll not be having a newsletter next week, but the week after, we'll be back to preview the earning season. So thank you for joining us this week. See you again in two weeks. Bye.

The Transcript is a reader-supported publication. To access all our content, consider becoming a paid subscriber.

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.

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

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 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 - - 

Conclusion

[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.

Give us feedback. Let us know if there are areas where you would want us to put more emphasis on. We want to make The Transcript better and serve you better and give you quality quotes that are able to make a difference in terms of the way you invest and in the way you look at the economy.

So thank you for joining us this week. See you again next week. Thank you so much, and goodbye.

Welcome to Episode 61 of The Transcript Podcast

Episode Summary:

In this episode, we discuss the recession fears amidst the strong consumer spending, the signs of moderation on housing, and our tweet that got a response from Mark Cuban.

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

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

00:00:15 Jamie Sees a Hurricane Coming

00:01:14 Worsening Macro, Strong Consumer

00:04:05 Confessions of Janet Yellen

00:06:03 A Strong US is Hurting Earnings

00:07:27 The End of an Era

00:08:26 That Response from Mark Cuban

00:11:05 Conclusion

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 editor of The Transcript, along with Erick Mokaya who’s our lead author. We sent out a new issue of the newsletter yesterday. It was our first one in a couple of weeks because we took Memorial day off.

Jamie Sees a Hurricane Coming

“...look, I'm an optimist. I said there's storm clouds, they're big storm clouds, they're -- it's a hurricane It's, we -- right now it's kind of sunny, things are doing fine, everyone thinks the Fed can handle this. That hurricane is right out there down the road coming our way. We just don't know if it's a minor one or Superstorm Sandy or -- yes, Sandy or Andrew, or something like that." - JPMorgan Chase (JPM) CEO Jamie Dimon

There were a lot of quotes in there over the last two weeks. The most provocative quote of the week was from Jamie Dimon, who was basically giving a hurricane warning to the economy, saying that things look sunny right now, but there's clearly some storm clouds gathering that are hurricane strikes off the coast so to speak and that the hurricane may blow through the economy.

This is what we picked up in other quotes, not just Jamie Dimon. I think people who are focused on financial capital markets,  the financial sector is very concerned right now about the storm clouds that are brewing. But people who are more focused on the real economy, especially consumer spending, are seeing that the signals are still very positive.

Worsening Macro, Strong Consumer

“Macro conditions worsened since we provided our guidance in early March which resulted in our sales being slightly lower than our expectations. Those trends have continued into Q2 and, as a result, we are revising our sales and profitability expectations for the year.” - Best Buy (BBY) CEO Corie Barry

But if you look at the data, at least through the 28th of May, the consumer was essentially spending at the same level as they were in April and actually prior to April because the trend has been in that range for quite a while." - Visa (V) CFO Vasant Prabhu

So consumers are still spending very rapidly, very strong spending from consumers, but financial capital markets are weak. In particular, venture capitalists seem to be some of the most negative of anybody that we're seeing commentary from anywhere. Erick, any thoughts on it?

[00:01:14] Mokaya: Actually mine is more of a curious question. How do you reconcile that? Because one part of the earnings calls that we read last week, some are extremely negative, especially in the financial market aspects of it, or at least social media like Snapchat. Those ones are a bit negative in terms of macroeconomic conditions worsening for them. But then the other aspect of where they're doing quite well, especially in consumer spend, I'm actually very surprised that it's still holding up very strongly this far into the inflation season that we are having right now. Three quotes there from Visa, MasterCard, and Bank of America all saying that consumer spend is strong throughout the month of May. Anyway, you can reconcile those in terms of there's a hurricane approaching, but then right now, things seem to be a little bit calm, especially in the consumer aspect of it?

"We're in North Carolina. You've got hurricanes that come every year. So we're always prepared for if we don't have a choice." - Bank of America (BAC) CEO Brian Moynihan

[00:02:07] Scott: Yeah. Dimon’s analogy was apt in that the data that you're seeing coincidentally looked sunny, but the storm clouds are off the coast and they're coming through. I think from an economic perspective where that usually plays out is just leading versus lagging indicators. Capital markets are historically the most forward-looking part of the economy. They're the ones who are forecasting what's coming down in the not too distant future and capital markets are sending a very clear signal about a potential recession here. The storm isn't completely blowing through yet, but I think the people who are watching the leading indicators are most concerned. The flip side to me on this, though, where we may be able to avoid recession is that the Federal Reserve, I mean, the inflation data that we've been tracking, which is really the reason behind this, the Federal Reserve is tightening up obviously. At the margins, it's starting to get a little bit better. We did pick up a big thing which was that supply chains are starting to heal and inventories are starting to get better. Also, the fact that you are seeing China open back up, these are things that should help the supply chains and should help put negative pressure on inflation.

"Right now, it’s very hard to see the case for a pause--We’ve still got a lot of work to do to get inflation down to our 2% target. We’re certainly going to do what is necessary to bring inflation back down. That’s our No. 1 challenge right now." - US Federal Reserve Vice Chair Lael Brainard

“I support tightening policy by another 50 basis points for several meetings. In particular, I am not taking 50 basis-point hikes off the table until I see inflation coming down closer to our 2 percent target” - Fed Member Christopher J. Waller

And this may allow the Fed’s step back from tightening quite as much as it had been. That said last week, there were quotes from the Federal Reserve saying that they're not ready to step back from tightening. The political pressure on the Fed is very clear at this point. We're going to the midterm elections in the United States and inflation is the number one issue that people are voting based off of. And so the politicians are talking about inflation. The Fed is feeling that pressure. And so it'll be pretty difficult for the Fed to change course, probably through the fall, as long as we have those elections going on. And so that is just one more element of the storm clouds though. And the Fed happens to be the biggest driver of cost capital and for directions of securities markets generally.

Confessions of Janet Yellen

"...I think I was wrong then about the path that inflation would take--there have been unanticipated and large shocks to the economy--that have affected our economy badly that I, at the time, didn't fully understand, but we recognize that now" - US Treasury Secretary Janet Yellen

"Janet Yellen finally did come out and say I was wrong. I mean, everybody is giving her all this credit for the Mea culpa like what took so long? Like how clear did it have to be to kind of admit you were wrong, right? Like how long ago did inflation go from 2% to 4%, 4% to 7.4%, and then 8.5%. And you have to ask yourself like, where is inflation really today?" - RH (RH) CEO Gary Friedman

[00:04:05] Mokaya: The only problem though, is that this past week also Janet Yellen came out and said that they made a mistake. I think they say they were wrong about the path that the inflation would take. I still keep hoping that the Fed should really be subscribers to The Transcript at the end of the day so that they can be more data-driven than they claim to be. Because these are things that we were highlighting from very early on, and it does dent a little bit of their credibility. And I think it's RH CEO, Gary Friedman who was talking about what took them so long. Like clearly did you have to wait until 8.5% for you to actually say that we are wrong. So there've been steps along the way that they've missed out on. So I really do hope whoever is listening and is close to the Fed can tell them to subscribe as much as possible.

[00:04:49] Scott: Yeah, I mean, I think our data is supporting that the Fed probably could get to a more neutral rhetoric. They're in a pretty tight rhetoric position right now. Obviously, the rate itself is very far from neutral. It's extremely accommodative, but they could potentially go to a more neutral rhetoric. Still, they just produce so much extra liquidity during the pandemic and have stimulated so much interest rates still so low for the past 15 years, that there's still a lot of inflationary pressure and the economy so it's a tough job. Everybody's saying it's a tough job. They have not made it easier on themselves.

"I think the European consumer is much more stressed about what's going on in the world. They're talking about mid-teens inflation kind of numbers hitting there. They're talking -- they've got a war going on in their backyard. They've got Russia threatening to cut off their gas supply. Energy price is up tenfold. And so there's much more kind of anxiety and stress there, and it changes in behavior. There is changes where people are trading down to private label." - Hain Celestial Group (HAIN) CEO Mark Schiller

[00:05:26] Mokaya: If you think they're Fed a tough job, you should see what the ECB is up to. They have a tougher job because inflation is running into the tens and twenties in some of the countries in Europe. The difference between here and the US is it's hard to coordinate the actions of central banks across Europe. I think it was Hind Celesta Group CEO who said that the European consumer is much more stressed about inflation. Europe is very close to Ukraine and Russia, where all these triggers of some of the inflationary aspects that you're seeing are coming from. So I think that's something that we should pay attention to. 

A Strong US is hurting Earnings

"I'd say if you saw the 8-K today, it was purely a currency fluctuating in strength. The continued strength of the dollar essentially is what we talked about in that filing. And we're obviously incredibly bullish on just about everything else that we have." - Microsoft (MSFT) CMO Christopher Capossela

But something else I came across, Microsoft reporting the strong USD is actually impacting their earnings. And it's very rare for Microsoft to actually - - it’s one of the companies that people watch very closely during the earning season. The demand is okay. The aspect of it that they are most worried about is the USD. 

"Debt issuance volumes have been extraordinarily weak year-to-date….And May is normally, from a seasonality perspective, a very important month for issuance. And looking at that weak month of May and particularly hardly any activity in the below-investment-grade and leveraged loan space, we realized that the guidance we gave a couple of weeks ago was not applicable" - S&P Global (SPGI) CFO Ewout Lucien Steenbergen

And the second thing of course was about debt issuance, volumes are weak. Very very weak. I think for S&P to come across and say that May is usually the strongest month, or at least it's an indicator of the rest of the year and that May was really bad. So I think they are expecting a really bad year going forward. And of course, Jamie Dimon was not mincing his words about the provisions aspect of it, especially in tough times and releasing and the accounting aspects of it. So that was a bit of an interesting quote. Any thoughts on any of those aspects?

[00:06:51] Scott: Yeah, I mean, I think the strong dollar aspect will certainly be a hit to earnings for the index. In general, I've never seen that really translate through to significant change in securities prices. Usually, investors tend to look through that sort of thing, but it is noteworthy and could contribute to some missed earnings results next quarter as we were looking at it. It is also, though, should be noted as another marginal headwind to inflation.

The End of an Era

"The era of being rewarded for hypergrowth at any costs is quickly coming to an end--With the cost of capital (both debt and equity) rising, the market is signaling a strong preference for companies who can generate cash today" - Sequoia Capital

So I think two quotes that stood out to me for the week both said, end of the era. One was for the VCs’ end of the era of unprofitable growth and people thinking this was from Sequoia talking about how companies need to focus on cash flows in the near term.

"The housing market is sending clearer signals that the pandemic-driven housing frenzy is coming to an end” - Redfin (RDFN) Chief Economist Daryl Fairweather. 

And then the other was the end of the era for the housing frenzy that we had seen throughout the pandemic. And this one is a really interesting one, just because it's, again, as we've been tracking this long marketing cycle, especially of housing. It was such a hot place during the pandemic. And we're really starting to put some distance between where we are now and where the pandemic mindset was. And so, especially as interest rates are rising, you're having headwinds on the mortgage side in terms of affordability of housing. You're seeing that you're kind of closing a chapter on the economy there, but you still have a very low amount of inventory. And so home prices have some support on that side.

That Response from Mark Cuban

[00:08:26] Mokaya: So for me though, to maybe finish up the week, I would really urge anyone who has time to really listen to the YouTube CEO Susan Wojcicki, I can’t pronounce the second name very well, but she had a really long talk. I've never really heard the story of YouTube from the very beginning. And one of the quotes I put out was talking about how Mark Cuban responded to the first time they were making the position to buy YouTube. She made a proposition to Google to buy YouTube for, I think 1.26 billion or something. And then the response from Mark Cuban back then was that only a moron would buy YouTube. So I posted this on Twitter and surprisingly, Mark Cuban himself responded to the tweet, and it is pretty interesting to see Mark Cuban respond to a small tweet from The Transcript, but it seems like it touched a bit of a raw nerve somewhere. What are you thinking back then when Google bought YouTube?

 [00:09:30] Scott: I wish I could say that I saw the potential for YouTube to grow into what YouTube has been. And obviously, that has been fairly broad. That YouTube is one of the most incredible businesses in its own right that exists in the country today. And you know, the foresight that it's Google to purchase YouTube, and the fact that Google has not only number one in search, but then also. YouTube is something just as unfathomably great about the company to me. The assets of that company really are spectacular. So yeah, it was funny to see Mark Cuban get called out for that. I think that there's a lot of things that a lot of people say that probably don't age so well. And we live in an era where the internet can remind us of all the dumb things that we said at any given point in our lives. So Mark, thanks for being gracious, but don’t take it too personally, hopefully.

[00:10:27] Mokaya: I hope so too, but it's a great interview all in all. I mean, one of the things that YouTube is trying to do is actually, they're trying to tone it down by I think the end product is trying to compete with Amazon. That's a very interesting aspect because I've never known Google to have ambitions in terms of moving into the retail business. But I mean, they have the capacity, they have the data and they can easily compete with Amazon if they wanted. It's incredible growth from spending $1.7 billion in acquiring it and now generating around $7 billion in revenues per quarter. It's an incredible piece of business so to speak so we can all get it wrong sometimes.

Conclusion

So thanks to Mark for also responding to that. So I think we'll finish up there for this week. Thank you for joining us this week for The Transcript podcast and continue being a subscriber and supporting our content. Bye.

Welcome to Episode 60 of The Transcript Podcast where we discuss the key themes and takeaways from the Q1 2022 earnings calls.

This is a special episode of a recording of a Twitter Spaces conversation we held on Wednesday, 18th May with our guests:

* Sam Ro of Tker.co

* Alex Morris of The Science of Hitting

* Mostly Borrowed Ideas of MBI Deep Dives

This week’s episode and transcript are available to all our subscribers, both paid and free. Become a paid subscriber to enjoy access every week:

This review is brought To you By Stratosphere Analytics:

Stratosphere makes it easy to get the financial data you want and to develop beautiful out-of-the-box graphs for your research process. No more complex user interfaces, no more limited historical data. You will get access to:

* 10 years of historical financial data & customizable views

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Show Notes

00:00:00 Introduction

00:07:18 Macro Perspective from the Earnings

00:17:27 Historical Context for the Current Market State

00:32:32 Intersection of Tech & Consumer 

00:36:48 Valuations

00:41:12 Q2 Outlook & Closing Thoughts

Introduction

[00:00:00] Mokaya: Welcome to our Twitter spaces. Thank you so much for joining us. My name is Erick Mokaya. I co-write the Transcript. Once every quarter we get to analyze what we learned from the earnings. We tried to hold it after the earnings season is over. Mostly the earning season for Q1 is behind us, except for retail companies, which are reporting this week. But most of the companies have reported, especially the big tech, the banks, and all. 

We have really good speakers today. Sam Ro writes a lot about some of the key takeaways, especially the macro stuff from the earnings calls. MBI does really deep dives on specific companies, and Alex Morris does a lot of deep dives on specific companies especially trends in streaming. I’d want them to introduce themselves and start with the Sam Ro, then MBI, and Alex Morris in that order. Sam, welcome.

[00:00:50] Sam: Thanks for having me. I'm Sam Ro, I write the Tker Newsletter. You can find it on tker.co. It's also all linked on my Twitter profile. I spend a lot of time writing about how market activity and short-term economic news and data fit into longer-term themes and longer-term trends. I write a lot for longer-term investors who are looking for some historical context and data that'll help them understand what's going on in the news today in the context of their long-term investments. So yeah, that's me. Anything else you wanted me to add off the top?

[00:01:24] Mokaya: Maybe you can tell us, how did you develop your interest in earning calls?

[00:01:28] Sam: I used to write for a couple of stock picking newsletters about 15 years ago before the financial crisis if you can believe that was a thing then. I spent my entire full-time job, I guess about a third of the time, thumbing through earnings calls to get the details you need to fill out DCF models and stuff like that. But I was always really interested in what executives would say on earnings calls because every once in a while you get those sort of interesting anecdotes from the front lines of business where they'll tell you what is going on with their customer behavior. 

And consumer behavior can provide some really unique insights as to what's actually going on in the economy. I'm a huge fan of what's going on, especially with earnings calls because a lot of this stuff is off-script and even though all these execs go through all of that training to not say anything ridiculous, they will go off script a little bit and we'll share things that you normally don't see in press releases. Earnings calls are incredibly interesting and insightful and if you have time, it's always great to be listening to them.

[00:02:32] Mokaya: Great. MBI.

[00:02:33] MBI: Hi Mokaya and everyone. Thanks for inviting me. My name is Abdullah Alrizwan. People usually call me MBI on Twitter. MBI is the abbreviation of my Twitter name Mostly Borrowed Ideas. I write MBI deep dives. I write one deep dive every month. Apart from doing a company-specific deep dive, I try to follow closely the companies I own in my portfolio and also follow earnings calls from time to time whenever they're happening. That's pretty much what I do. Mokaya asked me before to talk about why I love to follow earnings calls. Well, first of all, many of the companies that I follow are in my portfolio, so just based on pure self-interest I need to follow these companies. 

The other thing is it's just a better way to grasp how things are going in the economy. Earnings calls in many ways can be a great way to understand businesses. Sometimes the management as Sam was mentioning is willing to share things that you wouldn't find just by going through the public filings, like 10Ks or 10Qs. Sometimes an analyst would ask questions and in response to these questions, management would share some interesting sometimes unique insights. And also just because of the sheer size of some of these companies, you tend to gain a better understanding of how certain aspects of the economy are fairing. I remember back during COVID time there was pretty much a dichotomy between reality and what we are kind of seeing in the stock market. 

The market was 35% drawdown, macro was kind of going up against our intuition. And at the same time, we were stuck at home, so there was a kind of a dichotomy between how we are kind of living our day-to-day life and how the market was reacting. And similarly even today we are kind of seeing a similar dichotomy now. We are going out, people seemingly spending more time outside, they're spending money, and they're generally enjoying life much more than probably they did in the last couple of years but in the market, we're seeing quite the opposite. The market is going down so obviously markets trying to tell us what may happen maybe a year from now or two years from now.

[00:04:36] Mokaya: Alex.

[00:04:37] Alex: Thanks to the Transcript for putting this together as always and excited to be here with Sam and MBI, some good speakers. My name is Alex Morris. I run the TSOH Investment Research Service. Long story short, I worked on the buy-side for about a decade and I've been writing online for about a decade. In April 2021, I left my role to launch a full-time research service where I essentially share all the research that I'm doing on a daily basis for subscribers. And then anytime I make any portfolio changes, I disclose those to subscribers before doing so. 

I use quarterly calls and transcripts really as a way to kind of verify and build confidence in my long-term investment process, which is really focused on partnering with honest and able management teams. I think when management is communicating with you directly, whether it's at an investor day or a quarterly call or shareholder letter, those are the opportunities where you get to see someone in action. And you can find things that are really encouraging or at times you find red flags that can be checked on and maybe informative in terms of how you react to your investment. So that's really how I use it as trying to frame the commentary in terms of the long-term strategic direction of the company and the quality of the management team.

[00:05:49] Mokaya: Great. In the Transcript, my co-author is Scott. Scott's here now. Maybe you can introduce yourself.

[00:05:55] Scott: Hey everybody, Scott Krisiloff. I am a co-author of the Transcript. Erick and I have done this together over the course of like 10 years now, it seems like Erick. We rebranded as the Transcript, I think two or three years ago. We were Avondale Asset Management earnings call notes before that. Why do I read transcripts? I think that the management teams that contribute to the transcripts obviously are leading these companies have some of the best views of what's going on in the economy. Where information asymmetry really comes out is in earnings call transcripts. My theory on this always was that everybody has a story to tell, but not everybody's listening. Every one of these management teams has people on the call, but the whole market doesn't necessarily digest all of the insights that they have on those calls. 

There have been many many times well-documented throughout the life of the Transcript, where we read a tidbit of information in one company's earnings calls that actually means something else for a different company, and we're able to highlight that for readers as an actionable investment catalyst. Personally, I manage my own money based on the things that we see in the Transcript. So really whatever the headline is in the Transcript from week to week, whatever the coincident indicator of the economy seems to be the right way to position my portfolio over and over again. So this is really core to my personal investment process.

Macro Perspective from the Earnings

[00:07:18] Mokaya: All right. Thanks, Scott. Let's dig right into it.  I'll start with Sam. Sam, maybe you can give us a macro perspective from what you learned from the earnings calls this Q1.

[00:07:28] Sam: Great. Thanks. I was preparing for this call last night and thumbing through my notes, and I think it's really hard to compete with what Target said today. In their earnings call on their press release, they really sort of checked off a whole lot of boxes. And of course, because their earnings announcement was today, it's probably the most timely perspective on what's going on both in retail as well as sort of the macroeconomic situation. I think there are probably like three things that came out. I'll start with this first quote, “Guests are focused on getting back to many of the habits and behaviors they suspended during the heart of the pandemic, including travel, out-of-home activities, and social gatherings. Importantly, even as the mix of what they're buying continues to evolve, their spending capacity continues to benefit from elevated savings rates, high employment, and healthy wage growth.” 

Those are two gigantic macro themes that are happening right now in the economy. So that first part, what they said about people getting back to travel, out-of-home activities, and social gatherings reflects this huge shift that we're seeing in consumer spending right now, where we're consumers are shifting from buying goods that they were spending on during the early part of the pandemic since they couldn't go on anywhere, they just shop on Amazon all day long buy furniture, home gardening equipment or whatever it is. People are going out and doing stuff. And this was echoed earlier this week when United Airlines filed that 8K where they had to revise upward their revenue estimates for the rest of the year.  The consumer is doing stuff. They're probably not buying as much stuff as they used to, but they’re certainly doing stuff. So anything that involves services especially when it comes to travel and vacationing, all those areas are doing particularly strong, and, Target was willing to say that upfront. Related to that second part of that quote, I just mentioned they're talking about consumers, “Their spending capacity continues to benefit from elevated saving rates, high employment, and healthy wage growth.” These are the big three things that are driving the consumer's capacity to spend. 

Excess savings is one that a lot of folks have been talking about but sometimes gets under-covered. This is all the extra money above-trend savings rates that consumers put away since the beginning of the pandemic. This has accumulated to about $2 trillion worth of extra savings that consumers have. And high employment, I think is also something that's really important to remember. Just in the first four months of this year, US employers have added 2.1 million jobs. These are 2.1 million people who went from not having income to having an income. This is very important, especially in the context of wage growth conversations. 

You can't forget the fact that a lot of these wage growth measures don't account for the fact that there are these 2 million people who are now working as opposed to not working. Now, I understand some of these are second jobs or whatever, but the point is that this is a considerable source of incremental income for the consumer. So the consumer is very healthy. And the other thing I would note is that this is why I particularly see value in listening to earnings calls, Target didn't have to say this, they could've very easily managed expectations and shifted the tone a little bit and they did mention this a little bit, but they could've really focused on this whole idea that we're starting to see cracks in the consumer.

Consumers are getting a little bit more conservative and all this stuff. And while they may have mentioned that a little bit the fact that they are continuing to reiterate this point of elevated savings rates and high employment is just as solid a confirmation as it gets that here's yet another business that understands that the consumer is strong. So those are the first two points in terms of the macro. And then the third point and Alex just tweeted this before the call, this is another quote from Target, and this is in regards to cost. And so the quote starts, “Actual conditions have been much more challenging than expected. For the year, we're now expecting around $1 billion of incremental freight costs, even compared to our expectation three months ago.” 

For you guys who have been following the corporate story and the inflation story, inflation has been a concern for at least a year now. The word inflation itself has been repeated over and over, and it's really sort of coming to a head right now. But even with all of that lead time in terms of understanding that there was inflation in the pipeline a company like Target has all the information in the world when it comes to logistics, lowballed their costs by about a billion dollars. That speaks to how unexpected, how intense, and how sort of unprepared a lot of companies were for the amount of inflation that we're continuing to see. 

Maybe it's a matter of people sort of not expecting inflation to have persisted for this long, but I guess that's what we can say about the Fed as well. But I think that Target really sums things up from my perspective today. And just to summarize consumers are going out and doing stuff far more than they're actually purchasing stuff. Two, consumers are very healthy. They have a lot of savings, people are still going back to work, and they are experiencing wage growth. And three inflation has been higher and hotter and more persistent than even some of the savviest corporations could have expected. That's sort of from my perspective, the state of the business environment as told through Target's eyes.

[00:12:47] Alex: It's a great introduction. I think there are a couple of things I just add to that. On the first one, in terms of Sam's comment on goods to services, you look at a company like Airbnb, they just reported the strongest quarter in the company's history. Nights and experience booked crossed the hundred million bookings for the first time. Another example, Disney domestic parks are absolutely slammed. People are spending significant amounts of money. And again, in both of those cases, there's still a fairly significant problem with international travel. It's a meaningful part of both of those businesses, and yet they're still seeing some of the strongest results we've ever seen. 

So I think it really speaks to that good to services shift that Sam talked about. On the other point about, Target and Walmart collectively generate more than half a trillion dollars in retail sales in the US alone. And it's pretty amazing to think as Sam called out, retailers have been talking about the cost of shipping and freight costs for six months, a year now or longer. It's pretty amazing when you hear a company like Target come out and say, the change in the past three months has blindsided us so much that it's a billion dollars of incremental cost. As a reminder, this is a company that had a huge tailwind in the last couple of years, but this is a company that in 2019 generated less than $5 billion of EBIT. That's a very significant cost increase. It's about a hundred bips on sales. 

I think the other really interesting comment that they made and it really echoes what Walmart said yesterday is it's always the last lever we pull, but external conditions led us to raise prices across a broad set of items in multiple categories. As you've seen in recent quarters, overall costs have been rising much faster than retail prices resulting in year-over-year declines in our gross margin rates. So they're taking pricing because they have to, and it's pretty clear from their commentary that for the core, call it CPG and food products that people need. Obviously, they're going to keep buying those things. 

In some of these other general merchandise categories, whether it's TVs, appliances, outdoor furniture they're seeing a major headwind there in terms of what they're putting through. And, Walmart specifically said, “While we're happy, our inventory is up because we need to be in stock. It was a 32% year-over-year increase, that's higher than we want it. And it's going to take us a couple of quarters to work through all this.” It's an interesting time, and the consumer certainly seems strong when you look at certain businesses, but a data point like that to me, kind of suggests maybe that's starting to crack a little bit, especially as costs continue to skyrocket as we all see when we go to the grocery store.

[00:15:06] MBI: Just to add to both Alex and Sam's point, when I think about all the transcripts that I read and all the earnings that I followed over the last quarter, one thing that kind of became quite clear to me is that the last two years have been an insanely difficult operating environment for these businesses. And I don't think we as investors, perhaps appreciated how insanely difficult the last couple of years has been. Just quickly refreshing our memory we had COVID and if you think about a key e-commerce operator, like Amazon, demand overshot, and Amazon in the last earnings call, they mentioned we quickly transitioned from being understaffed to being overstaffed resulting in lower productivity. 

And so you started from COVID, demand shot, and then you have Omicron, China COVID shot, Ukraine war, this led to supply-side disruption, and you've had persistent high inflation, 8% that's like 40 years high in US history. You also had the work from home and the rising cost for tech talent, so it's been just incredibly difficult to forecast demand, resolve supply chain issues, and also manage costs. It's like the perfect storm, as Alex mentioned. It's been a very difficult environment even for some of the best operators out there. And, one of the concerns that I personally had as an Amazon shareholder is whether this is an Amazon-specific thing, whether they have kind of bungled it up in terms of how to respond to some of these challenges. 

And just listening to Walmart or Target's calls, it's abundantly clear that it's not an Amazon-specific thing. It's just an incredibly difficult operating environment for these businesses, and it may take a while to transition into a more normalized environment. But this feels like more of a macro thing rather than an individual company's specific thing. Usually, in an environment like this, the difference between good operators and average or below average operators becomes and more clear the longer it goes on. The difference between a competitively advantaged business versus a less competitively advantaged or commoditized business will be more and more apparent. 

That's one of my biggest takeaways, just this realization of how incredibly difficult this has been for the operators. I know investors have lost money and investors have their own issues and problems and challenges but I think we should probably take a moment and understand how incredibly challenging the last two years have been for the management and operators who are running these businesses.

Historical Context for the Current Market State

[00:17:27] Mokaya: Scott, maybe you could give us a little bit of historical context as to some of the happenings in the market

[00:17:32] Scott: Sure, thanks for the plug, Eric. For those who don't know, I read every Time Magazine in history from 1923 to 2000. Eric and I on our podcast weekly cover a lot of, not only the Transcript but also historical trends from different cycles. And in the quarterly letter that we wrote this week and distributed to readers, we talked about a little bit at the end, some of the historical analogs for the period, and we've covered a lot of management teams talking about how no one's ever really operated in an environment like because we've had relatively low inflation for the last 40 years. If you were 20, 40 years ago, you're 60 now, you're basically towards the end of your career. 

But there's certainly have been massive inflationary periods in US history. And one that always felt super analogous to me, in this case, is the post-World War Ⅱ period because in the 1930s you had deflation. The deflationary period was ended really by a global event in World War II. In which that global event, you had the federal government investing heavily into the economy to address the event, and in that case, putting money directly into consumers' pockets by employment, because we had a really labor manufacturing economy at the time. So you had that, and then you also had the supply chain shocks that you have today.

You've had massive disruptions. We didn't actually produce any automobiles for several years during the war. And so when you came back out of the war, you had a retransmission phase where you were bringing the economy back into a consumer mode, you had supply chain disruptions, and you also had consumers with just a lot of money in their pockets. And the way that they dealt with inflation at that time was with price controls. So you had price controls that were kind of being lifted and you have large double-digit inflation. And actually, during that period, you had transitory and the fact that it was like a few years' worths of inflation and then ended up going away. 

The reason it went away was the federal reserve ultimately came in and started raising interest rates there, and so that was kind of the end of that. You had a big inflationary period, and that was where you saw the value of the dollar get cut in half just through that. And then you have the other big inflationary period in the 20th century, which is kind of 1966 through 1981/82. And that was driven just by monetary push inflation, the federal reserve, and government spending being much higher than it should have been. And you had just this chronic inflationary period in which you would have the economy recover from recession with easy monetary policy, and then you would have the Fed come in and tighten monetary policy again, and then you would go back into recession. You just had a ratcheting up of interest rates. 

The Fed always has had a bias towards being looser than the economy probably needed until Volcker came in. And that's again where we find ourselves today. The federal reserve talked about this transitory inflation throughout 2021 and never really addressed the thing that we saw management teams talking about consistently throughout the year, which was, that this is actually the largest inflation that we've ever seen. There's nothing transitory about this and policymakers should be addressing this. The federal reserve decided not to address it, and consistently just has a bias towards dovishness it seems throughout the last 15-year period. We may be entering an inflationary cycle, higher costs of capital, and that's what on a macro basis we're seeing in markets today.

[00:20:42] Mokaya: Despite the challenges in terms of inflation and all, the consumer is of course a bit resilient. And most of the earnings calls are talking about how the consumer is doing well, and how he is strong. And even the federal reserve chair yesterday was also saying the same thing. Something else that we noticed is that the Microsoft CEO said that IT budgets are not being cut and that some of the companies that are benefiting in these kinds of times are companies that have been in the tech space. I know MBI, you follow a lot of the big tech companies and also Alex. So maybe you could give us a bit of perspective on some of the key things that you heard in the earning calls of some of these big tech companies. We can start with Alex.

[00:21:19] Alex: Yeah. I don't follow a ton of these companies, I follow the really big ones fairly closely, and there was a lot of consternation about what the results would look like. And I know especially well for Microsoft because I followed it for a long time, and at the end of the day, I think it's pretty fair to say that they just crushed it. It was another very impressive quarter across the board. And as you noted, Satya Nadella said, companies don't really look to this as an area cut, because it's what drives efficiency and is so important to productivity, strategic vision, and everything about running a business. So it's a place that you might actually look to spend in tough times as opposed to cutting because it's the way that you become more efficient. 

In terms of actual results, the Microsoft Cloud is now at just shy of a hundred billion dollars in run-rate revenue. It's still growing mid-thirties, and it's just become a massive business. It's larger than the company's entire revenues were five or six years ago. AWS was widely accepted as the leading player in this space, call it 15 years ago now, and it's just really amazing how this has just really flipped things in the tech world and in the business world broadly. But I think the results there have been really strong. These companies have a lot of considerations on things like compensation and when the stock market starts to do really poorly, especially for some of the smaller players in the tech land. 

I'm sure it's very difficult for them to retain employees who see a fairly significant percentage of their compensation stock and, might wake up one day and go, Hey, my comp over the last four years, I thought it was 400K a year, and now it's 180K a year or whatever the swings can be. So you're even seeing companies like Microsoft have to come out and be pretty public about ensuring that they're continuing to improve employee relations through higher comps. So I think they'll see this as well, but they certainly seem to be well-positioned relative to some of the smaller and younger companies that are in a much less secure place in terms of the strength of their balance sheet, but also just in terms of the underlying strength of the business.

[00:23:15] MBI: Alex made some pretty strong points here. I did not get a chance to go through Microsoft earnings or Apple earnings, but I kind of did go through Amazon, Meta/Facebook, and Google's earnings calls. Broadly speaking, I think earnings this last quarter were generally okay to find markets at this point are much more concerned about maybe two, three quarters from now, than what's going to happen like this and next quarter. Markets are always an expectations game and it's always trying to understand or incorporate the future. There weren't a lot of concerning materials that I have heard or read in the earnings calls. Amazon mentioned Prime members have meaningfully increased their spending since the start of the pandemic and that they are consistently renewing at high renewal rates. 

But they did also mention that they're not immune from inflation pressures on the cost side which is generally known and acknowledged especially with rising fuel and transportation costs and all that. The retail side of the business is much more exposed to the inflationary situation. But they're first-party businesses certainly much more exposed down there. Services business, which is the third-party business, or even AWS. AWS, GCP, or even Microsoft Azure, are oligopolies and reasonably competent, really advanced multi businesses. I know most people are talking about inflation and how exposed they are to the retail side of the business, but what really stood out to me from Amazon's earnings is basically AWS's EBIT margin. They posted a 35% GAAP EBIT margin. 

I remember when I started looking at Amazon sometime in 2019, and the biggest concern at that time around AWS was that their margins are too high. It used to be probably 30% in 2018 or somewhere around that, and in one quarter or two, it came down to 26, 27%. And then the talk of the town was that these margins are too high, it’ll eat the commodity business, Microsoft Azure is coming, GCP is coming, and margins are going to go down. And since then in the last two, three years nothing of that sort has happened. All three companies have continued to grow at a rapid pace. GCP is growing at a 45% CAGR rate over the last two, three year period. AWS is growing at a pretty crazy rate. 

I don't think in the history of capitalism, any company with this sort of a top-line is growing at a speed that AWS is growing. They're growing at 68% year over year which is just insane when you think about it. So the fact is that after all these concerns AWS has accelerated its growth and at the same time they are posting higher and higher margins. To me, that's going to be perhaps the bigger story three, four years down the line. Inflation is consuming all of our attention today and that's no doubt that's a relevant topic, and that can derail things, and the operating environment can be very challenging for the retail side but the more I look forward to it, I think one of the biggest takeaways from going through earnings calls is how strong it always has been.

And it's not like, they are growing at the expense of the other two, everyone is growing. And I think that the Cloud has been a strong secular force, and that's going to be tested if we face a recession. One of the uncomfortable things about big tech is some of these companies weren't really built at this size and scale during the global financial crisis, everyone talks about how digital ad, advertising like Google and Facebook or Meta, like will face severe headwinds if there is a recession because advertising tends to be cyclical. But we just don't quite be sure to what extent and whether they will be affected. There are some points and counterpoints about whether they’ll be affected at all, or even if they do, maybe it's not going to be as devastating for them as it used to be, let's say, in the linear world or in the physical world. 

Lots of unknowns and markets seem to be at this point trying to price all the unknowns, but the fact of the matter is in many cases we don't have a quite clear-cut answer. We don't know how affected Cloud will be. Intuition says that it's actually much more cost-conscious to move from on-prem to cloud, and there is a reasonable case to make that secular force would probably be accelerated during a recessionary period, but that remains to be seen. At the same time, in digital advertising, there's a point that even if we faced a recession next year, it's possible that we may see strong positive nominal growth. Real GDP may see some headwinds and may decline a year from now, but if inflation presses this would be a positive nominal growth environment. 

And in that case, it's possible that since these are auction-based systems, the revenue top-line may not be affected much for Google and Facebook. The other thing from Facebook call, the operating environment has changed a lot in a very short period of time. The companies are probably reassessing a lot of the costs to make sure that they are spending in a way that has a greater ROC and greater profitability going forward. And, it's going to be much more under the scanner as we kind of navigate through this challenging environment. Facebook is freezing their new hires. They're also cutting down on some of their expenses in Facebook reality labs. One of the things that I personally I'm trying to understand and look forward to figuring out more as we go through the rest of the year is to what extent some of these big tech companies have discretionary expenses.

 Amazon talked about overbuilding, Facebook's costs have risen at a crazy rate, and its capital has gone up at a crazy rate. Google has been hiring a lot, and they have said they'll continue to hire at an accelerated rate going forward. Although I doubt they'll be able to follow through with that promise. If they have a lot of discretionary expenses in a difficult operating environment, their earnings may not go down, even if their growth slowed down materially. Even if they are, gross margins get somewhat pressured for some of them but overall maybe operating margins or net margins or net profitability may not go down as materially as perhaps the market is pricing at the point. But then again, I just also want to disclose that Google, Facebook, and Amazon are three of my largest holdings, so I may have my own biases there as well. I look forward to kind of figuring it out as we move to the rest of the year.

[00:29:26] Sam: Hey Eric, I just wanted to add something real quick to your initial question about CapEx and IT/tech investment. And just real quick zooming out a little bit, early a couple of weeks ago we got the latest monthly report on durable goods orders from the census. This is surveying every business in America. And one of the sub-components of this survey is technically its called non-defense capital goods orders, excluding aircraft and the shorthand for that as core CapEx and a little bit more informally, this is CapEx business investment. As of March, which is the most recent reading, that number for core CapEx orders, these are business investment orders by businesses, hit a record high of 80.8 billion. 

And there's also an outstanding backlog for this equipment, this stuff hasn't been shipped yet and has also reached new record highs that are way above pre-pandemic levels. So just sort of like a general matter when it comes to CapEx spending, businesses are still ordering equipment like crazy and the stuff hasn't even shipped yet. And so as far as what the outlook looks like for the businesses that provide capital equipment, whether it's computer machinery or water pumps or whatever it might be, the outstanding demand and excess demand for a lot of this stuff are still really high. It's one of these huge tailwinds when it comes to the manufacturing industry, this whole matter of businesses still trying to get CapEx equipment under their roof so that they can conduct business.

[00:31:01] Alex: I just want to add one thing real quick to what MBI said because I think it's really interesting, at least less than for me or something that I'm seeing now, especially as we come out of this quarter and probably the best place to see this is in the video-on-demand space. Most notably, Netflix came out and had a very difficult quarter with big changes in long-term expectations. And, I think that was met with, on the subsequent calls from every other major media company, some assurances that, Hey, we're focused on spending efficiently, which they always should be, but a company like Disney came out and said, Hey, we're not going to spend 33 billion this year. It's going to be 32, really small changes, but just kind of signaling where their attention and focus go. 

And I think you can just focus on the industry that a company operates within, direct competitors, and think about how those things flow through the whole industry, and what impact that has as we see a different part of the cycle. But even to MBI's point on a company like Amazon, you think about it, the big tech companies have their hands in a lot of different places where direct competitors are somewhat supplemental to the other operators in the business, whatever it may be. You can imagine that someone like Jassy coming in as CEO and very new in the job kind of reassessing some of the priorities and thinking about whether it's retail stores, whether it's their interest in the video business, whether it's their interest in podcasting. There are a couple of different layers where I think you can see how a period like this may have a pretty big impact on how companies think about where they want to focus their resources and their time and attention.

Intersection of Tech & Consumer

[00:32:32] Mokaya: I want to pivot a little bit to maybe the intersection of tech and consumer something that has been a big talk of the town, the past two or three months is the issue of streaming services and how they're doing. And one of the quotes we picked this quarter was about YouTube and the scale at which YouTube is operating, which is pretty impressive, and the way they're positioning themselves as competitors to the streaming services. I want you to find out what your hot takes are on this area of streaming, and what's your key takeaways, especially as Disney and Netflix, pivot into providing ad-supported tiers. Maybe you could start with Scott this perspective because you've also been following this on the Transcript for a while.

[00:33:09] Scott: Yeah. We've been talking about this for several months Mokaya and we have a podcast from a month or two before Netflix reported earnings talking about how it could be down 25%, and that ended up being the case. I think that what we're seeing is saturation for subscription services and people have been subscribing. There hasn't been quite that much competition for a long time, and we saw competition has been intensifying over the last several years like Disney Plus, Paramount Plus, Peacock coming into the market, and Hulu. But you're just starting to see them sort of mature into having enough distribution and distribution channels where there's fragmentation now in the streaming market. And it's actually hard to figure out where you're going to watch anything. 

And the last few months, even nights, just as a consumer, I've been flipping around trying to find channels on my Apple TV or things to watch. And it feels like we're back to the old TV joke of, well, I have a hundred channels and nothing to watch. Now it feels like the entire world of content is at my fingertips and I can't figure out anything to watch. I ended up just watching old movies and shows that I've already watched before. So I think that speaks to me too. Again, the old notion of content is king speaks to how important a brand is on the internet, a brand of specific shows, a brand of people, and historical artifacts, things that really matter and have the cultural gravity to survive the long term. These are all things that have become more and more important with the internet as a distribution mechanism and streaming is just seeing that as the tip of the iceberg.

[00:34:45] Mokaya: Alex, you write a lot about this. What have you noticed in the Disney versus Netflix world?

[00:34:27] Alex: Well, there's a couple of layers to that. I think one of the biggest ones, and it's not really a story from this quarter, but it's the success that Disney has had with their D2C strategy out of the gates and relatively early, it's only been not even three years since Disney Plus launched, and it's just shy of 140 million paid subs globally, and has a significantly lower ARPU on average than something like Netflix. But you can see how its strategy is starting to unfold. A big question will be over the long term what type of spend do you need to commit in order to support the business and what the economics eventually look like. 

I think the market and investors rightly looked at a company like Netflix that very clearly laid out a margin progression over the course of a period of I think, five or six years, and they lived up to what they told the market that they could achieve. Now we've had a very rapid change in terms of what people are looking for over the next handful of years. And, to Scott's point, if it's not meeting a need for the consumers and the companies, I do think that there's going to be some change in that one way or the other. A good example of something like Avon and a company saying they're not going to do something, it's very different to frame it relative to what we kind of all came to experience, at least in the US in terms of an ad-supported TV product, which was linear. I think Kantar dat had it at 20 minutes an hour of ads. When you're comparing it to something like Disney Plus coming out and committing to a four-minute ad load per hour, you're just talking about completely different worlds. I think as technology evolves, there has to be some presumption that the ARPU on a product like that will be justified by the CPMs or the economics of that advertising portion of the business. I certainly think you'll see companies try different approaches and, as a management team, I think what you probably need to do is not be so dead set on one route versus the other and be open-minded. And when the world starts to change, you need to try to react as effectively as possible.

Valuations

[00:36:48] Mokaya: Speaking of reactions in markets, I think this is a quarter that valuations have come down significantly. So I'm wondering, how are you positioning yourselves, especially in the market with regards to some of the valuations that have come down and some of the companies have significant challenges. I think it was Facebook, they were speaking about employee retention issues given that valuations have come down and that some of the employees are a little worried about some of the stock-based competition that they have. So any takeaways in that regard, but generally also on the state of the market currently, thinking more not just for the short term, but also positioning yourself with the long term. Maybe you can start with MBI.

[00:37:25 ] MBI: In earnings calls, there are some positive, some negative, and some neutral stuff that management talks about depending on the macro and market sentiment. Investors seem to focus on just one of those three aspects predominantly. In 2021, it used to be mostly just the positive stuff. People tend to kind of brush through the negative or neutral stuff but I feel like we have gone to the opposite extreme these days. As I mentioned, for example, in Amazon's earnings call they talked about how they're not immune from inflation, how the cost side, and the retail side of the business, and the fact that they have probably overbuilt those are some of the negative that they talked about and investors need to account for those things. 

But I also think investors sort of overlooked the fact that AWS has been posting a 35% GAAP EBIT margin. Two years from now if AWS consistently puts a 35% GAAP EBIT margin I think that's going to be a much bigger talking point than whatever we are discussing, the inflation and stuff, or overbuilding and CapEx investments in the retail side. We would probably be discussing for maybe a quarter or two or maybe the rest of this year but I don't think that's going to be a bigger story if we are having another discussion in 2025 or 2026. And also on the retail side, when I was going through Shopify's earnings call, I also felt investors ignored some of the positive elements. People are much more focused on Value Prime, how Amazon is doing on their platform business, and potentially they’re matching solutions revenue. 

Shopify is pretty big on Shopify payments and if Value Prime starts eating into those sides of the business that's pretty bad news for Shopify. But I also felt the fact that Shopify’s GMV grew faster than Amazon was kind of a big thing, at least to me. That wasn't the case ever. Shopify, GMV increase divided by Amazon's GMV increase used to be like 25% in 2020 and 50% in 2021. Now Shopify GMV increase in the first quarter was actually higher than Amazon's GMV increase. We all talked about how Shopify is going to suffer because of Apple's IFDA changes and all that, and despite all these headwinds, Shopify’s GMV was a bit of a surprise, especially in the context of Amazon's GMV. 

They did not meet analysts' expectations or customers’ expectations, but when you set the context, what was Amazon's GMV? What was Shopify GMV? Shopify came out much better than probably many people give them credit for. We don't know if Value Prime is going to be a big hit, that's not going to be good news for Shopify but that remains to be seen. We don't know yet how they’re going to respond and frankly speaking, there are not many details either from Shopify or from Amazon on how Value Prime is going to play out. I guess there are positives and negatives in almost all earnings calls. For example on Facebook's call, there was the fact they focused and they reiterated that they want to grow earnings even after funding reality labs' ambition. 

That was probably a reassuring thing for shareholders, they're just not going to burn money in order to chase metaverse ambitions. Mark clearly understands the importance of growing operating income, and then the fact that they have kind of held back their hiring ambitions, and they also cut down the expense guidance. And my guess is that expense guidance is going to be cut throughout this year. I suspect analysts will be surprised how much they will pull back even for next year. So I was just checking Meta’s operating expenses is 102 billion, I wouldn't be surprised if it's like 92 billion next year. So there can be a $10 billion divergence between what analysts are expecting and what Facebook may actually declare in Q3 this year. So those are kind of the things that I'm thinking about,  and I feel these are real concerns. I'm not saying investors are not right to think about this stuff, but many of the short-term concerns that I see, I just feel like we're not going to talk about it maybe two, three years down the line.

Q2 Outlook & Closing Thoughts

[00:41:12] Mokaya: Alright. We’re almost coming to the end, maybe any quick thoughts and anything that you're watching going into Q2 and maybe something that you may not have covered this far.

[00:41:22] Sam: Just two real quick things, especially in the wake of Walmart and Target disappointing on the bottom line because of profit margin concerns, I think that's going to be the hot thing for Q2 earnings announcements, the degree to which profit margins hold up or how much should they contract. I think I sent you a chart and the notes that we have, but analysts continue to expect profit margins to be at record levels for 2022. If Walmart and Target are any sort of indicator of what's to come in terms of the direction of margins and it could be trouble for earnings broadly speaking. And getting back to what you were talking about with what's going on in the stock market and valuations, valuations have come down obviously with stock prices coming down, but forward earnings expectations continue to hold up really well. 

Of course, those could certainly come down if we do find out that margins are contracting and all this stuff. But even if earnings hold up and margins hold up it could be a pretty difficult time in the stock market for a little while because if you've been following the federal reserve has very explicitly said it's actively tightening financial conditions and its effort to get inflation to cool down. And stocks are a huge part of how most folks calculate financial conditions. So a stock market rally isn't exactly the kind of thing that the Fed is looking for in the near term. Again, they've signaled that they'll get more hawkish if financial conditions stay loose. It looks like the stock market probably has a cap on it for a little while until we actually start to see inflation and inflation expectations come down materially. It should be a bumpy ride, but I'm looking forward to when we do this call again in three months.

[00:43:05] Alex: The thing I'm probably watching most closely is for companies and management teams that are always looking to strengthen their long-term competitive position and to find paths to really improve their business. And, in the short term that includes being cognizant of the risks that arise as conditions change and appropriately reacting to those developments. But something I believe more and more is that a truly great CEO and a really great management team is about strategic vision and the ability to execute against that vision. But it's also things like understanding when there are opportunities to do things inorganically and ways to really strengthen your business when dislocation occurs. And I think that certainly fits with what's happening more broadly and in some of the sectors and some of the companies that I follow pretty closely, it's probably been even more painful than kind of the general pain that's been felt. 

So it's monitoring the companies and those industries seeing the reactions of the different competitors, and if someone makes a move and does something that seems really smart, being prepared to act. The only other layer on top of that, that I know, and this isn't investment advice, but it's also ensuring that when dislocation occurs that you don't let, at least for me, let these many given single investments take precedence over having a thoughtfully diversified portfolio and having a portfolio that you are really comfortable with for the long-term. For someone like myself, who's fairly concentrated that might still mean a smaller number of positions, but it's thinking about it in a way where you're not really introducing too much risk or being exposed to any single trend. As always balancing that aggressiveness and that need to be conservative.

[00:44:42] Mokaya: Before MBI and Scott give their closing thoughts, I wanted to give some time to the sponsor for today's Transcript call. Stratosphere, are you able to speak?

[00:44:51] Stratosphere: Hey Mokaya. Just hopped off a little podcast recording, I was catching the end of this. This is awesome stuff. Thanks for letting us have the opportunity to sponsor today's Transcript. Really cool, I like tuning in at the end here. I know Alex and MBI, I don't know Scott and Sam, but we'll have to connect over the next coming week. Stratosphere is a data platform where you can search any North American listing, find all the financial data you'd look for, and data visualizations, you can set your watchlist tons, tons more and it's available for free at stratosphereinvesting.com. If you want to give it a try, we will be happy to have you there.

[00:45:31] Mokaya: Thank you. MBI, do you have some closing thoughts? And then Scott can close for us.

[00:45:36] MBI: Yeah, one of the quotes that kind of stood out to me during this earning season is a quote by ISS CEO Joe Livin. He said, “Market reaction is driven by an appropriate resetting in valuation frameworks rather than an exogenous Black Swan event. And this time there's no shot in the arm, literally or figuratively on the horizon to snap things back.” I think he has gotten that right. I think it's going to be a draining experience for both the operators and the management team and investors as well. I don’t think it's going to be a rapid snapback, like the one we experienced during COVID time, it's going to be probably a much more draining experience for everyone involved. 

To Alex's point, I think it goes back to the management teams and how good they are going to be and how well they are going to navigate this challenging period over the course of this year and probably the next couple of years as well. I think once these things are kind of back to normalizing we will begin to appreciate the difference between the good, average, and below-average operators and management teams. And the next one or two quarters will be a lot of interesting things to look forward to. For example, just off the top of my head, I know in the next quarter I'll be keen to kind of understand whether Meta guides on revenue acceleration in Q3. 

They talk about hiring, a tough comp in Q1 and Q2 but there's a general expectation that the revenue may accelerate once they wrap the ATD impact and the last year COVID related impact. So that's something I kind of look forward to. The other question I have is whether Google will be able to keep its hiring pace. They mentioned they will keep the pace of hiring for this year. It'll be interesting to see whether their tone kind of changes in the next earnings calls. And, AWS, there’s this kind of meme or joke that's going around that, basically at this price you'll get retail for free. So I was kind of doing this exercise, like, what we need to forecast for AWS to get the retail side of the business for free. 

And we just need to maintain the revenue like a dollar growth that AWS has seen in the last year or throughout this decade, I think roughly $20 billion. If your AWS keeps $20 billion revenue growth for the rest of this decade there is a strong case to remain that you probably get the retail side of the business for free. I'd be very keen to see whether that dollar revenue growth for AWS and the top-line growth maintains the pace and at the same time that GAAP EBIT margin they talked about, 35%, whether that's a one-off thing for reducing credit reasons, there's probably some exchange rate effects margins. So it would be interesting to see whether that sustains at a 34, 35% level, or it comes the back to high twenties or low thirties. Those are the kinds of things that I'd be looking at. 

Also, I think SBC stock-based compensation has all of a sudden become an important topic for all these tech companies. Some of these big tech companies generate a lot of cash, a lot of free cash flow, and probably all of them are going to buy back stock, especially given how stock prices are going down these last few weeks. So it's going to be interesting to see to what extent they are issuing stocks and to what extent they are buying back stocks. Whether they are issuing more stocks to kind of increase retention or to maintain retention or whether they're just being aggressively buying back stock, especially, that's probably more relevant for Google and Facebook and less relevant for Amazon.

[00:48:47] Scott: All super interesting. I want to jump in real quick just to close up because I have to run to something else. I wanted to say thank you to everybody who participated today and joined us. Sam, thank you as always Alex and MBI for the first time joining us, thank you very much. Closing thoughts, two weeks ago, we titled our newsletter at the end of an era question mark. And I think the reason we titled that was because we had seen a lot of quotes in the same week of people questioning, whether we've moved finally from an era of easy money and deflation into an era of inflation. And I think it still is definitely a question mark. Nobody can predict the future, but certainly, people are thinking about that today and that is what's driving financial markets and driving our investment environment. 

And I think the biggest thing to me that signifies is throughout the deflationary period, we talked about the Greenspan put that started in the nineties and certainly has happened since the financial crisis. Anytime you started to get a hint of deflation or a potential recession, the Fed would come to the rescue. And I think the difference, again, going back to that 1960s period and the period potentially today is that put kind of turns into a call where if you have inflation starting to pick back up, the Fed puts a clamp back down on the economy until it goes away. And if that's the case, we could be in for a period where you have the longer-term lid on securities markets, capital markets valuations, and a trend lower towards what may be a more normalized cost of capital. We have existed in the abnormal world for a long time here, and that could cause some dislocations and we will be tracking that through earnings calls. So thanks again to everybody. Eric, do you have any closing thoughts?

[00:50:27] Mokaya: My closing thought would be there's a quote yesterday, “I would say there would be some pain involved in restoring price stability.” My hunch is that we are in for a bit of a painful period for the few months ahead. I don't know how long that would last, but I think to be prepared as you position yourself and your portfolio for that. That would be my closing thoughts. For our speakers, if you want to see where to find them just posted a tweet showing where various write-ups happen so you can follow them there. You can find us at thetranscript.substack.com and you can always sign up. We have a podcast every week, we release it every Tuesday and every Monday we send out the newsletter, so you can catch up with us there. Thank you so much for joining us today. We do this every quarter, the next one will be three months from now. Thank you so much and have a lovely evening.

Netflix reported its Q1 2022 earnings yesterday and reported a slow down in consumer growth that was unexpected to many except keen readers of The Transcript. We have been covering the streaming slowdown throughout the past 3 months in our newsletter and podcast.

Attached is a clip from our podcast from 2 weeks ago discussing a potential big earnings miss for Netflix. Specifically, take a look at this quote from Scott:

“I think there are some pretty strong headwinds to Netflix growth that I keep hearing, not only in earnings calls around different companies that we're listening to, but I'm also hearing it just anecdotally from friends and family and people who are thinking about changing their Netflix subscription, or, you know, dropping some of these SVOD subscriptions. The fact that churn is going up It's a, it's a real headwind essentially for these stocks that for Netflix, especially they could overhang for a bit. So if you're a Netflix shareholder this could be a decent time to be trimming…These sorts of anecdotes are the things that big earnings misses are made of, like I could totally see next quarter, we have Netflix down 20% on the day that they reported earnings because they miss subscriber numbers. This is something that people should be paying attention to”

We have been following the rising churn on streaming services for most of Q1:

"In the SVOD space, U.S subscriptions overall are not materially growing despite the ever-increasing number of options available to viewers. We believe the most attractive remaining growth opportunity for SVOD is overseas -- you've already seen, I think, probably the 9% or so reduction in SVOD hours that are procured in the last period last -- I think it was the last quarter over prior years. People are churning off of those SVODs, I think, and learning how to manage them better." - Chicken Soup for the Soul Entertainment (CSSE) CEO William Rouhana

From the earnings call yesterday, we note that Netflix is considering an ad-based tier just as Disney did in March:

“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. So that's something we're looking at now. We're trying to figure out over the next year or 2. But think of us as quite open to offering even lower prices with advertising as a consumer choice” - Netflix (NFLX) Co-CEO Reed Hastings

"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..." - The Walt Disney Company (DIS) CFO Christine McCarthy

This is more in line with a theme we have been following closely of subscription fatigue and openness to ad-supported tiers. Too many subscriptions have led consumers to start seeking and being more open to ad-supported content:

"It started out that most of us did our consuming on -- and I'm speaking as a consumer for a minute. Most of us did our consumption on Amazon and Netflix SVOD offerings. And then over time, we were introduced to things like Hulu and now so many others that are AVOD or hybrid like in Hulu's case. And as we've learned from so many of them, it's often a better way for them to monetize to be an AVOD company. And it also is what the consumer typically prefers. As in Hulu's case, 80% of consumers prefer the ads. Now some of that has been a phenomenon for many years, but that predates what I'll describe as -- is now peaking, which is subscription fatigue. And so that was true at Hulu many years ago. It's still -- it's even more true today because, of course, there's more subscriptions. It takes more work to figure out where to watch what you want to watch. It is. And for the average American household to be paying for 15 subscriptions instead of 2 or 3 that they were a few years ago, the cost is prohibitive. So insert AVOD. And now all of those companies are graded on subscribers. How many subscribers do they get? And just some pretty impressive numbers across the board. And just from many of them, as we watch how they reported on their last year. But in order for them to keep those subscribers, they have to make it affordable. So we expect to see more and more of them adopting advertising. They need that to be relevant so that they show fewer ads that are more relevant to the user so that they keep an amazing experience for the consumer, but then the consumer can also afford it. So I believe strongly that the most promising part of our future is in CTV because of those market dynamics." - Trade Desk (TTD) CEO Jeffrey Green

There is a key theme in play here. Do subscribe for more of such actionable investment catalysts from our team: