Speaker 1: Hello, and welcome to What Goes Up, a weekly markets podcast.
Speaker 1: My name is Mike Reagan. I'm a senior editor at
Speaker 1: Bloomberg and this week on the show, Well, one of
Speaker 1: the strongest sectors in the stock market this year has
Speaker 1: been the banks. They're up thirty three as a group
Speaker 1: year to date in the SMP five hundred, and they're
Speaker 1: picking off their earning season. This week, we'll talk about
Speaker 1: that with a veteran fund manager who has especialty in
Speaker 1: banks about what he's looking for to sustain this rally.
Speaker 1: What first, a special announcement from Charlie Pellett. Vill Donna
Speaker 1: is off this week, So this week's mystery co host
Speaker 1: is Police Morons. Felice is an editor for Bloomberg Markets
Speaker 1: Live Blog. She's a native of Newark, New Jersey, a
Speaker 1: graduate of Yale. I'm the founder of Bloomberg News is
Speaker 1: first bureau in Israel in the nineteen nineties. That's back
Speaker 1: when Reagan had hair so long he looked like a
Speaker 1: member of the spin Doctors. Least, that's that is absolutely
Speaker 1: true about my hair. I don't believe you started that
Speaker 1: bureau in the nineties. You must have been a teenager
Speaker 1: back then. Well, thank you, Mike. But what was that
Speaker 1: like starting the bureau in Israel? That was that was
Speaker 1: an exciting time to start a bureau in Israel. That
Speaker 1: tell us a little bit a bit about that. It
Speaker 1: was incredibly exciting. Bloomberg News had very few people, and
Speaker 1: the what was then called the Peace Process was unfolding,
Speaker 1: and Israel was becoming more of a focus both politically
Speaker 1: and for businesses. The high tech boom was yet to come,
Speaker 1: but it was just starting, and Bloomberg really wanted someone
Speaker 1: on the ground in Israel, and I was lucky enough
Speaker 1: to become that person and then to eventually open and
Speaker 1: build the bureau. That's pretty fast s nating. Yeah, what
Speaker 1: a pretty historic time, I guess, uh, to be starting
Speaker 1: a bureau. But least also, I know something that excites
Speaker 1: you as much as those glory days is uh bank
Speaker 1: stocks earnings Week kicking off this week, and Uh, We've
Speaker 1: got a great, great guest to help us break it
Speaker 1: down what to expect, what to look for in bank earnings.
Speaker 1: He is a portfolio manager and chairman of Davis Advisors.
Speaker 1: His name is Chris Davis. Chris, welcome back to the show.
Speaker 1: Thanks so much, Michael. It's good to be here. So
Speaker 1: we're recording this on Wednesday, just so our listeners know
Speaker 1: we won't have all the earnings in our hands to
Speaker 1: to dissect. But we did get JP Morgan's earnings, which
Speaker 1: are usually a pretty good indication of what to expect.
Speaker 1: And I'm curious how you look at it from your perspective,
Speaker 1: because you know, earnings in general can be noisy. The
Speaker 1: last couple of years with all the you know, the
Speaker 1: boom and bust from the pandemic, I feel like financials,
Speaker 1: especially have a lot of noise in the numbers. You know,
Speaker 1: JP Morgan had a huge release of loan loss reaeser
Speaker 1: HERVs UH two point one billion dollars. They had a
Speaker 1: strong m and a quarter really strong I p O quitter.
Speaker 1: It seems like the stock market's a little disappointed, though
Speaker 1: I guess it's it's focusing on the loan growth um.
Speaker 1: But talk put specifically, Uh, you know about banks in general,
Speaker 1: what you sort of look through for when you go
Speaker 1: through these reports? Uh, given sort of you know, you
Speaker 1: can have a booming trading quarter for a bank one
Speaker 1: quarter and then it's back to you know, normal the
Speaker 1: next quitter, What are sort of the underlying things you
Speaker 1: look for as a long term buy and whole type
Speaker 1: of investor. Well, the nature of bank stocks in particular
Speaker 1: and financial stocks in general is that there is so
Speaker 1: much noise in any one quarter that it really doesn't matter.
Speaker 1: And it's part not just uh because of the long
Speaker 1: term nature of the businesses, but it's because so much
Speaker 1: of the earnings reflect estimates. So a nefarious management would
Speaker 1: have lots of flexibility to goose short term earnings or
Speaker 1: or a sandbagged them. You see it in insurance companies
Speaker 1: with reserves, and of course in banks and so on.
Speaker 1: So what really matters over time as a financial stock investor,
Speaker 1: and I started our financial funds more than thirty years ago,
Speaker 1: it's sort of hard to believe. And what's amazing is
Speaker 1: that that that fund is is it's not just outperformed
Speaker 1: the financial index, but it's outperformed the S and P
Speaker 1: five hundred. Because within financial services there's such a range
Speaker 1: of business models and positioning, and what we look for
Speaker 1: in quarterly earnings are signs of culture, signs of culture,
Speaker 1: because financial services is an industry where culture, a conservative
Speaker 1: cultural culture is actually a sustainable competitive advantage. Right when
Speaker 1: companies have made conservative decisions in the past, it gives
Speaker 1: them more flexibility in the present, whereas when companies have
Speaker 1: been aggressive in the past, they end up being really
Speaker 1: strained in the present. So what you saw in JP Morgan,
Speaker 1: for example, was a wonderful sign of a conservative culture. Right.
Speaker 1: It was a company that had overreserved in the past,
Speaker 1: they had been too conservative. That is a hallmark of
Speaker 1: Jamie Diamond that goes back not just you know, one
Speaker 1: quarter or one year, but goes back all the way
Speaker 1: to his first and your report, which people should read
Speaker 1: that he wrote when he became the CEO of Bank one. Uh.
Speaker 1: It's a culture of we'd rather take the hits up front.
Speaker 1: We want to be transparent, we'd be conservative. We don't
Speaker 1: want to be playing catch up. So with all of
Speaker 1: the noise around current quarter earnings, the real story is
Speaker 1: this is that for more than a decade since the
Speaker 1: financial crisis, everybody was terrified that banks are risky, risky businesses,
Speaker 1: and people were unable to recognize that the financial crisis
Speaker 1: wasn't a recession. It was the sort of thing that's
Speaker 1: happened once every fifties, sixty years. It was a one
Speaker 1: time reset and the companies that came through that were safer,
Speaker 1: more regulated, better capitalized, more conservative than any time in
Speaker 1: my career. And yet for the next decade, even though
Speaker 1: these banks built their profits, you know, the bank percentage
Speaker 1: of SMP earnings has grown for a decade, and yet
Speaker 1: the market caps as a percentage of earnings have fallen
Speaker 1: for a decade. Right, So nobody believed it, right that
Speaker 1: nobody believed that they somehow they were stronger, that they
Speaker 1: weren't risky. COVID was the ultimate test, and the banks
Speaker 1: banking sector as a whole past it with flying colors.
Speaker 1: They were part of the solution. They were providing liquidity,
Speaker 1: they were working with customers. They were doing just what
Speaker 1: banks are supposed to do and by the way, have
Speaker 1: done for most of the last hundred years, just not
Speaker 1: during the depression and not during the financial crisis. Those
Speaker 1: were one time huge resets. So I think what we've
Speaker 1: seen here is the beginning of a change in the
Speaker 1: perception investors have towards this sector. So any noise around
Speaker 1: the quarter is just going to be noise. The real
Speaker 1: bottom line is that people are going to recognize these
Speaker 1: are fortress institutions. Enormously resilient, enormously well capitalized, enormously profitable,
Speaker 1: conservative in nature, and therefore dramatically undervalued relative to other
Speaker 1: sectors where investors have that perception, like utilities or consumer
Speaker 1: products or something like that. So I think we're gonna
Speaker 1: have a decade of changing perception and we're only in
Speaker 1: the second inning. I think Jamie Diamond would be really
Speaker 1: happy to hear what you have to say that, Chris,
Speaker 1: that was an excellent case for bank stock rallies, but
Speaker 1: also for culture. And you know, I met Jamie when
Speaker 1: you know, I started my career thirty two years ago.
Speaker 1: I've invested with him all along the way, from commercial
Speaker 1: credit to Primerica, Travelers to Travelers ATNA, Traveler Solomon Smith
Speaker 1: Barney to Travelers Solomon Smith Barney City, you know, uh,
Speaker 1: and then to to bank one. Um. He he really
Speaker 1: embodies what I mean when I talk about culture as
Speaker 1: a competitive advantage, because there's a whole culture in financial
Speaker 1: services that can evolve based on one very simple fact,
Speaker 1: which is you don't know your cost of good sold
Speaker 1: when you sell your product, and therefore it's an estimate.
Speaker 1: And therefore, if people want to make their numbers and
Speaker 1: they want to look good. They can report whatever they can,
Speaker 1: and that filters all the way through an organization. And
Speaker 1: when you have somebody at the top that says we're
Speaker 1: gonna do things the right way. I understand your business.
Speaker 1: I'm getting into the weeds on it, it begins to
Speaker 1: build a culture. You see the same thing at Bertuer Hathaway.
Speaker 1: You see the same thing at places like but a
Speaker 1: One where you have very defined cultures, where the people
Speaker 1: at the top speak the same language as the people
Speaker 1: in the trenches making those estimates, and therefore there's a
Speaker 1: credibility and a thoughtfulness about how they approached the business.
Speaker 1: And there's a deep understanding at the top that the
Speaker 1: CEO must be must be the chief risk officer. Somebody
Speaker 1: else might have that title, but you're in big trouble
Speaker 1: if the CEO of a complex bank is not and
Speaker 1: does not think of him or herself as the chief
Speaker 1: risk officer and really understanding the nuance of risk, whether
Speaker 1: it's in derivatives, whether it's in interest rate curves or
Speaker 1: forward yield curves, or swaps, or or credit concentrations or
Speaker 1: correlated risks. UH. If you don't have a CEO that
Speaker 1: understands that, you're you're going to be in a world
Speaker 1: of pain sooner or later. And so I love the
Speaker 1: financial sector as a whole, but it's not a sector
Speaker 1: I would want to in decks. It's one where you
Speaker 1: really want to be looking for those companies where cultures
Speaker 1: a defining advantage, where they're what we call growth stocks
Speaker 1: in disguise. Lately I would say their utilities in disguise. Uh.
Speaker 1: It used to be an insult to call a company
Speaker 1: or utility, but last night, check the utility indexes at
Speaker 1: twenty times earnings. The banking indexes at like twelve. And
Speaker 1: I would much rather own the banks because for one thing,
Speaker 1: many of them are still under earning based on interest rates. Uh,
Speaker 1: they have huge excess capital, and their dividend payouts instead
Speaker 1: of being sixty seventy fifty six as they are in
Speaker 1: a lot of utilities that diffen in payouts, might be
Speaker 1: thirty five. So it's it's it's a wonderful time to
Speaker 1: be in this sector. But it's again not one that
Speaker 1: you want to throw a dot, you know, Chris, I
Speaker 1: think bank earnings are interesting regardless of what you're invested in,
Speaker 1: just because they give you a good lens into sort
Speaker 1: of a lot of macro trends, you know, and I wonder,
Speaker 1: you know, are there any takeaways. Obviously it's early in
Speaker 1: the season with with only really JP we're gonna look at,
Speaker 1: but are there any takeaways from from you? And specifically
Speaker 1: I wonder, you know, when you think about sort of
Speaker 1: the health of the corporate and the consumer balance sheet
Speaker 1: coming out of this recession, both are really strong. You know,
Speaker 1: a lot of companies raised, you know, money to sort
Speaker 1: of gird against the downturn. Consumer savings rate went through
Speaker 1: the roof, so there's a lot of money just sitting
Speaker 1: on deposit. I mean, does that in a way boat
Speaker 1: ill for for the prospects for loan growth? You know,
Speaker 1: if there's all this cash in people's accounts, is there
Speaker 1: less of a need to borrow? And is that a
Speaker 1: risk at all? In your opinion? Oh? Absolutely, I I
Speaker 1: it's hard to see a lot of evidence of surging
Speaker 1: UH loan demand. And you know, we can say, okay,
Speaker 1: well that's a negative. If somebody is barishly inclined, they're
Speaker 1: gonna beat that drum. And my feeling is, if you
Speaker 1: own a company that's generating ten percent of its market
Speaker 1: cap in distributable capital, every year you're going to get
Speaker 1: a ten percent returned with zero growth. Now, zero growth
Speaker 1: companies don't have zero profit growth simply because they don't
Speaker 1: have loan growth. Right, they could have very slow roan growth,
Speaker 1: and they could have much better profit growth because spreads
Speaker 1: begin to widen after a decade of compression, for example,
Speaker 1: they could have real earnings growth. And I think maybe
Speaker 1: the most important topic we should spend some time on
Speaker 1: is fintech, the risk of fintech to banks, what it
Speaker 1: means for the big banks, where the risks are. But
Speaker 1: what I would say is that my first takeaway is
Speaker 1: that you can have an enormous amount of earnings growth
Speaker 1: from a reduction in the cost structure that comes from
Speaker 1: the intelligent application of technology. Now we could be crass
Speaker 1: and say, oh, it's closing branches and reducing people with
Speaker 1: computers and so on, but it's much more elegant than that.
Speaker 1: You're providing a solution to a client or a customer
Speaker 1: that is more satisfactory to them. It's more flexible and
Speaker 1: cheaper to deliver. So I think you could have long
Speaker 1: term growth from a reduction and a lot of operating expenses,
Speaker 1: so you have interest rate spreads, you have a reduction
Speaker 1: in operating expenses lots of different ways. But when you
Speaker 1: start at a ten percent earnings yield, you don't need
Speaker 1: a lot of growth, And I think that's what people
Speaker 1: are going to begin to internalize. So we'll wait a minute.
Speaker 1: When I own a utility, I don't have a lot
Speaker 1: of growth. A lot of consumer products companies are you know,
Speaker 1: trumpeting if they get four percent growth or three percent growth.
Speaker 1: I mean, I think the banks have done much better
Speaker 1: at half the multiple and a willingness to return that
Speaker 1: capital to sheruld. So your per share growth is going
Speaker 1: to be a lot greater even with no loan growth.
Speaker 1: So you know, with bank investors there's always something to
Speaker 1: worry about. But if you look at the big category
Speaker 1: stories of risk, regulatory risk, liquidity risk, interest rate risk,
Speaker 1: credit risk, regulatory risk, I mean, these are all about
Speaker 1: as low as we've seen in the last decade or two.
Speaker 1: So we have a lower risk profile with a gap
Speaker 1: in the valuation of banks versus the SMP that's just
Speaker 1: about as wide as it's ever been. Uh yeah, the
Speaker 1: bank stocks are up a lot, buts over the earnings
Speaker 1: because the earnings were so depressed last year. Uh, and
Speaker 1: so I think that that, you know, if people want
Speaker 1: to hate on them, they can hate on them, and
Speaker 1: it doesn't matter because there can their valuation is sort
Speaker 1: of with an advantage that gives them control of their
Speaker 1: own destiny. The lower the valuation, the higher the return
Speaker 1: on the share repurchase. For example, so banks are worth
Speaker 1: more at twelve times earnings than they'd be worth it
Speaker 1: fifteen times earnings. I do think that there are a
Speaker 1: lot of very interesting macro takeaways in bank earnings. JP
Speaker 1: Morgan was faced with a bunch of questions, including a
Speaker 1: heated discussion about inflation, supply chain dynamics, and bank regulations
Speaker 1: with the FEDS. Randall quarrels. Stepping down, I wondered if
Speaker 1: you had any particular thoughts about any of those broader issues. Well, Pulice,
Speaker 1: it's it's it's a good question. You certainly inflation in
Speaker 1: the specter of inflation, and whether it's transitory or whether
Speaker 1: it's is going to be an issue that's going to
Speaker 1: occupy all investors for the next twenty four months or so.
Speaker 1: We just will get more data. I I would saying
Speaker 1: I am inherently a warrior that invests because I feel
Speaker 1: that when I manifest all of those worries and I
Speaker 1: think about what do I want to do, the answer
Speaker 1: is not whole own cash or bonds with you know,
Speaker 1: two percent yields and things like that. I want to
Speaker 1: own businesses that have a proven record of resiliency and
Speaker 1: of adapting to different macro economic environments. I would say,
Speaker 1: without getting overly promotional about banks, that I can imagine
Speaker 1: a scenario where investors, short term investors, start saying, wait
Speaker 1: a minute, banks are one of the few sectors where
Speaker 1: we don't have to worry about supply constraints, Like we
Speaker 1: don't have to worry about you know, oh my god,
Speaker 1: they couldn't get parts, so they're gonna have to ship
Speaker 1: fewer cars or fewer iPhones. Uh, they're gonna have to
Speaker 1: cancel flights, or they can't get labor. Right. So I
Speaker 1: actually can imagine a scenario where people say, wait a minute,
Speaker 1: banks are kind of in a suite spot where we
Speaker 1: don't really have to worry about their earnings. The way
Speaker 1: we suddenly have a lot more unpredictability in the earnings
Speaker 1: even of companies that had been viewed as very reliable
Speaker 1: like Apple. Uh, because of some of these supply constraints.
Speaker 1: So I actually think that the macro question that they
Speaker 1: were tussling about, that JP Morgan are going to be
Speaker 1: with us for a long time. Because it's a parlor game.
Speaker 1: It's like predicting who's gonna win the Super Bowl. I'm
Speaker 1: not a sports fan, so I couldn't even name likely contenders.
Speaker 1: But but what I would say is nobody knows, and
Speaker 1: yet a lot of time is going to be spent
Speaker 1: discussing it, and then you know, we'll flip the coin
Speaker 1: in some time down the road. Somebody's gonna say I
Speaker 1: was a genius. I knew all along. Nobody knows, nobody.
Speaker 1: There's no period in history we can look at for
Speaker 1: what will be the outcomes of this incredibly aggressive monetary policies.
Speaker 1: You know, as I say, I'm by nature conservative. I
Speaker 1: don't like people borrowing beyond their means. I don't like
Speaker 1: governments spending our grandchildren's money. I don't think it's a
Speaker 1: sensible idea. It may work out fine, Uh, I don't know.
Speaker 1: But what I know is that no matter what, in
Speaker 1: an uncertain world, I want to own a folio of
Speaker 1: businesses that can adapt our own businesses that adapted to stagflation,
Speaker 1: businesses that adapted to recessions, businesses that adapted to you know,
Speaker 1: the geopolitical chaos of the sixties and seventies. Uh. So,
Speaker 1: resiliency and adaptability is I think what should be at
Speaker 1: top of mind for investors and as they start thinking
Speaker 1: of those characteristics. Of course they're wonderful businesses like applied
Speaker 1: Materials or Intel or uh. But businesses like Raytheon. It's
Speaker 1: hard to imagine a world where Raytheon doesn't have a
Speaker 1: lot of value. I don't I don't care if they're
Speaker 1: if we're buying you know, missile defense systems and seashells
Speaker 1: or bitcoin or uh. There's huge value for what they sell,
Speaker 1: and it is going to be resilient as a business model.
Speaker 1: And I think what people are coming to realize is
Speaker 1: really the same as true of banks. You know, a
Speaker 1: lot of our banks are in their second century, some
Speaker 1: of them are even in their third entry. Uh, basically
Speaker 1: providing the same service, selling the same product, with the
Speaker 1: same business model. You'd be hard pressed to name any
Speaker 1: other companies with that record of longevity, and yet here
Speaker 1: they are is the cheapest sector in the SMP fun
Speaker 1: you know, Chris as far as predicting the Super Bowl,
Speaker 1: I will predict it probably won't be the Jets, I'll
Speaker 1: go that far as tell you. But but I wanted to,
Speaker 1: you know, get back to as you said, Uh, you
Speaker 1: know your funds are actively managed. You you don't believe, uh,
Speaker 1: financials is a space the place to get passive. I
Speaker 1: did notice a Capital One a big holding in both
Speaker 1: the David's Financial Fund and the h and the Davis
Speaker 1: New York Venture Fund, which I believe is your your
Speaker 1: biggest fund right um and I know part of that
Speaker 1: is obviously just because Capital One has been appreciating in value,
Speaker 1: like outperforming everything in the space. You know, on the
Speaker 1: other hand, you're clearly not reducing the steak or removing
Speaker 1: it as your as your top weight. So so what's
Speaker 1: it doing so well for such hot performance and what
Speaker 1: what has you comfortable enough about that company to to
Speaker 1: keep it with a pretty heavy weight in both funds.
Speaker 1: It's funny I spent a day with the co founder
Speaker 1: who has since retired of Capital One just last week.
Speaker 1: Um well, Capital one is one of the only major
Speaker 1: banks in the US that's still run by the founder.
Speaker 1: Now we talked early about culture, but what's really extraordinary
Speaker 1: about Capital One is from its very beginning, Capital one
Speaker 1: was not a bank. It was a data science company.
Speaker 1: It always has been. It had no branches, it had
Speaker 1: no customers, and yet somehow managed to become one of
Speaker 1: the largest credit card companies in the country. No branches,
Speaker 1: no customers. How well they used data, They target marketed,
Speaker 1: They customized offers to consumers based on characteristics that they
Speaker 1: were able to surmise about consumers based on their occupation
Speaker 1: or their zip code. And they would say, you know,
Speaker 1: why on Earth the banks offer one credit card for
Speaker 1: all their customers. Some customers are very interested in revolving,
Speaker 1: some are very interested in points, some are very interested
Speaker 1: in prestige or affinity. People have all different considerations, and
Speaker 1: yet every bank had a one size fits all credit card.
Speaker 1: So Rich Fairbanks and Nigel Morris come along. Uh. They
Speaker 1: launched Capital when I was early in my career. Uh.
Speaker 1: They were a division of another bank. Then they were
Speaker 1: spun out. Uh, and they were still a data science
Speaker 1: company when they started buying buying branches. Uh. Not all
Speaker 1: that long ago relative to their history. And they did
Speaker 1: it because they realized that core funding had a huge advantage.
Speaker 1: They had relied in their historic history on securitizations to
Speaker 1: finance growth. But what they learned in some of the
Speaker 1: securitization crises is that that market can be fickle, so
Speaker 1: they went the other way. They went into branches. So
Speaker 1: we think of Capital One, A lot of consumers think
Speaker 1: of Capital One because they see the the bank branch
Speaker 1: on the corner. But that's an accident of history. It
Speaker 1: is fundamentally a data science company. And the analogy I
Speaker 1: would give you as Progressive in auto insurance, right, Progressive
Speaker 1: sells a commodity product that they have to file for
Speaker 1: the rates in states by and large historically through the
Speaker 1: same distribution channel as many other companies. In fact, I'll
Speaker 1: pick on one which was always a very high quality company,
Speaker 1: Ohio Casualty, because they were headquartered just about in the
Speaker 1: same town, selling a lot of the same products through
Speaker 1: the same distribution channels, and over a twenty year period,
Speaker 1: one compounded at one compounded at six is that possible? Well?
Speaker 1: Culture culture, and it wasn't just a culture of conservatism.
Speaker 1: It was a culture of innovation and using data and
Speaker 1: using science and how can we predict what is the
Speaker 1: likelihood of you having a car accident based on the
Speaker 1: type of car, your occupation, or your credit or all
Speaker 1: sorts of other things, and how can we give you
Speaker 1: a better deal, how can we customize So we're a
Speaker 1: data rich company. First, that's Capital One. So when I
Speaker 1: talked about all of the traditional risks facing banks, liquidity,
Speaker 1: credit regulation, UH, interest rates UH and so on, UH,
Speaker 1: I would say all of those risks are as low
Speaker 1: as I've seen in most of my career, but certainly
Speaker 1: in the last fifteen years. The one risk that is
Speaker 1: the most important risk is disruption. It's technological disruption. So
Speaker 1: as you invest and you think about risk and reward,
Speaker 1: part of Capital ones model is that they are a
Speaker 1: very profitable institution because they are wonderful at generating high
Speaker 1: yielding assets in a way that is difficult for others
Speaker 1: to imitate. And they have low cost core funds, so
Speaker 1: they have a good core business. But then that's the
Speaker 1: opportunity the risk. If banks have the biggest risk is
Speaker 1: financial UH is technological disruption, then I would say among
Speaker 1: the major banks, Capital one is one of the lowest
Speaker 1: because it's baked into their DNA to innovative. If they
Speaker 1: said tomorrow, you know what, we're gonna have no branches.
Speaker 1: We're gonna be entirely in the Internet bank, uh Internet,
Speaker 1: using media and data to market to come. That would
Speaker 1: be perfectly consistent with their culture. So that mindset, I
Speaker 1: think is another reason that I think Capital One is
Speaker 1: a good one. Now, in full disclosure, we have trimmed
Speaker 1: some Capital One in part because while it's always been
Speaker 1: a core holding, we bought so much during the COVID
Speaker 1: crisis that the appreciation. We think it's important to run
Speaker 1: a diversified portfolio. You know, one of the dangers about
Speaker 1: the Financial Index that people don't realize is the index
Speaker 1: is like forty percent in like four stocks. People when
Speaker 1: they buy an index think, well, at least I'm getting diversification.
Speaker 1: You're not. In the financial index. You're getting more concentration
Speaker 1: than in our financial sector fund. So I think that's
Speaker 1: a little too much risk from my blood. So we
Speaker 1: do tend to tamp things back as as they get
Speaker 1: very large, and we have a little bit of Capital One, although,
Speaker 1: as I say, still being run by the founder with
Speaker 1: that mindset is an extraordinary band. Plus they have a
Speaker 1: pretty funny TV commercials. I'll give them that, Chris, I
Speaker 1: don't know if that plays in your thinking. You know
Speaker 1: those data scientists. What's impressive is they didn't vet the
Speaker 1: commercials for their humor. They vetted them based on this
Speaker 1: is what works for and that they're very much inn
Speaker 1: a b testing mindset. I know a number of people
Speaker 1: even in the mid level ranks there, and they are
Speaker 1: math geeks and analytically inclined. It's a very different thing
Speaker 1: than the cigar chomping you know, three piece shuit banker
Speaker 1: uh mindset. So it is a very different culture. Please,
Speaker 1: you got one more good question for Chris before we
Speaker 1: go to crazy things. Sure, your emphasis on fintech reminded
Speaker 1: me that Jamie Diamond had said the bank was willing
Speaker 1: to spend whatever it takes to compete. Do you think
Speaker 1: that JP Morgan can actually be more agile, more nimble,
Speaker 1: throw more money at fintech and really uh dominate or
Speaker 1: do you see a different kind of disruptor coming to
Speaker 1: really shift the whole financial system, including with defy and
Speaker 1: other sorts of technologies. Well, it's the right area of
Speaker 1: focus on police. I think it is amazing though, to
Speaker 1: think about the amount of disruption that has been thrown
Speaker 1: at the banking sector in the last thirty or forty years. Now,
Speaker 1: let me just give you a good example. The money
Speaker 1: market fund was invented. Now, if you can imagine a
Speaker 1: more dangerous innovation, then the money market fund to the
Speaker 1: banking sector. Wait a minute, I can offer customers higher
Speaker 1: interest rates with no risk because I'm only in government bonds.
Speaker 1: I don't need any branches. All of a sudden, you
Speaker 1: would have thought a vast sucking sound out of the
Speaker 1: banking sector. Of all of their liabilities, all of their deposits.
Speaker 1: Now you know these you know, cigar chomping uh, pizza
Speaker 1: eating bulligans at Solomon Brothers. You know, gin up the
Speaker 1: mortgage backed security, right, and so all of a sudden
Speaker 1: you've got the mortgage backed security. Asset back securities are invented. Well,
Speaker 1: there go all my assets. Another huge innovation, you know
Speaker 1: Mike Milken and Bosky, you know they dream up the
Speaker 1: high yield market. You know, there goes a lot of
Speaker 1: my corporate business. You know. Then you get the A
Speaker 1: T M. I don't even need branches. Customers can come anywhere,
Speaker 1: and non bank financials you know, uh G E and
Speaker 1: so on. So you've had a massive amount uh the
Speaker 1: credit card banks we mentioned Capital One, you know these
Speaker 1: from the standing start. These three or four companies take
Speaker 1: the entire credit card industry, and yet here is the
Speaker 1: banking sector earning more money than it ever has in
Speaker 1: the past, and by the way, with as big or
Speaker 1: a bigger market ship. So they have been amazing at
Speaker 1: sucking innovation into their core. Now they do it partly
Speaker 1: by adapting. And I think Jamie is one of the
Speaker 1: best examples of somebody who has his eyes over. Brian
Speaker 1: moynihan has been amazingly masterful Bank American rolling out their
Speaker 1: digital products. Venmo is a great technology. We all love Venmo.
Speaker 1: Zel comes along, well, you know, in technology, we think,
Speaker 1: oh it should be winner take all. Venmo should win.
Speaker 1: Zell's bigger than Venmo today, right, So banking has not
Speaker 1: been that sort of winner take all Google model. They've
Speaker 1: been amazing. Now, if you wanted to be cynical, you'd
Speaker 1: say they also use regulation, right. Certainly, we saw that
Speaker 1: in China with aunt financial Right, regulators get a little
Speaker 1: touchy when the financial system gets too unregulated and people
Speaker 1: start going cowboy. We saw it ad ap peer to
Speaker 1: peer lending, for example. So there have been a lot
Speaker 1: of cases in financial services history where that innovation is
Speaker 1: absorbed in I would say the biggest thing that banks
Speaker 1: UH that positions banks well for withstanding the onslaught of fintech,
Speaker 1: is this. In the classic innovator's dilemma, the large, lumbering
Speaker 1: incumbent faces some innovation, and the trouble is to compete,
Speaker 1: they have to screw up their existing business, and they
Speaker 1: don't want to do that. That's why it's called the
Speaker 1: innovator's dilemma. What do I do if I'd have to
Speaker 1: cut my prices, I'd have to change. In the case
Speaker 1: of banking and Bank America, there's no institution that can
Speaker 1: demonstrate this better than Bank America. Pulling their customers onto
Speaker 1: a digital experience is significantly reduces costs and enhances the
Speaker 1: customer experience and enhances customer stickiness, which reduces UH turn
Speaker 1: which further reduces costs. So unlike the typical innovator's dilemma,
Speaker 1: the incumbents are economically incentivized to jump right into the innovation. Meanwhile,
Speaker 1: when I look at the valuation of a lot of
Speaker 1: fintech companies, I think a lot of them are gonna
Speaker 1: end up selling to banks because there's no way they
Speaker 1: can earn their way into their valuations. So a lot
Speaker 1: of them are now providing their services to the banking sector. Uh,
Speaker 1: they're becoming back engines for them, or they're helping them
Speaker 1: work their customer targeting mechanisms. And the banks have been
Speaker 1: very open to bringing it in, so we're watching it closely.
Speaker 1: You could see disruption. Schwab obviously lead with a single
Speaker 1: product of discount brokerage back in the day and has
Speaker 1: become a financial juggernaut that was a disruptor becoming a
Speaker 1: blue chip. Uh. It's possible some of these single product
Speaker 1: companies Chime Rocket, uh, some of the by now, pay later,
Speaker 1: Affirm and so on, that they'll be able to parlay
Speaker 1: that single product focus into a broad customer relationship. Uh.
Speaker 1: We're gonna watch it closely because it's a big risk.
Speaker 1: But I will tell you the spending and the effectiveness
Speaker 1: of the spending by by JP Morgan Chase in Bank
Speaker 1: America in particular, I think Wells is trying hard to
Speaker 1: get catch up. Um it has been. Uh, it's been
Speaker 1: really impressive to see and and the customers are using
Speaker 1: the products and they're all happy with them, and so
Speaker 1: I think it is a little overhyped at the moment,
Speaker 1: but it is the area to watch. But the incumbent
Speaker 1: success in the economic models give me some confidence that
Speaker 1: it's not the classic innovator's dilemma of the incumbents facing
Speaker 1: a Hobson's choice of to compete, we have to give
Speaker 1: up our core stand clear of the craziest things we
Speaker 1: saw in markets this week, Police speaking of big umbering
Speaker 1: incumbents and new actile disruptors, I think I'm the I'm
Speaker 1: the big lumbering income incumbent on this podcast, and you're
Speaker 1: the new innovative disruptor. So let's see if you can
Speaker 1: disrupt me with your craziest thing. What's the craziest thing
Speaker 1: you saw in markets this week? Well, my craziest thing
Speaker 1: actually parallels that in terms of Jamie Diamond calling bitcoin worthless.
Speaker 1: I thought that was completely crazy. With bitcoin trading at
Speaker 1: fifty five dollars, it's clearly not worthless, and there's an
Speaker 1: enormous infrastructure being built and everybody's using it and thinking
Speaker 1: about it. So I found that to be quite uh.
Speaker 1: The the the lumbering incumbent dilemma right there, that's a that's
Speaker 1: a good way of saying it. I'm gonna pile on
Speaker 1: yours your crazy thing, because my my crazy thing is related.
Speaker 1: And then we'll see what Chris thinks about all this.
Speaker 1: But Back of England came out with a report pointing
Speaker 1: out UH cryptocurrency assets are now worth two point three
Speaker 1: trillion dollars UH, growth of more than two since the
Speaker 1: start of the year. That makes them twice as big
Speaker 1: as the subprime market UH before the financial crisis, which
Speaker 1: is kind of mind blowing. Um knock on wood. We
Speaker 1: don't have a similar a similar resolution, but Chris, at
Speaker 1: least it makes me wonder, what do you think about
Speaker 1: this whole crypto economy and the potential disruption to centralized finance. Um,
Speaker 1: is it's something you're you know, you think a lot
Speaker 1: about or is it a fad? You know? How are
Speaker 1: you thinking about it? Oh? No, he studied it closely.
Speaker 1: And in fact, I've had a long term close friendship
Speaker 1: of somebody I admire greatly with Bill Miller, going all
Speaker 1: the way back to the start of my career, and
Speaker 1: we hosted an event together at the Santa Fe Institute
Speaker 1: about six years ago on the nature of cryptography and
Speaker 1: the nature of currency and stores of value and so on. Uh.
Speaker 1: So it's an area that I'm very familiar with, and
Speaker 1: I think it's perfectly plausible that these currencies replace gold. Uh.
Speaker 1: They digitize gold for example. Um, but I will take
Speaker 1: the other side just to pick a fight with police,
Speaker 1: which I think is a dangerous idea, but which is
Speaker 1: just to say that Jamie could be absolutely right that
Speaker 1: it's worthless and that it has no intrinsic value. You
Speaker 1: could say virtually you could say the same about gold.
Speaker 1: Now gold has some industrial value, but beyond its industrial value,
Speaker 1: you could argue it has an esthetic value, but it's
Speaker 1: really worthless. It has value because values subscribes ascribe to it.
Speaker 1: So I think Jamie is right that the the value
Speaker 1: there is no value. It is worthless. Uh, it doesn't
Speaker 1: have it intrinsic worth. But yet it could be very useful,
Speaker 1: and it could be useful as a digitized store or value,
Speaker 1: or it could create a better transaction system. So I
Speaker 1: think in a sense both can be right. And it's dangerous.
Speaker 1: When anybody clothes is their mind off. But I think
Speaker 1: in this case maybe the word choice matters a little bit. Uh,
Speaker 1: but I'm not certain so, but I do think it's
Speaker 1: an area that people should want. Now when people say, oh,
Speaker 1: how can you own bank in New York? I mean,
Speaker 1: all of that custody business could be done with blockchain.
Speaker 1: Do you know what Bank of New York charges for
Speaker 1: their massive trillions and trillions of dollars of assets under custody,
Speaker 1: their bonds, stocks, all that stuff. And you know what
Speaker 1: they charge for that less than one basis point. So
Speaker 1: you know, for less than one basis point, I get
Speaker 1: all their systems, their regulation, their assurance. That's not a
Speaker 1: big fat disruptible pool. Now. Visa, on the other hand,
Speaker 1: I think should worry, and I think I think mortgage
Speaker 1: you know, I think real estate brokers should worry. There
Speaker 1: are lots of title insurance, so lots of things that
Speaker 1: have big fat spreads. Uh that probably should be competed away.
Speaker 1: But you know, in my lifetime I started a commission.
Speaker 1: Uh the year I started was ten or twelve cents
Speaker 1: a share for an institutional investor. Now it's about, you know,
Speaker 1: round to zero. And yet somehow a lot of broker
Speaker 1: dealers are doing just fine. So you know, the financial
Speaker 1: system tends to adapt, and uh, I think Jamie Diamond
Speaker 1: will adapt, uh to if if if Bitcoin ends up
Speaker 1: digitizing gold, which after all Gold's market cappus something like
Speaker 1: ten trillion. I think, so there's a lot of shift
Speaker 1: as that ten trillion moves and uh and I think
Speaker 1: that's what sort of underway. That's a great point about
Speaker 1: Bill Miller, talk about someone who made the you know,
Speaker 1: caught on early at the right time, and you know
Speaker 1: a lot of a lot back when a lot of
Speaker 1: people were still very skeptical and he he didn't catch generally,
Speaker 1: he would be the first to say, like we walked together,
Speaker 1: go from thirty to three hundred, and then it went
Speaker 1: to five hundred, and then it fell back to three
Speaker 1: hundred and and I think he would say that's when
Speaker 1: he did. Really all of his buying was right after
Speaker 1: that conference that I mentioned. And uh So it is
Speaker 1: amazing how one of Bill's great gifts is his flexibility.
Speaker 1: For a lot of us. If you've missed a ten bagger,
Speaker 1: you don't want to look anymore. It's too unpleasant. It's
Speaker 1: an enormous gift to be able to look at you know,
Speaker 1: Amazon at e D after it's gone from eight to
Speaker 1: eighty and still see it as a value. Uh. And
Speaker 1: sometimes that's uh, you know, people confuse price and value.
Speaker 1: They think if something's gone up a lot, it's more expensive,
Speaker 1: or sometimes they think it's more attractive because it's gone
Speaker 1: up a lot. The price has nothing to do the past,
Speaker 1: has nothing to do with the future of that. Very
Speaker 1: very interesting. All right, chrisy, have you seen anything crazy
Speaker 1: this week? Do you want to share? All right, I'm
Speaker 1: gonna give you one that that is it's not really
Speaker 1: this week, but I'm just gonna give it to you.
Speaker 1: When we think about, uh, how the idea of price
Speaker 1: discipline has eroded. So I think the craziest thing in
Speaker 1: the market over the last several years has been dispersion.
Speaker 1: When you just get is crazy. See disparity and assets
Speaker 1: where you could you think there's rough comparability or visibility
Speaker 1: into their value, but they traded wildly different prices, so
Speaker 1: international versus domestic growth versus value. So here's my crazy
Speaker 1: one for you. If I was to take Tesla, Squares, Shopify, Spotify,
Speaker 1: and Zoom their market cap today's around one point three trillion,
Speaker 1: for the same one point three trillion, I could buy
Speaker 1: a big lion share of our core portfolio. So I
Speaker 1: could buy a hundred percent of Capital One, Applied Materials,
Speaker 1: Intel Rate, Yeon JP Morgan, Chase, Chub Banking, or Melon
Speaker 1: in American Express one point three trillion, one point three
Speaker 1: trillion equal price. The first companies earning nine billion. The
Speaker 1: second group of companies are earning nine Now you say yes,
Speaker 1: but those first group of companies, they're growing. This is
Speaker 1: the crazy part. Let's do a little thought experiment. Let's
Speaker 1: take that group of companies, tell us a square, Shoppify, Spotify, Zoom.
Speaker 1: In the next ten years, they grow as fast as Apple, Amazon,
Speaker 1: and Google grew in the last ten years. I think
Speaker 1: we'd all agree that's that's pretty good outcome. A decade
Speaker 1: of growth as fast as those three. And then let's
Speaker 1: say at the end of that, instead of having these
Speaker 1: crappy profit margins that inaggregate they have, they end up
Speaker 1: with the highest profit margins of any of those companies,
Speaker 1: which is Google. So they end up with Google's profit
Speaker 1: margins ten years of growth as high as Apple, Amazon,
Speaker 1: and Google. Now are boring group of companies. In the
Speaker 1: next ten years, they grow about They grow earnings about
Speaker 1: half as fast as they have in the last ten
Speaker 1: I think that would be a terrible outcome, but possible.
Speaker 1: So they only grow five percent, They only grow profits
Speaker 1: five percent a year for the next decade. Play that
Speaker 1: out over decade. In twenty thirty two, ten years from now,
Speaker 1: in our group of companies, you will have earned one
Speaker 1: point three trillion dollars. You will have earned the entire
Speaker 1: market cap group too, even with those crazy assumptions of
Speaker 1: high growth, high margins, You'll have only earned six d billion,
Speaker 1: half as much. And in twenty thirty two they will
Speaker 1: still be earning less annually. They will still earn less annually.
Speaker 1: So to me, that's crazy. And it's not this week crazy,
Speaker 1: but it's this time of the market crazy. And I
Speaker 1: don't know when that gap is going to close. But
Speaker 1: I sure love what we own versus where the where
Speaker 1: those crazy valuations are. Chris, that is the most thought out,
Speaker 1: crazy thing I think we've ever had. Fleece. You gotta
Speaker 1: check his math on all that, all right, Absolutely, I'll
Speaker 1: send it to you. By the way, they are group
Speaker 1: would be earning a hundred and fifty four billion, and
Speaker 1: that Group one would be a hundred and thirty billion.
Speaker 1: And I'm, by the way, giving some of them a
Speaker 1: little generous credit for uh, some of their more aggressive accounting,
Speaker 1: but I'll leave that aside. That's fascinating. I was I
Speaker 1: was wondering if Chris was going to say he could
Speaker 1: buy a whole lot of bitcoin and bitcoin will still
Speaker 1: be earning zero and it will still be worth the less.
Speaker 1: Let's say, right, Well, we're gonna have to get Chris
Speaker 1: back in two and see how that turned out, see
Speaker 1: if his math was right. I'm guessing he's probably right though,
Speaker 1: Chris Davis, Police Brands, thank you so much for your time.
Speaker 1: Really enjoyed it and hopefully we can do it again.
Speaker 1: Thank you. That's great. Thank you guys. I enjoyed it.
Speaker 1: What Goes Up. We'll be back next week. Until then,
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Speaker 1: produced by Too for Fourheads. The head of Bloomberg Podcasts
Speaker 1: is Francesco Levie, thanks for listening. See you next time
Speaker 1: than before.