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Speaker 3: Nice m and a trade here in the financial space
Speaker 3: here today we got Capital One Financial. They're acquiring Discover
Speaker 3: Financial and thirty five billion dollars all stock deals, so
Speaker 3: the need to go to the bond market. They're going
Speaker 3: to create the largest US credit card company by loan volume,
Speaker 3: giving the combined entity struggle foothold against some of the
Speaker 3: big Wall Street behemos.
Speaker 4: Let's see what's.
Speaker 3: Behind the deal here, and with the numbers show us
Speaker 3: Ben Elliott, he's consumer finance anols for Bloomberg Intelligence. Jurnes
Speaker 3: us via zoom from Washington, DC. All right, bet, what's
Speaker 3: Capital One thinking here? Is this another one of these
Speaker 3: deals that's really driven by scale?
Speaker 1: Yeah, so everything's driven by scale and the credit card business, Paul,
Speaker 1: And the big thought here from Capital One is that
Speaker 1: if they can acquire this sort of rare and valuable
Speaker 1: thing that Discover has, which is a discrete proprietary payments network.
Speaker 1: Then they can sort of start to compete with the
Speaker 1: Visa and MasterCard on a much bigger scale over time,
Speaker 1: and they're paying a premium for it.
Speaker 5: Ben is the timing at all surprise just given kind
Speaker 5: of the issues that Discover had towards the end of
Speaker 5: twenty twenty three.
Speaker 1: So it leaves Capital One with a potential legal overhang.
Speaker 1: The legal issues are not settled yet at Discover. They've
Speaker 1: had a couple of new issues that are sort of
Speaker 1: outside of the scope of of what they've been dealing
Speaker 1: with over the past couple of years. Discover's been talking
Speaker 1: about sort of a five hundred million dollars a year
Speaker 1: run rate of additional compliance expense. So that's sort of
Speaker 1: a burden that Capital One is going to have to
Speaker 1: take on with this acquisition. But I think it's probably
Speaker 1: pretty well understood the sc of that, and I think
Speaker 1: it's it's probably priced into the deal.
Speaker 3: All right, So give us a sense of the size
Speaker 3: of Visa, I guess, the Visa network, the master Card network,
Speaker 3: and now this new combined network is it is it
Speaker 3: competitive to Visa and MasterCard?
Speaker 1: I guess even amics So historically it's completely non competitive.
Speaker 1: Visa and MasterCard together are about penn trillion in domestic
Speaker 1: US credit and debit card volume, and Discover is about
Speaker 1: five hundred and fifty billion. So it's always been this
Speaker 1: sort of the tiny, you know, red headed stepchild of
Speaker 1: the of the large payment networks. But you know, if
Speaker 1: you add to that capital ones hundreds of billions of
Speaker 1: dollars of credit card loans and you sort of extrapolate
Speaker 1: future growth there, it has the potential to sort of
Speaker 1: compete more like an American Express, which is closer to
Speaker 1: one and a half trillion.
Speaker 5: Then I feel like we can't talk about deals without
Speaker 5: the threat of regulatory scrutiny. What does this bring and
Speaker 5: what could the FTC raise any red flags about?
Speaker 1: Yeah, so I'm obviously not a regulatory expert. Paul knows
Speaker 1: well that we have a great m and a analyst
Speaker 1: Bloomberg Intelligence. Generally, I'm sure you guys will ask her later.
Speaker 1: But overall, this deal I think will be relatively sort
Speaker 1: of non offensive to regulators. You know, Discover is historically
Speaker 1: not been very competitive with the large networks, so actually
Speaker 1: bringing sort of the power of capital want to bear
Speaker 1: will make it more competitive with the large networks was
Speaker 1: as the potential to give customers a real sort of
Speaker 1: fourth alternative, whereas in the past you really only had
Speaker 1: one option. Right, you get a Discover card, it only
Speaker 1: has one sort of set of of rewards. It's got
Speaker 1: a relatively low credit line versus some of the other offerings.
Speaker 1: It doesn't have sort of you know, high end travel
Speaker 1: rewards offerings. So I think if Capital One can start
Speaker 1: to issue some of its sort of higher end cards
Speaker 1: on the Discover network, that could be pro competitive, and
Speaker 1: that might make the deal somewhat more attractive to regulators.
Speaker 3: So I'm looking at MasterCard. The shares of MasterCard and
Speaker 3: v so each down maybe two three percent. Do they
Speaker 3: really care here in terms of a response.
Speaker 1: You know, I think they're looking at this as sort
Speaker 1: of an interesting gambit. It's definitely like, you know, it's
Speaker 1: a shot across the bow visa MasterCard. But this is
Speaker 1: a huge, probably decades long battle that Discover Network, backed
Speaker 1: by Capital One, will be fighting. You know, they plan
Speaker 1: to keep the Discover branding in place for the most
Speaker 1: part and shift primarily debit card volume to Discover at first.
Speaker 1: So you know, even in the first call, it three
Speaker 1: years of this transaction, They're not really going to be
Speaker 1: issuing Capital One credit cards on the Discover network, and
Speaker 1: so that really puts off any concern for Visa and MasterCard,
Speaker 1: you know, into the medium to long term.
Speaker 5: Ben in terms of kind of what these credit cards
Speaker 5: offer Discover from my understanding, mainly cash back. Capital One
Speaker 5: has a range of some of those rewards cards. How
Speaker 5: does that impact potentially acquiring new customers and new users
Speaker 5: of for both companies or I guess the folded end company.
Speaker 1: Yeah, so I think that will make it a challenge
Speaker 1: for Capital One to issue some of its sort of
Speaker 1: high fee, high reward cards on the Discover network because
Speaker 1: historically the Discover network's only been used for a very
Speaker 1: limited cash back card with caps that I think it's
Speaker 1: like fifteen hundred dollars a quarter of cash back. So
Speaker 1: for your high spenders, people who are putting tens of
Speaker 1: thousands of dollars on a credit card, that's not a
Speaker 1: very attractive offering. So that means that the brand has
Speaker 1: not been sort of in their minds as you know,
Speaker 1: a potential credit card they might acquire. So Capital One
Speaker 1: is going to have to do some relatively heavy lifting
Speaker 1: and you see that in what is a very modest
Speaker 1: run rate synergy assumption in their in their sort of
Speaker 1: deal model which only cuts back discovers marketing costs ten percent.
Speaker 1: So you know one is gonna have to do some
Speaker 1: pretty heavy marketing I think to start to leverage that
Speaker 1: network on the credit card.
Speaker 3: Side, the American Express. What's the investment call there these days?
Speaker 6: Ben?
Speaker 4: What are investors thinking about MX?
Speaker 1: You know, MX is the super premium fashion of the
Speaker 1: highest spending, sort of most financially sound customers. So that
Speaker 1: is a sort of you know, it's sort of a
Speaker 1: recession safe trade, if you will. So you know, when
Speaker 1: people are looking at the forward curve and they're they're
Speaker 1: seeing rate cuts, you know, they're expecting a recession. Potentially
Speaker 1: they look at the AMX spender and think that this
Speaker 1: person will last the longest and have the sort of
Speaker 1: lowest level of charge offs through a potential recession. So
Speaker 1: that makes it very attractive. And additionally, MX is a
Speaker 1: ton of momentum in acquiring millennial and gen Z high
Speaker 1: earning customer, which is the most valuable sort of wallet
Speaker 1: chair that's out there, and MX does it better than
Speaker 1: anyone else, So that also kind of makes them attractive
Speaker 1: to investors.
Speaker 3: Hey, Ben, here at Bloomberg LP, we recently switched our
Speaker 3: corporate credit card from one vendor to another. Why did
Speaker 3: that happen? Is that simply priced? Somebody came along and said, hey,
Speaker 3: Bloomberg will do it cheaper.
Speaker 4: Is that how that that business goes?
Speaker 7: Well?
Speaker 1: Obviously I have no insight into that particular deal, but
Speaker 1: you know, that can be a number of things. That
Speaker 1: can be the sort of reward structure, that can be
Speaker 1: the cost structure. That could even just be you know,
Speaker 1: simple sort of customer service and applicability of sort of
Speaker 1: technology on the on the corporate fulfillment side. So you know,
Speaker 1: I don't really have any insight into what that particular was.
Speaker 4: It all works for me. It all goes to redo
Speaker 4: keeper of the whatever the card is.
Speaker 3: All right, Ben, So what is the big competitive overview
Speaker 3: of kind of consumer finance? Are we using more credit,
Speaker 3: more debit, more venmo what a kind of the big
Speaker 3: trends there?
Speaker 1: Yeah, So there's been a huge growth in credit volume
Speaker 1: over the last couple of years, especially sort of in
Speaker 1: the post pandemic period. There's been even more of a
Speaker 1: secular shift away from cash. As for the various sort
Speaker 1: of channels. Right, credit is really attracted to higher end consumers,
Speaker 1: people with more discretionary income, because that offers the huge
Speaker 1: valuable reward potential. And then if you step down to
Speaker 1: debit cards, there's some cash back but for the most part,
Speaker 1: not a lot of rewards there, but there's some convenience.
Speaker 1: And then sort of the lower tier kind of fintech
Speaker 1: payments systems, you know, they offer they're sort of targeted
Speaker 1: at sort of youngers or gen Z lower spenders, and
Speaker 1: they are the people who are exploring things like buy now,
Speaker 1: pay later, which is sort of a way to give
Speaker 1: credit to people who don't really have a lot of
Speaker 1: credit history or substantial earnings history.
Speaker 4: Ben, thanks so much for that. Appreciate it.
Speaker 3: Ben Elliott, consumer finance analysts for Bloomberg Intelligence is joining
Speaker 3: us via zoom on from Washington, DC. And then there
Speaker 3: are those of us walk around with a lot of
Speaker 3: cash because that's how you play.
Speaker 5: You pay who do you pay in cash?
Speaker 3: I got very few people, very few people now, And
Speaker 3: it used to be I mean, but I mean, you
Speaker 3: walk into a bar in the Jersey short you got
Speaker 3: to put a fifty down on the bar to make
Speaker 3: sure you let them know you have let them know
Speaker 3: you're serious.
Speaker 4: I mean, I'm not going to give them like tap
Speaker 4: my phone. I mean they throw me out. But no,
Speaker 4: you're right. I mean you just don't use cash anymore now.
Speaker 5: I only use cash at wholal carts in New York
Speaker 5: City and my dive bars that I can't say their
Speaker 5: names because otherwise people go to it, so we got
Speaker 5: to keep it secreted.
Speaker 4: But those are the only places I use cash.
Speaker 3: I know it's crazy, so but I mean, now it's
Speaker 3: just I'm thinking. You know, one of the greatest companies
Speaker 3: or technologies in that space was Square. They're the ones
Speaker 3: that revolutionized, I think for the local retailer. I mean,
Speaker 3: because all you have to do is stick nothing on
Speaker 3: your phone, and then a local retailer immediately has the
Speaker 3: ability to.
Speaker 4: Kind of migrate to a you know, you know more
Speaker 4: of electronic payment.
Speaker 5: That completely changed, especially here in New York City, where
Speaker 5: if you would go to a farmer's market before you'd
Speaker 5: have to worry about do I have enough cash?
Speaker 8: What if I want to buy more things?
Speaker 4: Just have to pay.
Speaker 5: It's so much more simple.
Speaker 3: But so great company Square, great ticker symbol SQ.
Speaker 4: What do you do then you change a name of
Speaker 4: your company to block Plock.
Speaker 5: You traded sixty five bucks, down from a high of
Speaker 5: two to eighty one.
Speaker 4: Yep, just crazy, let's change our name.
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Speaker 7: Bloomberg eleven thirty.
Speaker 3: Talking about Home Depot Company reported some numbers here, let's
Speaker 3: bring in Drew Redding. Drew covers all the home building
Speaker 3: stocks which had just been ripping really for the last
Speaker 3: couple of years, because that's the only way to get
Speaker 3: a home is you got to build a new one.
Speaker 3: And he also covers all the companies that are around
Speaker 3: the home building industry.
Speaker 4: Including HD.
Speaker 3: It's up about six tens of one percent here today, Drew,
Speaker 3: thanks so much for joining us here. Break down what
Speaker 3: you saw and heard from our good friends at Home Depot.
Speaker 6: Sure, so the three and a half percent decline and
Speaker 6: same store sales was pretty much freight in line with
Speaker 6: what was expected. You have to keep in mind though,
Speaker 6: coming into the quarter, the bar was pretty low for
Speaker 6: home depot. They continue to face the consumers who were
Speaker 6: pulling back in big ticket discretionary categories, so think things
Speaker 6: like flooring, cabinets, countertops. Conversely, they're seeing relative strength in
Speaker 6: some of the smaller scale projects, so there's big ticket
Speaker 6: projects are being deferred. We do think eventually they get completed,
Speaker 6: but that may be more of a twenty twenty five story.
Speaker 6: But coming into this quarter, the real debate was around
Speaker 6: how twenty twenty four was going to shape up. So
Speaker 6: they offered guidance suggesting that same store sales would fall
Speaker 6: about one percent, and given what we heard from a
Speaker 6: handful of their suppliers over the last couple of weeks,
Speaker 6: which we're calling for a flat market, I think people
Speaker 6: it caught people a little bit off guard. Ourselves included.
Speaker 6: We do think that the first half is going to
Speaker 6: be comparatively weaker than the second half as rates start
Speaker 6: to pull back, and we think you could maybe get
Speaker 6: a little bit bit of a boost from the housing market. Drew.
Speaker 5: This may be a dumb question, but when I look
Speaker 5: at some of the consumer data that we've been seeing,
Speaker 5: we are seeing a rising ninety day credit card delinquencies.
Speaker 5: How do things like that, What does the normal spender
Speaker 5: at home depot look like? You're mentioning kind of a
Speaker 5: pullback on some of those bigger projects. What kind of
Speaker 5: demographic does home depot really see in terms of driving
Speaker 5: sales and kind of putting those numbers together.
Speaker 6: Yeah, so about eighty percent of home depots customers or
Speaker 6: current homeowners. They typically have higher incomes, so they are
Speaker 6: higher spenders and they're a little bit more resilient of
Speaker 6: a customer. I think where we're seeing the relative weakness
Speaker 6: is in some of the low end spending, which has
Speaker 6: kind of gone away on the DIY side. But you know,
Speaker 6: if we look big picture, what's happening in the home
Speaker 6: improvement market is we're seeing a reversion to more typical
Speaker 6: spending pattern. So if you think back to the pandemic,
Speaker 6: we had the share of PCEE that went towards household
Speaker 6: durables was at all time record, and we've seen that
Speaker 6: moderate since really the first half of twenty twenty three.
Speaker 6: So we think that there's a bit more of a
Speaker 6: reversion that needs to take place with the remainder of
Speaker 6: this year, which is going to keep total industry sales muted,
Speaker 6: you know, but you talked about the consumer. You also
Speaker 6: have the consumer out there who's battling with the cumulative
Speaker 6: impact of massive inflation over the last couple of years. So,
Speaker 6: you know, while we look at the head headline number
Speaker 6: and we see that it's moderating, it's really the cumulative
Speaker 6: impact that's kind of pressuring spending in the category.
Speaker 3: Hey, Drew, what's the What do you think is a
Speaker 3: normalized top line growth rate for like a home depot.
Speaker 4: I'm I'm looking.
Speaker 3: You know, pre pandemic was kind of mid single digit grower,
Speaker 3: then of course exploded, you know, during the pandemic was
Speaker 3: some you know, big double digit gains. What do you
Speaker 3: think what do you kind of model out here for
Speaker 3: top line growth?
Speaker 6: Yeah, I think I think in a normalized environment, which
Speaker 6: we think we get back to in twenty twenty five,
Speaker 6: is probably in the three to four percent range as
Speaker 6: a baseline. You know, there's a couple of industry factors
Speaker 6: that we think will support that. Like I mentioned, we
Speaker 6: think as rates start to moderate, perhaps as we get
Speaker 6: through this year, we think that you could start to
Speaker 6: see a boost from existing home sales. Remember, existing home
Speaker 6: sales are the lowest level more than twenty five years,
Speaker 6: and we know that people who move spend about twice
Speaker 6: as much on remodeling as those who don't. So while
Speaker 6: we don't see total housing turnover returning to you know,
Speaker 6: kind of that five and a half level anytime soon,
Speaker 6: we do think the fact that things have been so
Speaker 6: depressed does serve as a tail and as we move
Speaker 6: through the year. At the same time, you know, we've
Speaker 6: had over forty percent increases in home prices since the pandemic,
Speaker 6: so homeowner's equity right now is at all time ties.
Speaker 6: The average home has about three hundred thousand dollars in equity,
Speaker 6: So we think that's a source of pent up demand
Speaker 6: for big ticket projects that once again, as rates start
Speaker 6: to moderate, people will get more comfortable with tapping that equity.
Speaker 5: And drew with that in mind, you mentioned some of
Speaker 5: those big purchases, bigger projects. How much of that was
Speaker 5: pulled forward though during the pandemic when people were buying homes,
Speaker 5: we saw a booming market around the US, and it
Speaker 5: did seem like cash being relatively free with the surplus
Speaker 5: spending and stimulus checks, that people were putting money into
Speaker 5: home improvement.
Speaker 6: Yeah, great question, and I think that goes back to
Speaker 6: the share of personal consumption that was spent on home improvement.
Speaker 6: It was a lot of that stimulus money that was
Speaker 6: out there for everybody. In terms of the big ticket project,
Speaker 6: we think more of the pull forward was probably done
Speaker 6: in the DIY segment. That's really where you saw the
Speaker 6: boom early in the pandemic. That being said, we have
Speaker 6: seen contractor backlogs over the last couple of years be
Speaker 6: you know, elevated compared to more traditional levels. So to
Speaker 6: some extent, it has been in both the DIY and
Speaker 6: big ticket category. But we do think that the big
Speaker 6: ticket categories where we're likely to see more growth from
Speaker 6: home depot as they go after the professional contractor, as
Speaker 6: they leverage you know, the age investments consumers are making
Speaker 6: because of the age of the housing stock that pentep
Speaker 6: equity they have in their home.
Speaker 3: He drew from an investment perspective, how do you differentiate
Speaker 3: home depot versus lows.
Speaker 6: Yeah, so, I mean both of the stocks that you
Speaker 6: mentioned earlier. The housing names have ripped recently. I think
Speaker 6: home depots since the end of October is up more
Speaker 6: than thirty percent because investors were placing their bets that
Speaker 6: the fed of rat height cycle would come to an end,
Speaker 6: so I think they're trying to get out ahead of
Speaker 6: that and out ahead of that. Improvement in home sales.
Speaker 6: In terms of comparing the two, Home Depot has really
Speaker 6: benefited relatives to the Lows recently because of their exposure
Speaker 6: to that professional customer. It's driven you know, outside outside
Speaker 6: same store sales. It's driven better margins, and we expect
Speaker 6: that the professional contractor is going to be a relative
Speaker 6: area of strength going forward. Now with that being said,
Speaker 6: Home Depot is trading out a premium to the market
Speaker 6: and one of the biggest premiums versus Lows over the
Speaker 6: last decade, you know. So to the extent that Low's
Speaker 6: is able to leverage its investments in e commerce and
Speaker 6: in their professional contractor business, that could be something to
Speaker 6: look out for.
Speaker 5: And drew, as we mentioned Dr Horden Toll Brothers, all
Speaker 5: these homebuilders building out new apartments, new homes. Does that
Speaker 5: benefit Home Depot or Lows or is that going to
Speaker 5: more benefit the likes of a whirlpool.
Speaker 6: Yeah, so that's that's primarily more geared towards the building
Speaker 6: product manufacturers, and Lows business is more built around that
Speaker 6: remodeling market and less so on the new construction side.
Speaker 5: So what's the.
Speaker 3: Average ticket size of a home depot? And not recently
Speaker 3: ask is I'd never really go there? So what's like
Speaker 3: an average ticket size? And is it different between home
Speaker 3: depot and lows?
Speaker 6: They're similar, probably somewhere between seventy five and ninety dollars.
Speaker 6: And what we've seen more recently is that that average
Speaker 6: ticket size has come down and that's one of the
Speaker 6: things that's pressuring same sotore sales. And the reason that
Speaker 6: average tickets are coming down is because you don't have
Speaker 6: the same leverage to big ticket spending those categories I
Speaker 6: mentioned earlier, like flooring, like cabinets, like countertops, Those are
Speaker 6: some of the things that really drive that growth. And
Speaker 6: with that pullback, we've seen a moderation and ticket we're.
Speaker 5: Talking about the sales declining for a fifth quarter in
Speaker 5: a row. When does that break out? Is it just
Speaker 5: easing cop numbers going to ultimately lead to a rebound.
Speaker 6: So that'll be part of it. I mean, the way
Speaker 6: we're looking at the market is that the second half
Speaker 6: outperforms the first half. I think home depot and the
Speaker 6: industry can start to return to growth later this year,
Speaker 6: kind of exiting twenty twenty four, and we think once
Speaker 6: we look ahead to twenty twenty five, that's when you
Speaker 6: start to see a more normalized growth in my environment
Speaker 6: in that low single digit range. Call it.
Speaker 3: All right, So home Depot they're primarily a US company.
Speaker 3: Did any of these companies think about opening stores outside
Speaker 3: the US?
Speaker 6: Yeah, they have. I mean both home Depot and Lows
Speaker 6: have had businesses outside of the US. Low's recently sold
Speaker 6: its business in Canada. Home Depot operates in Mexico as well.
Speaker 6: But for both of them, they've both made an effort
Speaker 6: over the last several years to really focus on the
Speaker 6: US market. So that's been a strategic initiative for both
Speaker 6: of them, just because they see that long term growth
Speaker 6: in the housing market and that's really where they want
Speaker 6: to focus their attention to.
Speaker 3: All Right, Drew, great stuff is always appreciate getting some
Speaker 3: time Drew reading. He's a home builder analyst at Bloomberg Intelligence.
Speaker 3: Joining us via zoom from the Bloomberg Intelligence headquarters in Princeton,
Speaker 3: New Jersey.
Speaker 2: You're listening to the Bloomberg Intelligence podcast. Catch us live
Speaker 2: weekdays at ten am Eastern.
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Speaker 3: At some economic data coming out. It's a little light today.
Speaker 3: We got more coming up later this week. But the
Speaker 3: I Think Index came out negative zero point four percent.
Speaker 3: The consensus was negative zero point three percent, So a
Speaker 3: little bit weaker there.
Speaker 4: Let's break it down.
Speaker 3: We had a negative revision as well to last month.
Speaker 4: Dana Peterson, chief economist at the Conference Board.
Speaker 3: So Dana talk to us about this leading index data
Speaker 3: point that came out today.
Speaker 4: What is it and what does it tell you?
Speaker 6: Sure?
Speaker 9: Absolutely, while it was down again, it's been negative for
Speaker 9: more months than I can count over the last two years.
Speaker 9: But the good news is that when we look at
Speaker 9: the six month average growth rate, it's no longer signaling recession,
Speaker 9: but it's still quite negative.
Speaker 5: And how does this play into kind of the feeling
Speaker 5: around the economy and what this can mean for market watchers,
Speaker 5: for people kind of trying to guess what the Fed
Speaker 5: will er won't do just given kind of some of
Speaker 5: the economic data we continue to be seen.
Speaker 10: Well, the thing is that it.
Speaker 9: Does signal that the US economy probably is going to slow,
Speaker 9: probably over the second and third quarter, maybe even starting now.
Speaker 9: In the first quarter, we did get that pretty weak
Speaker 9: retail sales data. But the thing is that the labor
Speaker 9: market is still pumping out jobs, wages are rising, so
Speaker 9: that could continue to support the consumer for some time.
Speaker 9: But I think that, you know, we are going to
Speaker 9: see slower economy, but that also means slower inflation. So
Speaker 9: I think all these pieces give the FED cause to
Speaker 9: start looking at interest rate cuts, probably around the middle
Speaker 9: of the year.
Speaker 3: So I mean, again, I'm looking at just this over time,
Speaker 3: and the leading index has kind of been you know,
Speaker 3: negative here since kind of I don't know, March of
Speaker 3: twenty twenty two. I mean, how often how predictive of
Speaker 3: is this index for the overall economy.
Speaker 9: Usually the Lady Index does a really great job in
Speaker 9: terms of poortending recessions, and that's because it captures a
Speaker 9: number of factors, certainly manufacturing activity, hours work which is
Speaker 9: often linked to manufacturing activity, financial market indicators, and credit conditions,
Speaker 9: and certainly expectations among businesses and consumers and so all
Speaker 9: those things. It's done a very good job of pretending
Speaker 9: recession this time. I think it was a little challenge
Speaker 9: because we had a surge and services activity and also
Speaker 9: labor shortages meant that a lot of companies didn't let
Speaker 9: people go, and those are things that aren't really captured
Speaker 9: in the Leading Economic Index. So maybe that's why it's
Speaker 9: been signaling for recession for a long time, but we
Speaker 9: haven't actually had one.
Speaker 3: All right, Danna, thanks so much for joining us. Appreciate
Speaker 3: you hopping on breaking down this data point. Dana Peterson,
Speaker 3: Chief Economists for the Conference Board. Again, the Leading Economic
Speaker 3: Indicator came in a little bit weaker than expected this morning.
Speaker 3: It's kind of been again negative really since for many
Speaker 3: quarters now, so the question is what does that mean
Speaker 3: for the economy.
Speaker 2: You're listening to the Bloomberg Intelligence Podcast. Catch us live
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Speaker 3: R J gallow joins is he's a senior portfolio manager
Speaker 3: fixed to them at Federider Hermes.
Speaker 4: You know, RJ, it's been a tough couple of years
Speaker 4: for you.
Speaker 3: Fixed income guys, twenty twenty two is just brutal, and
Speaker 3: thanks to November December of last year, you had some
Speaker 3: positive games, some pretty nice positive returns this year starting
Speaker 3: off in the red yet again.
Speaker 4: What's kind of your call here is as you look
Speaker 4: ahead in your fixed income space, well.
Speaker 10: Good morning.
Speaker 8: You know it has been a wild ride.
Speaker 11: But I think if you were looking at a fixed
Speaker 11: income one on one textbook, if you told a college
Speaker 11: student reading that textbook that inflation would rise to over
Speaker 11: nine percent in short order, do you want to own
Speaker 11: bond for rest or No? And then if you told
Speaker 11: them that that inflation would fall from over nine percent
Speaker 11: to a three handle, maybe even a two handle in
Speaker 11: short order, then your answer would be different. It's been
Speaker 11: a difficult time to be a fixed income portfolio manager.
Speaker 11: But I also think we've re established value in a
Speaker 11: market where yields had been suppressed for so long due
Speaker 11: to the subpar growth in the global global financial crisis environment.
Speaker 11: The pandemic demic unleashed many forces, the most important one
Speaker 11: was a series of inflationary forces, and the bond market
Speaker 11: paid the price. I think that prices in the past,
Speaker 11: I think that the returns, respectively are much more attractive,
Speaker 11: vastly superior.
Speaker 8: To what we saw in twenty twenty two.
Speaker 11: The fourth quarter of twenty three was extraordinary, but I
Speaker 11: think we're expecting mid single digit kind of total returns
Speaker 11: in a year that we face now as inflation is
Speaker 11: apt to settle its recent bubbling has been a little unwelcome,
Speaker 11: and the economy is doing relatively well. Recession doesn't seem
Speaker 11: to be in the offing, But we think that this
Speaker 11: environment for fixed income, given yields that have reset to
Speaker 11: much more attractive real positive levels, still have a place.
Speaker 5: Investors, Rgie, what do you like in an environment that
Speaker 5: I would say continues to be relatively warm from an
Speaker 5: economic data perspective, Well, I can tell you.
Speaker 11: How we're positioning our fixed income portfolios. I mean, generally speaking,
Speaker 11: the interest rate volatility that we just alluded to, we
Speaker 11: think the worst is behind us. We've been constructed with
Speaker 11: a neutral to a slightly long duration at various points
Speaker 11: in the last six months. That's an expectation of the
Speaker 11: fact that we think inflation will resume a downward march
Speaker 11: and the FED will ease monetary policy, lowering rates because
Speaker 11: high positive real rates are not normal. The FED is
Speaker 11: admitted that they're restrictive in their current positioning and that
Speaker 11: won't last. If inflation continues to march down towards two percent,
Speaker 11: the Fed will feel compelled to support lower real rates
Speaker 11: as well. They don't want to maintain a restrictive policy
Speaker 11: when inflation's cooperating.
Speaker 8: The economy has been It's.
Speaker 11: Very true in the fixed income space, I think a
Speaker 11: lot of money has been put to work chasing credit.
Speaker 11: Why because with the strong economies that support profits, we've
Speaker 11: been a little underweight credit number one. We had anticipated
Speaker 11: we'd have slower growth last year than we did, so
Speaker 11: that ended up being not helpful for our overall performance.
Speaker 11: At this point, though, we think the valuations have gotten
Speaker 11: very rich, so some slow down in the economy we
Speaker 11: think is apt to produce opportunities where spreads might widen
Speaker 11: a little bit and relative value will be more compelling
Speaker 11: than what we're seeing now.
Speaker 8: So we are overweight higher grade products.
Speaker 11: So we're still overweight mortgages for example, in our multi
Speaker 11: sector funds leaning long duration, as I mentioned in an
Speaker 11: underweight ig high yield and commercial mortgage back securities, where
Speaker 11: we think credit and valuation are not too compelling just yet.
Speaker 6: You know r J.
Speaker 3: I would say, up until I don't know, a couple
Speaker 3: of weeks ago, people were certainly pressing in cuts it.
Speaker 3: It's just a question of whether it was March, and
Speaker 3: then the took that off the table. Then it became
Speaker 3: if you look at the WORP function, maybe May, maybe June.
Speaker 3: Now on the last week or so, I've actually heard
Speaker 3: we had a guest com on say, hey, you have
Speaker 3: to have a scenario where the next move is a
Speaker 3: move higher in rates.
Speaker 4: Does that seem reasonable to you in any case.
Speaker 11: I can see why they would say that. I mean, so,
Speaker 11: remember we finished last year with this like torred fixed
Speaker 11: income rally, and we were happy about it.
Speaker 8: You know, we were constructive on bonds.
Speaker 11: It was great to see some positive returns which we
Speaker 11: thought we would get by the end of the year.
Speaker 11: And it really all happened in that fourth quarter. But
Speaker 11: the market overshot. The market had gotten to the point
Speaker 11: that some of the justifications I just mentioned for being
Speaker 11: constructive had been fast forwarded and baked into prices to
Speaker 11: a degree that wasn't sustainable by the data. Economic data
Speaker 11: is pretty clear, the economy is a pretty good shape.
Speaker 11: The labor market is still strong, inflation's a lot lower
Speaker 11: than it was, but it's not low enough to justify
Speaker 11: six or seven eases that had been priced into the market,
Speaker 11: say by December of last year. We felt that data
Speaker 11: would come along to probably push back on the market
Speaker 11: a little bit more effectively than say, Fed speak pushbacked
Speaker 11: on the market. Ultimately, what we saw was that data
Speaker 11: has proven more powerful pushback than speeches from the FMC.
Speaker 11: But the FMC has made clear they aren't going to
Speaker 11: ease preemptively. They're only going to ease if the data
Speaker 11: continues to back up justification that inflation is declining and
Speaker 11: the Fed should be normalizing policy at a lower level.
Speaker 11: What is normal policy remains a key question. Obviously, the
Speaker 11: Fed suggests three eases in this calendar year. As the
Speaker 11: median got in the summary the economic projections, they still
Speaker 11: have a long run neutral FED funds rate of two
Speaker 11: and a half percent. I would argue the bond market,
Speaker 11: if you look at forward rates, thinks it's about one
Speaker 11: hundred bases points higher than that, give or take. I
Speaker 11: would side with the bond market on that. That means
Speaker 11: that the bond market can can rally some as the
Speaker 11: FED eases and the economy slows, but absent a recession,
Speaker 11: I wouldn't be holding my breath for the ten year
Speaker 11: to hit you three percent anytime too soon.
Speaker 8: That's going to take a while.
Speaker 5: Arjie, you mentioned economic data mattering. We have f MC
Speaker 5: minutes tomorrow and then initial jobless claims pm I. What
Speaker 5: data points are you looking at to get a better
Speaker 5: read on what the FED can do and will do next.
Speaker 11: It's funny, you know, the FED looks at the totality
Speaker 11: of the data. I love that expression. But if you
Speaker 11: had to provide some insight on what you give greater
Speaker 11: attention to or greater weight, what you assign greater weight to,
Speaker 11: you know, the inflation data is fundamentally important. The FED
Speaker 11: would be very happy to see real economic data data
Speaker 11: portraying an economy that is continuing to expand accompanied by
Speaker 11: declining inflation.
Speaker 8: That's that's the soft landing. That's what they that's what
Speaker 8: they want.
Speaker 11: So I think the inflation data still is first and
Speaker 11: foremost the most important in the broader scope of data
Speaker 11: streams that's coming out.
Speaker 2: Uh.
Speaker 11: You know that said, if the economy looks to be reaccelerating,
Speaker 11: then the reason that's becomes a con or anything for
Speaker 11: the bomb market is that you would be more cautious
Speaker 11: about your expectations on inflation. Will inflation continue to decline
Speaker 11: if the economy in fact reaccelerates, that would be a
Speaker 11: real challenge for the market. That's the kind of data
Speaker 11: set that might feed expectations that maybe the Fed will
Speaker 11: tighten again.
Speaker 8: I actually think that's highly unlikely.
Speaker 11: I think if Fed funds rate of five and a
Speaker 11: quarter five fifty is already clearly restrictive, you don't need
Speaker 11: to tighten again as much as keep it there longer.
Speaker 11: So keeping it there longer, if you you know, Paul,
Speaker 11: you mentioned the work function before, that would translate into
Speaker 11: the work function having to move. You'd have to keep
Speaker 11: pushing out further and further into the future. You're easing dates.
Speaker 11: So the Fed would react to data that portrays a stronger,
Speaker 11: reaccelerating economy and or sticky inflation by just holding the
Speaker 11: fort you know, stay at five and a quarter five
Speaker 11: to fifty longer, and then that will reprice markets, as
Speaker 11: we've already seen this year, as the market had to
Speaker 11: reprice to higher expected yields after the we're shooting of
Speaker 11: last year.
Speaker 3: All right, ur Ja, thanks so much, for joining us
Speaker 3: yet again. We all just appreciate getting your thoughts.
Speaker 10: R J.
Speaker 3: Gallow, Senior portfolio manager, Fixed Income, Federated Hermes, joining us
Speaker 3: via Zoom from Pittsburgh, PA, one of my favorite towns,
Speaker 3: great town there and Federate one of the big, big
Speaker 3: money managers in Pittsburgh.
Speaker 2: You're listening to the Bloomberg Intelligence Podcast. Catch us live
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Speaker 3: We had that surge surgeon the markets in November December
Speaker 3: last year, where we had stocks just rallying dramatically continuing
Speaker 3: here into this year to a certain extent, and even
Speaker 3: in a fixed income space. You major year in November
Speaker 3: December last year. The question is did that pull some
Speaker 3: performance from twenty twenty four? Let's check out somebody who
Speaker 3: kind of does this stuff for a living. Terry Spath,
Speaker 3: founder in CIO of Zoom of Wealth, based in Malibu, California,
Speaker 3: joining us via Zoom.
Speaker 4: So, Terry, how did you start this year?
Speaker 3: What was your view of twenty twenty four going into
Speaker 3: the year, given that really strong finish we had to
Speaker 3: twenty twenty three.
Speaker 10: Yes, thank you for having me on, Paul, And there
Speaker 10: was a huge bond valley at the end of twenty
Speaker 10: twenty three, and that was great, But that was on
Speaker 10: the heels of the expectations of rate hikes in twenty
Speaker 10: twenty four. And while we're not clear when that will happen,
Speaker 10: when rate cuts will happen, how many we will get,
Speaker 10: we're very confident that.
Speaker 12: The FED is going to cut rates in twenty twenty four.
Speaker 12: And it's not just because.
Speaker 10: They feel as though they need to, because maybe inflation
Speaker 10: is contracting, our employment is getting our unemployment.
Speaker 12: Is getting too high. I think the FED is really
Speaker 12: going to have to do some.
Speaker 10: Work and pencil out how expensive debt is becoming for
Speaker 10: the federal government. We've got rates that are much higher
Speaker 10: than the were three four years ago when the government
Speaker 10: was issuing five year paper. We've got a debt level
Speaker 10: that's double what it was in twenty twenty. So those
Speaker 10: are going to be drags on the economy, and we
Speaker 10: do think that that's going to result in cuts in
Speaker 10: interest rates at the federal level and that will be
Speaker 10: a great tailwind, a continued tail wind for even just
Speaker 10: the safest bonds that you can buy out there.
Speaker 6: Terry.
Speaker 5: That's interesting because I feel like most times I've talked
Speaker 5: to people about a need for a cut, it is
Speaker 5: not spurred by the fact that the national debt has moved,
Speaker 5: has really picked up with the sharp move higher and
Speaker 5: interest rates just looking at the warp function, which I
Speaker 5: met reference far too often. Right now, we're penciling in
Speaker 5: just south of fore cuts this year. You look back
Speaker 5: coming into the year it was north of six Terry,
Speaker 5: where do we fall with these rate cuts and what
Speaker 5: does that path look like?
Speaker 10: Well, I mean, I think that's a tough question to answer.
Speaker 10: You know exactly when we're going to see rate cuts. Obviously,
Speaker 10: the markets got a little bit ahead of themselves looking
Speaker 10: for six cuts ats sort of an unprecedented level, And
Speaker 10: in fact.
Speaker 12: That was worrisome in our view because if you're having
Speaker 12: six cuts or something really wrong in the economy. That said,
Speaker 12: you know, they they raised rates late.
Speaker 10: I think the risk to our view is that they
Speaker 10: cut rates a little bit too slowly.
Speaker 12: But I do think that we're going to see that
Speaker 12: in twenty twenty four, and the reason for that is
Speaker 12: that unemployment is.
Speaker 10: Low, meaning full employment has been achieved, which is one
Speaker 10: of the views of the Fed. We're in, you know,
Speaker 10: knocking on the door of two percent inflation level that
Speaker 10: they're looking for, and at you know, north of five percent,
Speaker 10: and the FED funds rate and you've got it inverted,
Speaker 10: meaning short term rates are higher than long term rates,
Speaker 10: and that that's been the case now for a while.
Speaker 12: That doesn't make sense.
Speaker 10: I think the Fed is going to need to uninvert
Speaker 10: the curve. And so we'll see that over the course
Speaker 10: of this year. And just to do like a little
Speaker 10: bit of math on that, if you've got a five
Speaker 10: year treasury bond that's paying four percent and you get
Speaker 10: a one percent cut, you're getting another you know, three
Speaker 10: four percent in return. So on a five year treasury
Speaker 10: you can earn a high single digit return. That'll probably
Speaker 10: happen in twenty twenty four. And that's not a lot
Speaker 10: less than what we would expect in the stock market,
Speaker 10: but with a lot safer I guess characteristics.
Speaker 12: So while you know, just to wrap it up, I mean,
Speaker 12: when will that happen in twenty twenty four.
Speaker 10: We're not sure, but we're pretty confident it will happen
Speaker 10: over the course of this year that we'll see at
Speaker 10: least three four cuts.
Speaker 3: So, Terry, if I do think there's gonna be some cuts,
Speaker 3: you're constructor for stocks for sure. Do I stick with
Speaker 3: those Magnificent seven or maybe they're Magnificent five now names,
Speaker 3: or do I try to find some performance elsewhere, whether
Speaker 3: it's small to mid caps, whether it's value.
Speaker 4: How do you think about that?
Speaker 10: Yeah, I mean, listen, it's hard to, you know, make
Speaker 10: a case against the Magnificent seven with the momentum that
Speaker 10: it's enjoying.
Speaker 12: But anytime there's magnificent in front of something, you know,
Speaker 12: for an investment, it makes me a little bit worried.
Speaker 6: You know.
Speaker 12: I think even if you strip out if you look.
Speaker 10: At the Mac seven, the earnings have been spectacular and
Speaker 10: that has really driven the returns for those stocks. But
Speaker 10: even stripping those out, I think you can see some
Speaker 10: strength and large cap stocks continue through this year.
Speaker 12: And the reason for that, again comes back to interest rates.
Speaker 12: The problem the.
Speaker 10: Trouble for small stocks, and they've been really lagging, and
Speaker 10: the trouble for that is that their access to capital
Speaker 10: is weak. Interest rates are high, and they're just you know,
Speaker 10: that's just a challenge. Whereas large cap names have a
Speaker 10: lot more access to capital, they can handle a little
Speaker 10: bit higher interest rates, and we're going to see some
Speaker 10: nice earnings in the large cap stocks, you know, high
Speaker 10: single digit type earnings along with a dividend yield.
Speaker 12: So this is a nice situation where.
Speaker 10: You've got a year where we can see nice gains
Speaker 10: in large cap stocks as well as kind of barbelle
Speaker 10: over to the strongest the quality treasury market and you.
Speaker 12: Can have a really nice return in that type of
Speaker 12: a portfolio.
Speaker 5: Okay, So Terry, with leaning into some of the bigger
Speaker 5: stocks or their industries or sectors that you prefer, you know,
Speaker 5: I think.
Speaker 12: That there's sectors that we don't prefer right now.
Speaker 10: The energy sector has been weak, and the reason for
Speaker 10: that is that inflation's coming down. And when we look
Speaker 10: at the commodity sector, and that's another reason why we
Speaker 10: think inflation will stay cool in twenty twenty four. If
Speaker 10: you look at the prices of commodities, they've been weak,
Speaker 10: they've been negative, and that is that's the market telling
Speaker 10: us that inflation is going to be tame in twenty
Speaker 10: twenty four. So those sort of inflationary plays are not
Speaker 10: attractive right now. You know, the obvious choice on the
Speaker 10: other end of the spectrum are those companies that do
Speaker 10: well in a low inflation environment, and those are the
Speaker 10: ones that we've seen in technology, in the higher dividend plays. Actually,
Speaker 10: I think those have been underheld by investors, and I
Speaker 10: think that's attractive as a kind of pseudo bond play
Speaker 10: as well.
Speaker 4: All right, Terry, thank you so much for joining us.
Speaker 4: Appreciate it.
Speaker 3: Terry Spatha, founder and CEO of zoom of Wealth that
Speaker 3: they are based in Malibu, California.
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