What Happens to Stocks When the Fed Starts Cutting Rates?
Summary
Federal Reserve Actions: The podcast discusses the recent 25 basis point rate cut by the Federal Reserve and explores the implications of entering a rate cut cycle, including potential impacts on the economy and stock market.
Federal Reserve's Role and Independence: There is a detailed discussion on the history and purpose of the Federal Reserve, its evolving independence, and how political pressures have influenced its operations over time.
Market Reaction to Rate Cuts: Historically, stock market performance following rate cuts varies significantly depending on the economic context, such as whether the cuts are a response to recession fears or part of a soft landing strategy.
Bank Stocks and Yield Curve: The podcast notes that large bank stocks like JP Morgan and Bank of America are at all-time highs, despite concerns about recession, and discusses the implications of a flattening yield curve on the banking sector.
AI and Capex Spending: There is significant focus on the extraordinary capital expenditure in AI and related technologies, with companies like Oracle and Nvidia heavily investing, which could drive economic growth despite consumer sector weaknesses.
Payment Industry Challenges: The podcast highlights the struggles of payment companies like PayPal and Fiserv, which are experiencing declining stock prices and multiples due to competitive pressures and slowing growth in segments like Clover.
Deficit and Long-term Economic Concerns: Concerns are raised about the persistent high deficits since the financial crisis and their implications for future economic policy and potential yield curve control.
Investment Strategy: The discussion suggests that in a potential debasement scenario, investors might consider holding assets like stocks, gold, and Bitcoin as a hedge against economic uncertainties.
Transcript
Welcome, welcome, welcome. How's everybody doing? Hope you are doing well. My name is Andrew with Focus Compounding on Air Live with Jeff Ganon. Jeff, how's it going today? >> It's going very well, Andrew. How's it going with you? >> It's going great. We hope it's going great with everybody else as well. This is the first time you are tuning in with us. Thank you so much for joining us. Be sure to check out all of our content that we push out into the investing universe. The best way to do that is to follow me on X at Focused Compound. uh go to focuscompounding.com to get access to investment writeups from Jeff going all the way back to 2005. And of course, wherever you are watching or listening to this uh today, either through the podcast side of things or the YouTube uh side, make sure you hit the subscribe button to be notified every time that we upload a new podcast. So, in today's podcast, Jeeoff, we're going to talk about um the Federal Reserve. Uh last week Jay Pow in the Fed came out and they cut interest rates by 25 basis points. No surprise as the market was basically pricing that in. Um but want to talk about, you know, if we are going to go into a rate cut cycle, what that means for the economy, what that could mean for the stock market, how we're thinking about it, and um go over that. Uh but before jumping into it, I guess we should probably talk about why the Fed was created. Why do we have a Fed? Get your thoughts on it. I think it's kind of interesting because you're going back to, you know, uh a time period where we would have these panics and mania and the depression, right? And back to the point where sort of the area era where JP Morgan had to bail out the US government. Um so I I I have written down that that was during the panic of 1907 and the Fed was established from the Federal Reserve Act in 1913. Um and just talk about it. So yeah, want to hear your thoughts. It seems like the Fed is you know in in recent years it's been uh I don't know if their credibility if has always been questioned. Certainly their independence is probably being uh questioned at this point, right? Um so want to get your thoughts on just everything that is the Federal Reserve before we go into interest rates. >> Yeah. So they basically as they exist today have um uh objective of um keeping inflation from getting too high although not actually stable prices anymore. And they kind of set for themselves a target of 2% for that. And then unemployment. So sort of low inflation and low unemployment with trade-offs between those things. um the reasons for why they're created and what they had originally was a little bit different and technically some of the things that they're in try that they're supposed to be targeting are a little bit different but that's their perception of what it is today and that's kind of what it's become um I think so that's a pretty accurate way of talking about it today um why it was created originally is more like you said kind of to provide for a sufficient currency thing so basically to not have a situation like what happened in the financial crisis of um uh like 2007208 whatever that kind of thing more of like a seizing up of credit and stuff was kind of the original purpose because that's most similar to what you saw with the panic in 1907 that you're talking about but it quickly evolved away from that a lot of it because of what happened with the uh great depression and a lot of the blame for that is on like monetary policy and things like that and so things changed in the post-war period basically. Yeah. Um so and then in terms of independence like you said there there's evolved over time to be very independent of the other uh parts of the government almost to the extent of being similar to like the Supreme Court or something in terms of how independent it's gotten. It's more independent than the other agencies that are similar to it that are created by Congress and then people are appointed by the president. So even though it's kind of an executive thing, it does it's kind of seen as being separate from that and presidents don't exert much control over it even though it's what it's doing is basically you know executing policy for the government. So it that's made it very different that way. Um and it's kind of taken more seriously than some of the other independent things. Um but you know there obviously we there have been presidents in the past who've encouraged the Fed to do one thing or the other. Um, and you know, now probably is the most pressure that there's been, but there are others that were, you know, >> there's always been pressure, right? I think it was just like behind closed doors, you know, a little pushing and shoving. Now you just get to, you know, send off bombs on Twitter or X and make it public through social media. evening trillion dollar triage >> that book on how much Trump would call Jalow and >> telling them hey you got to cut rates you got to do this you got to do this I know you guys are independent but do this >> I think that there was actually a belief in independence for about 25 years or so for uh with um Reagan Bush Clinton Bush again um and Obama um but before that I think if you go back to the 40s through the 60s there was behind closed doors a lot less independence and then today there's a lot less independence that way um or at least pressure but you know that I mean there's I mentioned the Supreme Court there there have been presidents who said exactly what how they want the Supreme Court to rule um it doesn't really stop them from ruling one way or the other you know uh those are political issues and they talk about it the Fed used to be um like I said for that period then let's say from the 80s through until Trump was elected. Um that was a period in which they even didn't comment all that much a lot of the time. Um and there's reasons for why that would be. The biggest reason is it followed up the great inflation. And so, uh, it was actually that they were scared of, um, being perceived as having coordinated Treasury and Fed type stuff like they did sometimes in the 70s and things and that that was bad and that that um, reduces trust in things over time. And then since then, you difference in attitude with Trump about other things too. FCC is very similar to Fed uh, kind of thing historically. And um, so that's part of it. The other part honestly is that you just went through a really long period until COVID where you weren't that concerned about inflation. What that would feel like just like as you got further away from the Great Depression, people were less concerned with New Deal things and employment and stuff. If you haven't seen huge unemployment for a long time, then you don't really think those policies are as important. If you haven't seen really bad inflation for a long time, then you're not as concerned about that, you know. So, I think that's the other reason, too. Um, and it actually kind of coincides with the the time in which the Fed independent stuff people believed in the most is also the time when they believe the most in balance budgets and things. And you've kind of seen the same trends in both cases where, you know, um, because it doesn't it doesn't politically help your side on either case to have in all cases a Fed that is independent. nor does it really help you to have a balanced budget, but you believe in it because you believe on average, you know, regardless of which policies are implemented by which party. Uh it's good, right? And so that's the part that I mean that's kind of broken down. So because you'll see the Fed now being criticized for two opposite things sometimes in ways that before they might be reluctant just like don't criticize the Fed because we should have an independent Fed even though I don't agree with the policies, you know, on different sides. Um, so and I think that's similar to the balanced budget thing and both of those probably peaked around 2000 that you had the most people believing in balance budgets and the most people believing in Fed independence about then and since then it's kind of deteriorated a little bit. >> It was interesting listening to JP talk. He was giving it was like a Q&A or whatever and he was talking about how the Fed used to completely be a black box where they wouldn't even put out >> you know their remarks their dot plots like basically what happened and now they do to try to >> um you know uh give transparency to what they're doing. But I didn't even realize that at one point basically they completely acted almost off the record in silence. You know, you didn't know what they were doing. >> Yeah. And it's interesting if that's good or bad. Uh I mentioned Supreme Court before. Courts work the exact same way. So uh courts now put out very extensive decisions. People probably assume that's how they always worked. They didn't. Um and that's reversed from like um uh vetoing and things like that. Whereas now on some vetos and things there's no real comments from the uh person vetoing it. Whereas in the, you know, 250 years ago, you had lots of comments about why someone vetoed something, and you didn't have lots of comments from courts, but it developed into something to explain their decision-making a lot. So, both of them did that. And I think that's pretty common among things that are independent that way. And there's probably reasons why they do it both. Um, uh, it it helps with being perceived as impartial probably over time if they do that. They could be seen that way. It has big downsides. I mean, I I think that's one of the problems for the Fed is that they've given too much guidance and too much information about what they're doing and everything instead of being more uh fly by the seat of their pants. I think that the policy's not been as good because of that. But there's lots of academic stuff that suggested they should do that. So, um I just think it has certain risks and uh if they had not been saying much in public, I think they could have acted quicker to raise rates like in CO and stuff and but they'd said for so long so many things that it makes it harder to turn policy if you're on record for so long saying things and then you have to wait for all the other members have to say things. They all have to give their speeches and you know you have to see okay are we all giving the same sort of speeches in between the meetings and you're basically deciding at one meeting kind of giving hints of what you're going to do at the next meeting. It gets pretty >> there definitely some like gamesmanship to it and PA has even talked about before how like >> you could almost uh >> I don't want to say leak even though he does leak it to Nikki leaks like Timmer whatever his name is and um how you know sometimes a lot of it like he likes to leave the tea leaves for people to just price things in. I I feel like he doesn't like the unexpected stuff because he knows that markets hate uncertainty. That's true. Um, but it's also a short-term versus long-term type trade-off. The more because the future will actually be uncertain. So, the more uncertainty that you leave out there, the more prepared you are to take actions which you didn't expect to take now. For instance, they they may very well end up not cutting rates as much as they expect or other people expect. it could happen and they may that may now surprise people whereas if before they'd been really vague about that then it wouldn't be as likely to if you always have a par once you start cutting it's unlikely you cut just once then that starts to get anticipated and limit like exactly what you can do so um but like I said um it's something they believe in big time and uh I think you saw the big thing of it was with quantitative easing and everything in the after the great recession which they really did a lot to give like kind of forward guidance of like we're not going to raise rates for a really long time. We're going to do it in a certain order. We're going to slowly do things with the balance sheet. Like trying to push it out years in advance to kind of bind themselves to a decision. Um and then they even said, well, we'd be willing to do like average inflation rate things to make up for the in the past. But then they ended up overshooting because for the last from 2007 to today they've averaged 2 and a half% inflation. So that includes the entire great recession and they went over the 2% they were aiming for. So you know obviously they said they're not going to do that anymore that average thing. But obviously that wasn't good. Um so I just mean because you don't predict you're going to have a great recession. You don't predict you're going to have a pandemic. Um, so you could just say, "Look, things changed a lot." But it's harder to say, "Well, I believe one entirely different thing two months ago, and now I believe, you know, something else." >> I mean, so we're currently at four and a quarter, and as you can see from the screen right now, we got already four more uh rate cuts coming in um or being priced in. So um yeah, want to talk about your thoughts on that. Um and the yield curve itself. Interestingly, bank stocks are liking it. If you could look at uh like Bank of America, could pull it up right here was Bank of America, JP Morgan, basically all of the large banks uh are at all-time highs. So I thought that was uh interesting. Uh if I could pull this up here and then we could go over historically what happens to stocks, right? Because the difference is is that different market environments, rate cuts uh tend to affect stocks differently, right? Like are you cutting because you're worried about recession? Are you cutting because you want a soft landing? What is it? Right? And uh we could walk through that, but yeah. So JP Morgan, Cityroup, um Wells Fargo, all at all-time highs in the stocks. >> Yeah. I mean, now you're cutting because you're worried about a recession. >> I think they're pretty honest, open about that fact. There's no other reason to cut. They've been running above the inflation levels that they wanted. It'll be they're going to hit five years straight running over the inflation they want. You wouldn't cut just because of that in anticipation of it. So it's concern about a recession which is you know um I mean yeah and if you have a recession that tends to do a lot to bring down inflation. So it's totally understandable that you would feel that if you're headed into a recession a you should cut to try to reduce the likelihood that you're in a recession and b you don't have to be that as worried about inflation because a recession is going to tend to reduce inflation for what you're seeing right now you know in your expectations. Um because the financial things that haven't done as well are things that are exposed to like possible losses and things like that and and then also some things that rely more on short-term money because until recently there wasn't much of a uh uh any steepness to the yield curve. Right? So that was the other problem. >> So they're going to cut over the next year, call it, right? um or at least you know close to it. Equity prices are at all-time highs. Precious metals, gold, I don't know if you've been following gold just been going absolutely bonkers. >> Um you know worried about a recession. I just I wonder how much of that is going to help uh recession fears, but I do wonder how much of it is going to almost further this K-shaped economy that we are currently in where you're still going to get the wealth effect where basically all the wealth is going to go to top earners and you know the top whatever percent of uh the economy and everyone else is basically going to get left behind. I mean, it seems like a very precarious position to be in from the Fed's perspective. >> Yeah. And I don't think they care about the stock market. I mean, I know on this show and stuff, we'll talk about it like they care about that. I think they I mean, Pal said it's overpriced basically. Um, and I think they might see that. >> Did you say fairly valued or do you actually say overpriced? >> No, he said fairly highly valued. >> Okay. Interesting. which is the way of saying uh overpriced. >> Um but so here's I think it is relevant though in that um what the Fed does works through financial conditions. And so the the problem is that there's not a lot of signs that financial conditions are tight in any sense. And there aren't even it's hard to say that reducing that even cutting a lot and expectations for rates to be a lot lower would cause much looser financial conditions that would be helpful um to the overall economy. Right? So that's you know is it the right tool to use and will accomplish what you want um is kind of more the the issue I guess. Um it that doesn't mean that you'll have a recession or something. You might have wonderful breakthroughs in AI, things that help out with productivity. You might change fiscal policy. You might do all sorts of things that cause there not to be recessions and to go into booms and whatever. But, um, getting people much more excited about the stock market or something as being helpful in stopping a a recession is, you know, hard to believe at this point, right? Um, so it's just not as effective as it would be on on the flip side of that where uh things would seem to be too tight or something like that, you know. So, um, I don't remember what the Fed funds was at this time in 2007 or something, it was probably a bit higher than this, probably 100 basis points higher or something, but at that point, let's say when you're having a housing crisis or whatever. Yeah. So, beginning of 2007, yeah, 5.25%. If you started cutting a lot then then maybe that would help because you know by halfway through that year you had real signs and subprime and stuff that things weren't so good. Um on the other hand inflation wise they would have been like well inflation is kind of running a little hot in those years. Um so but there would have been more of a uh it feels more bubbly now than it did in 2007. Let's put it that way. Um, so I it's just like financial conditions seem looser as any way that you can measure them um than they did then. But >> you're referring to with all the AI stuff and it's just extraordinary numbers >> of capex, right? Oracle and I mean Oracle. >> Oh yeah, >> Oracle the sleepy Oracle company. It's like now this is just like >> the best. I mean it's like another Nvidia basically and you got Oracle and you have Nvidia and you have Chat GBT. It's just one big flywheel with each other, right? Like what is it? Uh Nvidia is investing 100 billion in Open AI. Open AAI is going to buy 100 billion or whatever of Nvidia's chips. It's just one big cluster together. >> Yeah. And I saw some companies which is very unusual um in recent years that there's a little bit of borrowing you know um adding to borrowing more than just what's maturing um for some big tech companies which has not been common at all for a really long time and you said like the capex some of those expectations for it are the difference between one projection another one or 2% of GDP in capex just for AI things and especially when you take into account like some of the um estimates I saw for electricity use, you would have to have capex on those things for electricity and move it from where it is now to where it'll be. Unless you have other people conserving a lot of electricity and prices changing and everything. If if it's just being added, then you're going to need to produce more electricity, which will need new generating assets and things. So, all that can totally >> Where's that gonna come from? >> Where is it going to come from? >> Yeah. >> Well, so the simple the biggest thing comes from Oh, >> I have I have a rule I have a I have a rule in the White House. You can't call it coal. You have to call it beautiful, clean coal, >> nuclear. >> So, >> yeah. Um, >> anything that's not windmills or solar or stuff like that, >> right? So technically you can't come from wind and solar on sort of a net based entire >> for the entire um grid because you need to run it all the time right now to the extent that you could have other things that can run on wind and solar but are not now then you don't but yes it is true that there's a limit to how much you could have on uh things that aren't uh able to operate at all times. So yeah, the I guess environmentally friendly thing is natural gas uh of the ones that we just mentioned. And then you said nuclear, but realistically I think they mean like small um I don't know if they call them small modular reactors anymore, but f uh there's companies that are involved in in smaller reactors that are fast reactors and things that are directly deployed at at the site, which is the same kind of idea. Um, and if that's true, um, then you know that's great from a whatever carbon basis and it's faster to do it. Um the problem with nuclear power from uh bigger things that you would need is you know I don't know the numbers but I'm going to guess that to do a new nuclear power station we're talking like around10 billion uh and around 5 years or something if even if you you know now of course you can change everything else that you could change everything about you know can China build them faster if they have no rules about anything and they encourage it and stuff. Yeah, if there was a war and you needed it, you would build it faster. Um, and and maybe cheaper and everything because a lot of the expense is safety. Um, but yeah, that that's not going to be I mean the projections I saw for AI things don't bother going out 5 years. So by the time you have new big scale nuclear things that's outside of the range of what they're already like what they think they can even hope to predict about how big AI will be. So, um, probably not that. But all that I meant is, um, if we think about that, and this could be true, but I I I don't know. I just don't believe that changing rates on that will actually change the investment in those things. I think that the multiples which are on those things, which are critical to why you invest in that stuff, don't seem to be being um, very closely related to that. If it was all funded by debt, that um, it would be a different story. But I do think that some of it is that you have really high multiples on these things. Um, in terms of where the capital is coming from, that's pretty easy to tell. It seems to be that venture capital and stuff doesn't do anything but AI anymore. That all the big money only goes to AI and so all other technologies and things just aren't getting funded. Um, you know, so that's what's kind of crowded out by that stuff and whatever. >> Let's talk about uh historically. So, as we said, um there's really no playbook as it relates to stocks on what happens when the Fed starts starts to cut interest rates. >> Problem is with markets is, you know, every general likes to fight the last war. Um, every situation is a little bit different, but we pulled up this article by Morning Star from September 16th, 2024. So, almost a year ago when they cut before the election, right? Was that a 50 basis point cut? I can't remember. I think it was 50, right, that they cut and then the long end took off. >> Yeah, we didn't mention that, but actually um in this cycle, I believe that the rates that would affect longerterm borrowing for businesses and things are exactly the same. Last I checked, they're the same. Yeah. On that side. Yeah. >> Yeah. And I mean, a lot of people are speculating well because they started they did come down over the past month. So, they were like pricing in the Fed cutting and Yes. but there hasn't been anything since the uh since the actual cut itself. Uh >> this person, this article says, "The last four major rate cutting cycles show why it's challenging to draw sweeping conclusions. Market performance can vary dramatically in the year after a new easing cycle starts. The Morning Star US market index rose more than 21% in the 12 months following the beginning of the Fed's 1995 easing cycle as the economy achieved a rare soft landing. But returns cratered more than 10% when the Fed began cutting rates in 2001 as the dotcom bubble burst. Um, and then we have these different uh stock performance at the onset of a rate cutting cycle. So 1995 looks like 21.58% 2001 down 10.63% uh 2007 down almost 18% and 2019 up 11.43%. So take us through these different regimes here Jeeoff. Why do you think the returns happened? Can we cycle analyze this or or do a post-mortem on why these returns happen after they started uh cutting during these years? >> So yeah, so 2001 and 2007 uh after the cuts there was recessions. Um the 2001's really complicated. Um it barely recession. Who knows if it would have happened without September 11th and you know whatever. But technically, so technically all three of those uh the first one, the the one that the cut in 1995, no recession followed. So no recession. The other three technically recessions followed all of them. However, one of them, the uh cut in 2019, uh is complex because the recession that followed is COVID, right? So that so it was very short and very deep and it's hard to know if it would have happened otherwise but uh if there hadn't been co right and then of course the market can't look forward and have expected co to have happened but in the other ones which is what kind was my point about September 11th too there's no way to anticipate you know price that in um but they could be pricing in in September of 2007 subprime obviously so those two are that there were recessions and then the stock market did badly and in some cases um like the 2001 cut underestimates it because if you count 12 months ahead so the beginning of it it's not too bad but that went on for years. So the overall uh those both of those marked really bad performances is just how long they went on for versus how quick they were. So recessions followed and bare markets followed that were big in those two cases 2001207 cuts >> affected federal funds trade over time. Let's see it says roughly half the time the Fed has started easing policy because it felt the economy was headed heading for a recession. In other cases it reduced rates to recalibrate monetary policy what some call a maintenance cut rather than in response to an economic threat. So we said that we think they're doing it now obviously because they are worried about a recession. Um and this article talks about a good indicator to differentiate between the you know hey is this rate cut going to propel the market versus uh hurt the market is to look at earnings growth. Uh no surprise there. Um says rate changes don't tell the whole story. Earnings are a more reliable predictor of future stock market returns. When earnings growth is positive and accelerating and rates are falling, that's a positive for the market over the next 12 months. Um, let's see. According to her analysis, when that happens, the stock market, as measured by the S&P 500, returns an average of 14% over that time, compared with the baseline average of 11% when rates fall and just 7% when earnings growth falls along with rates. After the second quarter earnings season, firms in the morning star US market index saw more than 10% annual earnings growth on average. Um so basically just tracking earnings growth. Are earnings going to fall off a cliff? Is this recession um you know going to hurt the companies? Obviously I think that's pretty self-explanatory. Uh of course though I do think it is kind of unknown. Like what's weird now, Jeeoff, if you look at like the current if you call plumbing or health of the market, like yeah, everything AI related or uh techreated is up a bunch, but sort of these like real economy stocks are are getting like smoked, right? Like look at anything consumer, anything consumer >> near downstream. Yes. Yes. destroyed, >> you know, like I've been thinking I'm like when's it when's it going to be time, you know, to start dabbling, you know, and trying to pick a bottom and consumer and maybe it is, but I'm just like the flows, you just look at it, they just go down to every single day. It's almost like the algorithm just they just have the the the uh the algorithm on sell mode, you know? Well, yes, but all the >> I just suspect as it's like September, as it's September, you know, into the end of the year, I just from like a momentum standpoint, I just expect they'll probably just continue going down. >> Yeah. Uh old economy things that are tied to stuff that were more we talking about commodities and energy and stuff though are not down. So, it's exactly what you're saying for to the actual production and consumption of things in the real offline economy that doesn't have to do with AI. Absolutely. Those things are down. Um but anything that you know but like um well kind of things we just mentioned like um uh I mean there's energy things that are probably up as much as the NASDAQ or more in year to date. Um you mentioned gold. Gold is probably gold and the S&P are probably up about the same amount of the last five years which is you know when the inflation started running hot it's over target for four and a half five years now. Um so that's not a bad time to pick of saying that. So, um, now S&P yields some stuff and things, so I don't know, but price change in gold and S&P is probably about the same last 5 years. So, um, but I agree with you if we're saying like Starbucks and Chipotle versus, um, AI things and stuff. Absolutely. Yeah. >> So, this is over the past three years. We could look at five years and Yeah. >> A little bit better. So, three years. Gold's better. >> Gold. Gold. Gold's catching. What's going on with platinum? Platinum needs to I think throughout my entire life platinum is traded higher than gold and uh platinum is uh trading pretty cheap. Um anyways but yeah so um yeah anything consumer right you could think about like uh David Busters um Celsius even though Celsius is has come back a little bit. um restaurant stocks. I mean, I I kind of have like a long-term view on restaurants where, you know, you look at the numbers. This is like a very top down view that's like going to play out, I think, over my lifetime. >> Um, anyone I saw this stat, it was something like uh in the 2000s, it was like 30 or 40% of people under the age of 30 drank alcohol. um they ran a recent study and it was like 8% of people under the age like 30 something early 30s drink alcohol >> and I do wonder how many how much of these restaurants make their you know ton of money from alcohol sales as opposed to just like food sales >> and if people aren't going to be drinking a lot like what's going to happen to um to that that company that restaurant. Uh but restaurant stocks have have gone um you know hit um payment related stocks have gone hit. I don't know why but that's an interesting one that we could discuss here. Mhm. >> Yeah. It seems like anything consumer related is having a tough time and anything AI related and techreated as everyone knows that's listening is you know doing >> and it's always hard with those to know if that's a prediction about what the likely results are for the company in the near term or something or longer term or if those are technical issues having to do with competition for the funds. So like for instance, it's possible, we mentioned VC things, we don't have data on it, but it's possible that if you're in things that are venture capital funded, not public, but in private market things, and you're not in AI, then you're saying, "Oh, why are they so pessimistic about me?" They might not be pessimist about you. They're just putting their money in AI, so there's less to give to you. Um and same thing if anything that is uh growthoriented and not AI might have problems in the public markets because where do you take that money from? You know you could you know people could be buying less value things and buying more um of that but more likely is that they're they're buying less growth things and buying more AI stuff. And that may have been going on for a long time, but because of the way it works, the market caps of the things we're talking about, handful of things that are very kind of tied into AI stuff, um, have gotten really big. And so even though you're like, well, it didn't move up that much. Yeah, but that's on $3 trillion market cap as opposed to, you know, it makes a that can cause, you know, as opposed to stocks that are 30 billion, it doesn't take that much to not go into them as to go into that. That's the part of it that does look more like the.com thing. Um, we talked about that before mostly although stock prices have been high when people were in lockdown and day trading and stuff. Yeah, that had some similarities to do. Now with AI, this has similarities to do where you're seeing big differences between stocks based on whether you're in the kind of group or not of the theme. You know, there's an overall theme kind of driving the whole market. So you can find things that have good growth and everything and they're kind of not doing that great as stocks and that's because they're not in the very best thing which is what happened with do with telecom media and technology specifically do things but everything kind of went more to those and away from other kinds of stuff. >> We have uh the uh yield spreads up here on the screen for people listening. Uh 102 is at 52 basis points 53 basis points. uh 10 year to three month is uh at 20.5 uh basis points. Um what are what's within your range of expectations for uh bank stocks? We talked about it at the beginning of the podcast that you know at least the large ones are trading um at their all-time highs got 15 times earnings. This is JP Morgan 2.4 times book. uh could look at sort of all the big ones and they you know look kind of similar. Bank of America of course Buffett has been selling or sold uh 13.6 times PE price to book 1.3 Wells Fargo one and a half times book 13 times >> uh Cityroup see 13 times under book but pretty crappy return on equity of 7%. Um but yeah, what what are your thoughts? And I think uh regional banks have sort of lagged a little bit, the KRE um ETF at least compared to the large ones. But yeah, what are your thoughts on banking where we are currently with, you know, the yield curve and and yield spreads >> and uh with the assumption that we are going into a rate cut cycle, >> you know, it depends on the bank, but I don't think that this will have huge effects for the most part. Um, I don't think the cycle is likely to be that large and from the point that they're at now and how long they've been there. I think this is very minor compared to when rates were first uh actually either when they were cut last time because it was so rapid and large and then um when they went up both because it was kind of rapid but also because of how long they they've been there. So even when we talk about something that is potentially harmed or some to some extent like a frost or something, I think it's very very minor if you do the calculations as compared from going from zero to three or something going from four to three, you know. Not that I'm predicting exactly four to three, but you know what I mean. Um I just think it'll be really small compared to to the other things that we've been seeing. And the other part of it is that so far, you know, with this being the the Fed funds rate that we're talking about, um, we haven't been sure that that translates 100% into movements in in other rates that also would be important to them. So if you're actually lending five to 15 years and it's fixed for five years or something like you know a lot of things might be in say mortgage things or whatever um I don't know if that necessarily will move as much as the um Fed that we just talked about. I mean it hasn't for basically this whole cycle you're not that that different. So I mean what if we call this cycle the cuts that they made before and then uh last year we're talking about it and then also um this. So if we kind of count if we count a cycle as since you last raised rates um it's been pretty flat for some things for for longer term things and that you can see that in the treasury is just the easiest way to see that is that for I don't know a year and a half or something it hasn't moved as much. Um. >> Mhm. >> So if you wanted to borrow as a business or something seven and a half% in a year and so going probably seven 7 and 12% this year, you know. >> Mhm. Mhm. What's going on with Fiser? Fiser down 36% year to date. PayPal is down 24. FICO, which we've talked about a lot, down 21%. Um Jack Henry down nine. Fidelity National Informational Information Services down 18. What's going on with this industry? I mean, if you look at this stock, I'm like, this is got to be one of the cheapest points >> that the stock has traded at in a very, very long time for a very dominant business. >> Mhm. >> 21 times earnings, 18 and a half times >> uh EV to free cash flow. They do have a lot of debt. Mark market cap 71 billion uh 97 billion enterprise value. Uh but look at the 10-year Kager on EPS 13.7% free cash flow 17% they buy back stock. Uh is this the meta moment for Ferf? >> Uh I don't know that's a good question. It's kind of same similar issue as with uh meta where people are predicting something and I don't not uh or people might be predicting something. I'm not smart enough to know because I think big change with uh Meta's you know at that time it was engagement and stuff with meta that meant that it was going to be bad for for ad things over time and likewise here it does seem like you said that anything that's related to payment things has not uh done well um and >> I was reading before like earnings calls and everything and they said that people basically the consensus is worried about Clover that growth is slowing for Clover. >> For Clover, which makes a lot of sense for Ferve. Yeah. >> And they compete with like um I guess Block for like Square and stuff, right? Um I mean it's complicated. I've read some of these companies or boards and things. They kind of have different parts that compete with everybody. So, but in terms of product to product, what we're talking about, that's probably what's competing is is Clover and Square. Um, yeah, and they're not I mean, but some of them are kind of I was going to say they're not exactly value stocks exactly and so they can fall between two sorts of um camps that way. But you you mentioned like PayPal or something. PayPal basically is like value now. So, um that's not exactly true what I was saying. I mean this is like a some of these are almost a what's the markets multiple? These things have never traded below the markets multiple really. And that they are I mean they did you mentioned FICO FICO definitely uh FICO yeah it traded below the market multiple I guess for a moment and the great recession so it's it's possible but I mean the markets P is very high compared to PayPal's right >> um 14 times >> that is is that the first time ever I mean look at this I think this is the lowest multiple that PayPal has ever traded at >> a multiple of earnings. >> Why is that? Wow. 12 and a half times EV to free cash flow. >> Mhm. Um well, it's interesting. Uh obviously very slow growth in the last few years that and um deteriorate and even slower growth in some of the other numbers that we talked about. uh when you know you can see here you can see the operating profit and all these other items down there it it's so the trajectory is not good that way right the decelerization the deceleration is not good and sometimes that can you know I was talking to someone about this that can sometimes be a really strong indicator and that what might be what growth investors pick up on and people who know the industry of competitive dynamics and that's what they're afraid of on an absolute basis it's not bad I remember this from many years ago talking about Alibaba with people that way. The argument the whole way down was always that well given its returns now and its price it's cheap and each year that would be true but its returns were dropping so much versus what it had once been that it's just an alarming thing competitively because it's if your returns on capital are are being you know haved every year or something then something competitively is not going well in the business for that to be happening. Um, but the interesting thing about all these companies is that they grow every year. I mean, I don't know that we could find one of these examples that doesn't grow. And I don't just mean grow in terms of revenue, but earnings are usually higher one year than the next. To have a PE of 14 or something is common enough among stocks that are somewhat cyclical, but if you have a stock of any kind, food stock, you know, a um payment stock, whatever stock, you don't have to grow very fast. you shouldn't really have a really low PE of every year. People expect your earnings to be a bit higher. So, the possibility is durability, right? So, like maybe people say things are going to change in in um payments and things. I can own American Express forever um but I can't own PayPal forever because I don't know what it's going to be five or 10 years from now for some reason. And that's where I just don't know enough about why one is very durable and one isn't. and I've tried reading some of them to understand it, but these are not the easiest things for me to understand um across their entire business. Um so the peak multiple earnings multiple it looks like was around 117 times >> and how fast was it growing back then? If we look at quick FS >> 20%. >> Yeah, it wasn't that. I mean, it was growing at 15 to 20% for like, you know, uh, seven years in a row or something. Um, yeah, I mean, there's I don't want to overstate that, but there also is something to Let's Let's just look at the stock's chart to see the price. Um, sometimes if the business Yeah. So, where are we back to in terms of the actual price? You haven't made money in the stock as a long-term holder for when was the first time you got here? back in 2017. Is that right? >> Well, looks like Yeah. 2017, 2018. Yeah. >> Okay. So, sometimes when you haven't made money in a stock for seven years, and of course, they made money for a while. They they um what is that quintupel? Uh no, they six or seven times their money at some point. Um but they've given all that back and are in the same place. So, sometimes um when the so the business performance is whatever it is, earnings have been growing for three or four years still, but obviously since what is that date? Four. Okay. Four years the stock is down and flat you know. Um so even though the business has been improving uh its earnings even though like by certain metrics it's not as good as it was um there's no progress in terms of the stock and so maybe you should focus in on the stock. I mean whoever was buying it at that multiple is not looking at the the quarterly EPS very hard. You know what I mean? So, uh, they're not they're not the kind of investor who's going to hold on to something that's going sideways for four years probably if they were getting in at that price, but it should attract a different kind of person to buy it now. You would think. So, you know, we're talking about um, Fundsmith or something. You would think that they'd be loading up on PayPal. And I don't know, uh, do you have um, I think Fundsmith is in data roma, so we could look at who owns PayPal like among funds and things if value investors have been buying it. Um, >> just one little point to point out. So the multiples contracted about 90%. And the stock is down call it 79%. >> Well, unfortunately that's how the math works because it's a product of the two factors combined. So yeah. >> Yeah. It's just fascinating to see. >> Let's see. >> If your multiple contracts 90% on almost anything, unfortunately the math is such that it doesn't work out well even if the business does really well. And it's hard for people to understand that. But >> Norbert Lou, >> yep. just >> card management buy. Yeah. Let's see who else. Anyone else you recognize? >> Yeah, I recognize some of these. >> Yeah. >> But let's see who's added those have added almost nothing to it. So, mainly it's Norbert Lou. So, Punchcard added in just this most recent quarter. And then um we have a couple large holders there. Yeah. And then insiders have been selling with no buys, you know, which is like every company out there basically. Um yeah, in fact some got out uh some did they get out? Yeah. So Dorsey Asset Management, that's a the former Morning Star person. Um yeah, big on Moes and things like that. And PayPal was not a huge position in the portfolio in the LA at least since the last few years we're seeing here, but that's selling out of that. Um, yeah. I mean, we'll see if it keeps going, but yeah, actually, if you look at the last quarter at least. Well, no, they're in and out. I was going to say those are more value investors that you see Mason Hawkins, Norberloo, a couple there. You do see the ones in red there are more super high quality to what I would just say is outright growth stuff. And then the ones you see in green are more value. So, you might be seeing a shift from from growth to value. who owns it. Yeah, that's possible. The percentage change the portfolio unfortunately is not big enough except for like an Orberloo which is not a big portfolio to matter that much. These are not big positions um for some of them. >> Mhm. >> Yeah. >> Interesting. Yeah. I didn't even realize that that was down to about 14 times. >> Yeah. And while it is a PayPal issue there, what you mentioned is like some of the others, it's not unique to just PayPal like you said that that's kind of it's more extreme in that case that the P is that low of like 14 and how big the drop has been. But it seems to be something across most of these uh newer payment technology companies. Um >> why is that the past wave I guess change that people are expecting on that? I really don't know. It's really fascinating. I I mean I literally have I mean it's interesting. So I've read some of these companies filings and things and um I don't think the business is that hard to figure out and figure out what's really going on. It is true that they make money in a bunch of different ways and so it is a little tricky to understand what's happening in each individual case but it is across all of them. And then you also don't see in the final financials companywide things that would necessarily be that concerning to you. We just went over some of them. Why would you have a company trading at 14 20 times earnings, whatever, if it has results that are that good? There has to be expectations about the future being so much worse. >> Um, >> but is that like a macro type thing or is that an individual company type of call? >> It's got to be an industry thing. It's got to be I think payment stuff is going to be upended and the big losers are not the cutting edge companies of today or the legacy companies of a long time ago. They're not Visa and Mastercard and American Express and you know they're um the companies that are from the internet era but not the um newest things. That's I mean that's the easiest way to I mean we talk about Fer and stuff. It's a much older company. Some of these others are much older, but their technology for some of the things they're doing, I think the reason why they're dropping is the stuff that's internet and post internet stuff. Some of those companies have roots going back to the middle of last century, um, doing things for banks. But yeah, I mean, what's the market up? I mean, literally, even the best of those was like Jack Henry or something. I mean, everything is down on a relative basis. You got to be 25% behind the market or something even in the best of them. >> Yeah. The price return for the S&P up 12%. >> Okay. And the best of the ones we just looked at was down 9 or 10 or something. >> Yeah. >> Yeah. >> Interesting. >> Yeah. >> So, it's not something that changes that much year by year for the economy. I mean, the volume of payments and stuff really doesn't move much. So, it's a market share and durability thing. It's not, you know what I mean? Like, when you talk about consumer things, well, some of them have credit risk. If you were some fast growing restaurant, you know, pot belly is getting bought out or something, but say you were a pot belly or something and you're about to go into a recession and your credit is what it is, then that makes sense that those could none of these have any credit risk or anything and none of them are that sensitive to a recession. So, it's a longer term industry issue. >> Yeah. Pop Elli's game purchased acquired $17 a share. >> Yeah. By a gas station basically, right? >> Yes. Yeah. That's right. Yeah. Interesting. >> Was it racetrack? I thought it was but I didn't. >> Yeah, they're racrack. Yeah. >> Yeah. Racetrack. Interesting. >> So, so where do we go from here, Jeff? I mean, what's going to happen to small caps, the Russell, right? So, it's like, okay, generally speaking, those companies should be sensitive in a good way >> to interest rates coming down, right? Um, but of course, if it's, you know, they're also probably more sensitive to a recession as well. Uh, so I've just, you know, it's like the Russell just you just get hit on both ends. Um, what's going to happen here? Are we just in one big debase? Are we just one big uh boiling frog in a world of a debasement? You know, like what what's going on? It's like, so they tried cutting Doge. Obviously, that didn't work. >> Now they're going to try stimulating and and growing us out of this, right? Cut rates. >> Um, it's pretty clear Fed independence. anyone that's not in line is going to be kicked to the curb. Uh, and if that doesn't work, think it's going to lead us to some sort of form of yield curve control. Maybe that's 5 years from now or 10 years from now. I don't know what. But what do we do? What what what are your how you feel? >> Well, we didn't we didn't even get into that topic. But that's my big the bigger thing is um >> we're all a boiling frog, huh? the the the big change is not >> which means if that's true you should just own stocks, gold, Bitcoin. >> Yeah. Um I I mean I think the big issue is the is the debt the deficit basically. not not even necessarily the debt but the deficit which is that since the financial crisis um I mean almost there's like one or two exceptions but almost all the biggest percent of GDP deficit years have happened since the financial crisis except for during World War II. So sometimes we have higher deficits, sometimes we have lower deficits, but cumulatively we have almost all high deficit years are years between then and now. And that doesn't seem to be changing and that's significant. It becomes more significant if you already have a lot of debt. So I do think that in the long run when you're talking about what the Fed will do and Fed independence and all these things, it's it's the debt. It would be totally different if you had 30% debt to GDP and a balanced budget. That's going to feel very different from what it is now. And so if people get worked up about the Fed and Fed independence and what should interest rates be and all this stuff in the long run it's going to be because people are concerned about things that they're seeing happening with um with that. Um I can um uh let's see um uh so in terms of the risks of recession and things like that um honestly I think it's hard to predict because okay so you have federal debt total public debt as percented gross me product yeah the the bigger concern for me is really the deficit thing about changing it um so it's not like this has caused is by having um although it's captured pretty well in here how much it's gone up from from 2008 period to now um but it's just it's the fact there's so few years that are not oddly large deficits um is more the concern. If you had really high debt but you had a year where you had a surplus, you know, or something then I would have a different attitude because it's like oh government policy changes all the time on this and who knows. But if you're consistently running deficits and it's not big news, um that that's more of the long-term issue. Um and that's really noticeable. I mean it's oddly I mean it's basically COVID but it's really noticeable in that you know if there hadn't been COVID and who knows different person won in 2016 or different party or whatever maybe it would have started to get more restrained after that right it makes sense after the financial crisis you can understand why there'd be huge deficits and things but sometime in the mid2010s you would have expected something changing there um it's mainly just yeah there was a lot during COVID, but there's just been no reductions in those things along the way that you'd expect for having what 4% unemployment at times. I mean, if you you know, if you're ever not going to run a big deficit, it should have happened by now in the last few years, right? Like um if you think you're having inflation problems and unemployment is low, you shouldn't be running a big deficit. um whereas it would make sense to run a big deficit after that housing crisis and stuff. So you can see why people would do that. But um yeah, that's the big thing I think longer term. Um, in terms of what's happening right now, I think the big thing that's interesting is, um, I think it's really, really hard to predict what the future will be for the economy because, uh, I think that the possibility of acceleration in growth and things is because of like business spending and stuff. Basic basically what we're talking about is directly AI stuff. Um, higher multiples on stocks and things. sure has some impact on kind of their thinking in terms of those and um then all the related stuff about energy commodities whatever things some of those are pretty big and the things that I've looked at where they say how much will be needed um that requires a bunch of capex um eventually you spend too much and you have a bubble and it bursts but if when people say like oh the consumer is slowing down or whatever they can slow down a lot as long as everyone's willing to build um AI uh data centers and power plants or whatever ever. It takes very little of that to make up for all the difference in in GDP. Um I mean really little. You might be surprised but like uh the amount of increase possible under what projections had been versus now in say AI things could make up for very big declines in consumer stuff and and even out in like already even though consumer is what like many many times bigger because consumers don't alter their spending as much as capital spending changes things because it's capitalized. So um that's why it has such a big effect. That's also during the housing bubble and then the bust it has such a big effect because building a house just causes so much more um is so much more stimulative uh just as a car is or anything a durable thing where there's a huge impact that way. So it somehow people say, "Oh, it wasn't that much more houses we built than we needed." But it it doesn't take that many more to make it on a capitalized basis be such a big impact in the years where it happened, you know, and same thing here. If you end up building more data centers and things than you need, it'll have a really big impact um for the years in which you build it. So it could be really stimulative at the same time that consumers don't feel great. Um the the catch with that is so far we haven't seen evidence that it's increasing productivity or people like it or it benefits them, right? But I don't know how big a deal that is. I mean honestly in the early part of the internet people were really into it but it wasn't helping with anything. It took a long while before anything useful could be done on the internet. people were obsessed with the internet before they were able to utilize the internet in a way that was actually productive in any sense and maybe the same thing will happen now you know I don't know what do you think about the uh AI um spending that will happen and like what would cause it to stop and what would cause it to accelerate >> what will cause it to stop is is the returns that they get on it I think I mean the prices of these things is just going to get competed down clearly Um, it's an enormous amount of money that they're spending on this like AI buildout. I do think AI is obviously going to be around and and be a very big part of our lives, but the sums that people are spending and that companies are investing is crazy. And not only that, but I mean, how much of that's actually going to be able to be utilized because of like the timeline of all this stuff? I mean, isn't it just become obsolete within a few years? >> That is the part that's fascinating about it. So, my feeling on this because I was talking to someone about this before is um and I don't know if I'll stop, but these are giant public companies um with the exception of some that are private companies, but then they're partnering with giant public companies and even the private companies sell tiny parts of themselves and have some awareness of what that valuation should be. So what I mean is they're not controlled by individuals who are trying to take cash out of them or to fund it with cash or anything. They're basically thinking either I'm valued in the public markets or if I need to I could sell part of myself to get the money that I need. Now they have started talking about debt in just like the last few weeks uh and stuff um where we were talking about. But generally that's more the problem is if you have debt or you need cash. Absent that it's really a multiple issue. if if the market rewards you when you announce Cap X and if you get higher multiples. This was kind of my whole thing about streaming stuff and where I was like, well, people would always be like, why would Disney Plus or whatever pursue something that they know doesn't make as much money as doing it a different way. Well, the market is saying now you're more like Netflix, so it's rewarding you now. Then it stopped doing that. And at some other companies that had debt, obviously the market was concerned when they would do that. And so it would reward free cash flow or something. So um eventually that would stop I guess but right now if a dollar of AI related revenue is valued in some ways higher than dollars of other kinds of revenue then uh it it makes sense to keep doing it for them. Um, and you wonder about that even if it makes sense. um even if they don't believe that themselves, if it if it if they're being rewarded for it. The the one thing that's really interesting and different about it to me is um a lot of this is funded right now by really big companies that have a lot of money. And um that's interesting both in that it could go on longer and get a lot more funding. that could benefit society from this um than it otherwise would, but also that it might not result in as high returns for them because um it becomes less likely to result in, you know, a wide moat for somebody because literally you might end up in a situation like you had with um XM and Sirius, uh Uber and Lyft, whatever. um you have backers and you have a lot of money that you're willing to keep putting into something that's competing with something else, which is very different from being the only one that will survive or something. The just possibility that they'll survive for a really long time might be different and would be so radically different from do. Had huge numbers of competitors come in, go broke, and a few survive, which resulted in a different outcome um here. So, but the other thing is they could change their attitudes and and not pursue that. But I do wonder if it's like if there's a perception of winner takes all in some things if that keeps investment higher than it otherwise would be. You know, I don't know. I just think that if it was funded a different way from much smaller companies then maybe we'd be seeing something different than the involvement of these very large companies on the capback side of it at least because that's where we've seen the huge difference is um if you look at those cash flow statements I mean these companies the mag seven type companies used to be spending very little on capex and now they spend a lot on it. Yeah. So can remember people complaining they that they only buy back their own stock. They only sit on the cash. They don't do anything. They don't contribute to society and everything, you know. Um now they plow it back into building out stuff. >> Interesting. Cool. Well, I want to thank everybody so much for tuning in with the both of us on the Focus Compounding Podcast. This is the first time you're joining us, be sure to check out all of our content that we put out into the investing universe. If you're interested in learning about our money management services, you can reach out to me at andrewfocuscompound.com. And be sure to hit the subscribe button wherever you are listening or watching us here today so you can be notified every time we upload a podcast. I want to thank everybody so much for all the support and we will see you in the next podcast. Take care.
What Happens to Stocks When the Fed Starts Cutting Rates?
Summary
Transcript
Welcome, welcome, welcome. How's everybody doing? Hope you are doing well. My name is Andrew with Focus Compounding on Air Live with Jeff Ganon. Jeff, how's it going today? >> It's going very well, Andrew. How's it going with you? >> It's going great. We hope it's going great with everybody else as well. This is the first time you are tuning in with us. Thank you so much for joining us. Be sure to check out all of our content that we push out into the investing universe. The best way to do that is to follow me on X at Focused Compound. uh go to focuscompounding.com to get access to investment writeups from Jeff going all the way back to 2005. And of course, wherever you are watching or listening to this uh today, either through the podcast side of things or the YouTube uh side, make sure you hit the subscribe button to be notified every time that we upload a new podcast. So, in today's podcast, Jeeoff, we're going to talk about um the Federal Reserve. Uh last week Jay Pow in the Fed came out and they cut interest rates by 25 basis points. No surprise as the market was basically pricing that in. Um but want to talk about, you know, if we are going to go into a rate cut cycle, what that means for the economy, what that could mean for the stock market, how we're thinking about it, and um go over that. Uh but before jumping into it, I guess we should probably talk about why the Fed was created. Why do we have a Fed? Get your thoughts on it. I think it's kind of interesting because you're going back to, you know, uh a time period where we would have these panics and mania and the depression, right? And back to the point where sort of the area era where JP Morgan had to bail out the US government. Um so I I I have written down that that was during the panic of 1907 and the Fed was established from the Federal Reserve Act in 1913. Um and just talk about it. So yeah, want to hear your thoughts. It seems like the Fed is you know in in recent years it's been uh I don't know if their credibility if has always been questioned. Certainly their independence is probably being uh questioned at this point, right? Um so want to get your thoughts on just everything that is the Federal Reserve before we go into interest rates. >> Yeah. So they basically as they exist today have um uh objective of um keeping inflation from getting too high although not actually stable prices anymore. And they kind of set for themselves a target of 2% for that. And then unemployment. So sort of low inflation and low unemployment with trade-offs between those things. um the reasons for why they're created and what they had originally was a little bit different and technically some of the things that they're in try that they're supposed to be targeting are a little bit different but that's their perception of what it is today and that's kind of what it's become um I think so that's a pretty accurate way of talking about it today um why it was created originally is more like you said kind of to provide for a sufficient currency thing so basically to not have a situation like what happened in the financial crisis of um uh like 2007208 whatever that kind of thing more of like a seizing up of credit and stuff was kind of the original purpose because that's most similar to what you saw with the panic in 1907 that you're talking about but it quickly evolved away from that a lot of it because of what happened with the uh great depression and a lot of the blame for that is on like monetary policy and things like that and so things changed in the post-war period basically. Yeah. Um so and then in terms of independence like you said there there's evolved over time to be very independent of the other uh parts of the government almost to the extent of being similar to like the Supreme Court or something in terms of how independent it's gotten. It's more independent than the other agencies that are similar to it that are created by Congress and then people are appointed by the president. So even though it's kind of an executive thing, it does it's kind of seen as being separate from that and presidents don't exert much control over it even though it's what it's doing is basically you know executing policy for the government. So it that's made it very different that way. Um and it's kind of taken more seriously than some of the other independent things. Um but you know there obviously we there have been presidents in the past who've encouraged the Fed to do one thing or the other. Um, and you know, now probably is the most pressure that there's been, but there are others that were, you know, >> there's always been pressure, right? I think it was just like behind closed doors, you know, a little pushing and shoving. Now you just get to, you know, send off bombs on Twitter or X and make it public through social media. evening trillion dollar triage >> that book on how much Trump would call Jalow and >> telling them hey you got to cut rates you got to do this you got to do this I know you guys are independent but do this >> I think that there was actually a belief in independence for about 25 years or so for uh with um Reagan Bush Clinton Bush again um and Obama um but before that I think if you go back to the 40s through the 60s there was behind closed doors a lot less independence and then today there's a lot less independence that way um or at least pressure but you know that I mean there's I mentioned the Supreme Court there there have been presidents who said exactly what how they want the Supreme Court to rule um it doesn't really stop them from ruling one way or the other you know uh those are political issues and they talk about it the Fed used to be um like I said for that period then let's say from the 80s through until Trump was elected. Um that was a period in which they even didn't comment all that much a lot of the time. Um and there's reasons for why that would be. The biggest reason is it followed up the great inflation. And so, uh, it was actually that they were scared of, um, being perceived as having coordinated Treasury and Fed type stuff like they did sometimes in the 70s and things and that that was bad and that that um, reduces trust in things over time. And then since then, you difference in attitude with Trump about other things too. FCC is very similar to Fed uh, kind of thing historically. And um, so that's part of it. The other part honestly is that you just went through a really long period until COVID where you weren't that concerned about inflation. What that would feel like just like as you got further away from the Great Depression, people were less concerned with New Deal things and employment and stuff. If you haven't seen huge unemployment for a long time, then you don't really think those policies are as important. If you haven't seen really bad inflation for a long time, then you're not as concerned about that, you know. So, I think that's the other reason, too. Um, and it actually kind of coincides with the the time in which the Fed independent stuff people believed in the most is also the time when they believe the most in balance budgets and things. And you've kind of seen the same trends in both cases where, you know, um, because it doesn't it doesn't politically help your side on either case to have in all cases a Fed that is independent. nor does it really help you to have a balanced budget, but you believe in it because you believe on average, you know, regardless of which policies are implemented by which party. Uh it's good, right? And so that's the part that I mean that's kind of broken down. So because you'll see the Fed now being criticized for two opposite things sometimes in ways that before they might be reluctant just like don't criticize the Fed because we should have an independent Fed even though I don't agree with the policies, you know, on different sides. Um, so and I think that's similar to the balanced budget thing and both of those probably peaked around 2000 that you had the most people believing in balance budgets and the most people believing in Fed independence about then and since then it's kind of deteriorated a little bit. >> It was interesting listening to JP talk. He was giving it was like a Q&A or whatever and he was talking about how the Fed used to completely be a black box where they wouldn't even put out >> you know their remarks their dot plots like basically what happened and now they do to try to >> um you know uh give transparency to what they're doing. But I didn't even realize that at one point basically they completely acted almost off the record in silence. You know, you didn't know what they were doing. >> Yeah. And it's interesting if that's good or bad. Uh I mentioned Supreme Court before. Courts work the exact same way. So uh courts now put out very extensive decisions. People probably assume that's how they always worked. They didn't. Um and that's reversed from like um uh vetoing and things like that. Whereas now on some vetos and things there's no real comments from the uh person vetoing it. Whereas in the, you know, 250 years ago, you had lots of comments about why someone vetoed something, and you didn't have lots of comments from courts, but it developed into something to explain their decision-making a lot. So, both of them did that. And I think that's pretty common among things that are independent that way. And there's probably reasons why they do it both. Um, uh, it it helps with being perceived as impartial probably over time if they do that. They could be seen that way. It has big downsides. I mean, I I think that's one of the problems for the Fed is that they've given too much guidance and too much information about what they're doing and everything instead of being more uh fly by the seat of their pants. I think that the policy's not been as good because of that. But there's lots of academic stuff that suggested they should do that. So, um I just think it has certain risks and uh if they had not been saying much in public, I think they could have acted quicker to raise rates like in CO and stuff and but they'd said for so long so many things that it makes it harder to turn policy if you're on record for so long saying things and then you have to wait for all the other members have to say things. They all have to give their speeches and you know you have to see okay are we all giving the same sort of speeches in between the meetings and you're basically deciding at one meeting kind of giving hints of what you're going to do at the next meeting. It gets pretty >> there definitely some like gamesmanship to it and PA has even talked about before how like >> you could almost uh >> I don't want to say leak even though he does leak it to Nikki leaks like Timmer whatever his name is and um how you know sometimes a lot of it like he likes to leave the tea leaves for people to just price things in. I I feel like he doesn't like the unexpected stuff because he knows that markets hate uncertainty. That's true. Um, but it's also a short-term versus long-term type trade-off. The more because the future will actually be uncertain. So, the more uncertainty that you leave out there, the more prepared you are to take actions which you didn't expect to take now. For instance, they they may very well end up not cutting rates as much as they expect or other people expect. it could happen and they may that may now surprise people whereas if before they'd been really vague about that then it wouldn't be as likely to if you always have a par once you start cutting it's unlikely you cut just once then that starts to get anticipated and limit like exactly what you can do so um but like I said um it's something they believe in big time and uh I think you saw the big thing of it was with quantitative easing and everything in the after the great recession which they really did a lot to give like kind of forward guidance of like we're not going to raise rates for a really long time. We're going to do it in a certain order. We're going to slowly do things with the balance sheet. Like trying to push it out years in advance to kind of bind themselves to a decision. Um and then they even said, well, we'd be willing to do like average inflation rate things to make up for the in the past. But then they ended up overshooting because for the last from 2007 to today they've averaged 2 and a half% inflation. So that includes the entire great recession and they went over the 2% they were aiming for. So you know obviously they said they're not going to do that anymore that average thing. But obviously that wasn't good. Um so I just mean because you don't predict you're going to have a great recession. You don't predict you're going to have a pandemic. Um, so you could just say, "Look, things changed a lot." But it's harder to say, "Well, I believe one entirely different thing two months ago, and now I believe, you know, something else." >> I mean, so we're currently at four and a quarter, and as you can see from the screen right now, we got already four more uh rate cuts coming in um or being priced in. So um yeah, want to talk about your thoughts on that. Um and the yield curve itself. Interestingly, bank stocks are liking it. If you could look at uh like Bank of America, could pull it up right here was Bank of America, JP Morgan, basically all of the large banks uh are at all-time highs. So I thought that was uh interesting. Uh if I could pull this up here and then we could go over historically what happens to stocks, right? Because the difference is is that different market environments, rate cuts uh tend to affect stocks differently, right? Like are you cutting because you're worried about recession? Are you cutting because you want a soft landing? What is it? Right? And uh we could walk through that, but yeah. So JP Morgan, Cityroup, um Wells Fargo, all at all-time highs in the stocks. >> Yeah. I mean, now you're cutting because you're worried about a recession. >> I think they're pretty honest, open about that fact. There's no other reason to cut. They've been running above the inflation levels that they wanted. It'll be they're going to hit five years straight running over the inflation they want. You wouldn't cut just because of that in anticipation of it. So it's concern about a recession which is you know um I mean yeah and if you have a recession that tends to do a lot to bring down inflation. So it's totally understandable that you would feel that if you're headed into a recession a you should cut to try to reduce the likelihood that you're in a recession and b you don't have to be that as worried about inflation because a recession is going to tend to reduce inflation for what you're seeing right now you know in your expectations. Um because the financial things that haven't done as well are things that are exposed to like possible losses and things like that and and then also some things that rely more on short-term money because until recently there wasn't much of a uh uh any steepness to the yield curve. Right? So that was the other problem. >> So they're going to cut over the next year, call it, right? um or at least you know close to it. Equity prices are at all-time highs. Precious metals, gold, I don't know if you've been following gold just been going absolutely bonkers. >> Um you know worried about a recession. I just I wonder how much of that is going to help uh recession fears, but I do wonder how much of it is going to almost further this K-shaped economy that we are currently in where you're still going to get the wealth effect where basically all the wealth is going to go to top earners and you know the top whatever percent of uh the economy and everyone else is basically going to get left behind. I mean, it seems like a very precarious position to be in from the Fed's perspective. >> Yeah. And I don't think they care about the stock market. I mean, I know on this show and stuff, we'll talk about it like they care about that. I think they I mean, Pal said it's overpriced basically. Um, and I think they might see that. >> Did you say fairly valued or do you actually say overpriced? >> No, he said fairly highly valued. >> Okay. Interesting. which is the way of saying uh overpriced. >> Um but so here's I think it is relevant though in that um what the Fed does works through financial conditions. And so the the problem is that there's not a lot of signs that financial conditions are tight in any sense. And there aren't even it's hard to say that reducing that even cutting a lot and expectations for rates to be a lot lower would cause much looser financial conditions that would be helpful um to the overall economy. Right? So that's you know is it the right tool to use and will accomplish what you want um is kind of more the the issue I guess. Um it that doesn't mean that you'll have a recession or something. You might have wonderful breakthroughs in AI, things that help out with productivity. You might change fiscal policy. You might do all sorts of things that cause there not to be recessions and to go into booms and whatever. But, um, getting people much more excited about the stock market or something as being helpful in stopping a a recession is, you know, hard to believe at this point, right? Um, so it's just not as effective as it would be on on the flip side of that where uh things would seem to be too tight or something like that, you know. So, um, I don't remember what the Fed funds was at this time in 2007 or something, it was probably a bit higher than this, probably 100 basis points higher or something, but at that point, let's say when you're having a housing crisis or whatever. Yeah. So, beginning of 2007, yeah, 5.25%. If you started cutting a lot then then maybe that would help because you know by halfway through that year you had real signs and subprime and stuff that things weren't so good. Um on the other hand inflation wise they would have been like well inflation is kind of running a little hot in those years. Um so but there would have been more of a uh it feels more bubbly now than it did in 2007. Let's put it that way. Um, so I it's just like financial conditions seem looser as any way that you can measure them um than they did then. But >> you're referring to with all the AI stuff and it's just extraordinary numbers >> of capex, right? Oracle and I mean Oracle. >> Oh yeah, >> Oracle the sleepy Oracle company. It's like now this is just like >> the best. I mean it's like another Nvidia basically and you got Oracle and you have Nvidia and you have Chat GBT. It's just one big flywheel with each other, right? Like what is it? Uh Nvidia is investing 100 billion in Open AI. Open AAI is going to buy 100 billion or whatever of Nvidia's chips. It's just one big cluster together. >> Yeah. And I saw some companies which is very unusual um in recent years that there's a little bit of borrowing you know um adding to borrowing more than just what's maturing um for some big tech companies which has not been common at all for a really long time and you said like the capex some of those expectations for it are the difference between one projection another one or 2% of GDP in capex just for AI things and especially when you take into account like some of the um estimates I saw for electricity use, you would have to have capex on those things for electricity and move it from where it is now to where it'll be. Unless you have other people conserving a lot of electricity and prices changing and everything. If if it's just being added, then you're going to need to produce more electricity, which will need new generating assets and things. So, all that can totally >> Where's that gonna come from? >> Where is it going to come from? >> Yeah. >> Well, so the simple the biggest thing comes from Oh, >> I have I have a rule I have a I have a rule in the White House. You can't call it coal. You have to call it beautiful, clean coal, >> nuclear. >> So, >> yeah. Um, >> anything that's not windmills or solar or stuff like that, >> right? So technically you can't come from wind and solar on sort of a net based entire >> for the entire um grid because you need to run it all the time right now to the extent that you could have other things that can run on wind and solar but are not now then you don't but yes it is true that there's a limit to how much you could have on uh things that aren't uh able to operate at all times. So yeah, the I guess environmentally friendly thing is natural gas uh of the ones that we just mentioned. And then you said nuclear, but realistically I think they mean like small um I don't know if they call them small modular reactors anymore, but f uh there's companies that are involved in in smaller reactors that are fast reactors and things that are directly deployed at at the site, which is the same kind of idea. Um, and if that's true, um, then you know that's great from a whatever carbon basis and it's faster to do it. Um the problem with nuclear power from uh bigger things that you would need is you know I don't know the numbers but I'm going to guess that to do a new nuclear power station we're talking like around10 billion uh and around 5 years or something if even if you you know now of course you can change everything else that you could change everything about you know can China build them faster if they have no rules about anything and they encourage it and stuff. Yeah, if there was a war and you needed it, you would build it faster. Um, and and maybe cheaper and everything because a lot of the expense is safety. Um, but yeah, that that's not going to be I mean the projections I saw for AI things don't bother going out 5 years. So by the time you have new big scale nuclear things that's outside of the range of what they're already like what they think they can even hope to predict about how big AI will be. So, um, probably not that. But all that I meant is, um, if we think about that, and this could be true, but I I I don't know. I just don't believe that changing rates on that will actually change the investment in those things. I think that the multiples which are on those things, which are critical to why you invest in that stuff, don't seem to be being um, very closely related to that. If it was all funded by debt, that um, it would be a different story. But I do think that some of it is that you have really high multiples on these things. Um, in terms of where the capital is coming from, that's pretty easy to tell. It seems to be that venture capital and stuff doesn't do anything but AI anymore. That all the big money only goes to AI and so all other technologies and things just aren't getting funded. Um, you know, so that's what's kind of crowded out by that stuff and whatever. >> Let's talk about uh historically. So, as we said, um there's really no playbook as it relates to stocks on what happens when the Fed starts starts to cut interest rates. >> Problem is with markets is, you know, every general likes to fight the last war. Um, every situation is a little bit different, but we pulled up this article by Morning Star from September 16th, 2024. So, almost a year ago when they cut before the election, right? Was that a 50 basis point cut? I can't remember. I think it was 50, right, that they cut and then the long end took off. >> Yeah, we didn't mention that, but actually um in this cycle, I believe that the rates that would affect longerterm borrowing for businesses and things are exactly the same. Last I checked, they're the same. Yeah. On that side. Yeah. >> Yeah. And I mean, a lot of people are speculating well because they started they did come down over the past month. So, they were like pricing in the Fed cutting and Yes. but there hasn't been anything since the uh since the actual cut itself. Uh >> this person, this article says, "The last four major rate cutting cycles show why it's challenging to draw sweeping conclusions. Market performance can vary dramatically in the year after a new easing cycle starts. The Morning Star US market index rose more than 21% in the 12 months following the beginning of the Fed's 1995 easing cycle as the economy achieved a rare soft landing. But returns cratered more than 10% when the Fed began cutting rates in 2001 as the dotcom bubble burst. Um, and then we have these different uh stock performance at the onset of a rate cutting cycle. So 1995 looks like 21.58% 2001 down 10.63% uh 2007 down almost 18% and 2019 up 11.43%. So take us through these different regimes here Jeeoff. Why do you think the returns happened? Can we cycle analyze this or or do a post-mortem on why these returns happen after they started uh cutting during these years? >> So yeah, so 2001 and 2007 uh after the cuts there was recessions. Um the 2001's really complicated. Um it barely recession. Who knows if it would have happened without September 11th and you know whatever. But technically, so technically all three of those uh the first one, the the one that the cut in 1995, no recession followed. So no recession. The other three technically recessions followed all of them. However, one of them, the uh cut in 2019, uh is complex because the recession that followed is COVID, right? So that so it was very short and very deep and it's hard to know if it would have happened otherwise but uh if there hadn't been co right and then of course the market can't look forward and have expected co to have happened but in the other ones which is what kind was my point about September 11th too there's no way to anticipate you know price that in um but they could be pricing in in September of 2007 subprime obviously so those two are that there were recessions and then the stock market did badly and in some cases um like the 2001 cut underestimates it because if you count 12 months ahead so the beginning of it it's not too bad but that went on for years. So the overall uh those both of those marked really bad performances is just how long they went on for versus how quick they were. So recessions followed and bare markets followed that were big in those two cases 2001207 cuts >> affected federal funds trade over time. Let's see it says roughly half the time the Fed has started easing policy because it felt the economy was headed heading for a recession. In other cases it reduced rates to recalibrate monetary policy what some call a maintenance cut rather than in response to an economic threat. So we said that we think they're doing it now obviously because they are worried about a recession. Um and this article talks about a good indicator to differentiate between the you know hey is this rate cut going to propel the market versus uh hurt the market is to look at earnings growth. Uh no surprise there. Um says rate changes don't tell the whole story. Earnings are a more reliable predictor of future stock market returns. When earnings growth is positive and accelerating and rates are falling, that's a positive for the market over the next 12 months. Um, let's see. According to her analysis, when that happens, the stock market, as measured by the S&P 500, returns an average of 14% over that time, compared with the baseline average of 11% when rates fall and just 7% when earnings growth falls along with rates. After the second quarter earnings season, firms in the morning star US market index saw more than 10% annual earnings growth on average. Um so basically just tracking earnings growth. Are earnings going to fall off a cliff? Is this recession um you know going to hurt the companies? Obviously I think that's pretty self-explanatory. Uh of course though I do think it is kind of unknown. Like what's weird now, Jeeoff, if you look at like the current if you call plumbing or health of the market, like yeah, everything AI related or uh techreated is up a bunch, but sort of these like real economy stocks are are getting like smoked, right? Like look at anything consumer, anything consumer >> near downstream. Yes. Yes. destroyed, >> you know, like I've been thinking I'm like when's it when's it going to be time, you know, to start dabbling, you know, and trying to pick a bottom and consumer and maybe it is, but I'm just like the flows, you just look at it, they just go down to every single day. It's almost like the algorithm just they just have the the the uh the algorithm on sell mode, you know? Well, yes, but all the >> I just suspect as it's like September, as it's September, you know, into the end of the year, I just from like a momentum standpoint, I just expect they'll probably just continue going down. >> Yeah. Uh old economy things that are tied to stuff that were more we talking about commodities and energy and stuff though are not down. So, it's exactly what you're saying for to the actual production and consumption of things in the real offline economy that doesn't have to do with AI. Absolutely. Those things are down. Um but anything that you know but like um well kind of things we just mentioned like um uh I mean there's energy things that are probably up as much as the NASDAQ or more in year to date. Um you mentioned gold. Gold is probably gold and the S&P are probably up about the same amount of the last five years which is you know when the inflation started running hot it's over target for four and a half five years now. Um so that's not a bad time to pick of saying that. So, um, now S&P yields some stuff and things, so I don't know, but price change in gold and S&P is probably about the same last 5 years. So, um, but I agree with you if we're saying like Starbucks and Chipotle versus, um, AI things and stuff. Absolutely. Yeah. >> So, this is over the past three years. We could look at five years and Yeah. >> A little bit better. So, three years. Gold's better. >> Gold. Gold. Gold's catching. What's going on with platinum? Platinum needs to I think throughout my entire life platinum is traded higher than gold and uh platinum is uh trading pretty cheap. Um anyways but yeah so um yeah anything consumer right you could think about like uh David Busters um Celsius even though Celsius is has come back a little bit. um restaurant stocks. I mean, I I kind of have like a long-term view on restaurants where, you know, you look at the numbers. This is like a very top down view that's like going to play out, I think, over my lifetime. >> Um, anyone I saw this stat, it was something like uh in the 2000s, it was like 30 or 40% of people under the age of 30 drank alcohol. um they ran a recent study and it was like 8% of people under the age like 30 something early 30s drink alcohol >> and I do wonder how many how much of these restaurants make their you know ton of money from alcohol sales as opposed to just like food sales >> and if people aren't going to be drinking a lot like what's going to happen to um to that that company that restaurant. Uh but restaurant stocks have have gone um you know hit um payment related stocks have gone hit. I don't know why but that's an interesting one that we could discuss here. Mhm. >> Yeah. It seems like anything consumer related is having a tough time and anything AI related and techreated as everyone knows that's listening is you know doing >> and it's always hard with those to know if that's a prediction about what the likely results are for the company in the near term or something or longer term or if those are technical issues having to do with competition for the funds. So like for instance, it's possible, we mentioned VC things, we don't have data on it, but it's possible that if you're in things that are venture capital funded, not public, but in private market things, and you're not in AI, then you're saying, "Oh, why are they so pessimistic about me?" They might not be pessimist about you. They're just putting their money in AI, so there's less to give to you. Um and same thing if anything that is uh growthoriented and not AI might have problems in the public markets because where do you take that money from? You know you could you know people could be buying less value things and buying more um of that but more likely is that they're they're buying less growth things and buying more AI stuff. And that may have been going on for a long time, but because of the way it works, the market caps of the things we're talking about, handful of things that are very kind of tied into AI stuff, um, have gotten really big. And so even though you're like, well, it didn't move up that much. Yeah, but that's on $3 trillion market cap as opposed to, you know, it makes a that can cause, you know, as opposed to stocks that are 30 billion, it doesn't take that much to not go into them as to go into that. That's the part of it that does look more like the.com thing. Um, we talked about that before mostly although stock prices have been high when people were in lockdown and day trading and stuff. Yeah, that had some similarities to do. Now with AI, this has similarities to do where you're seeing big differences between stocks based on whether you're in the kind of group or not of the theme. You know, there's an overall theme kind of driving the whole market. So you can find things that have good growth and everything and they're kind of not doing that great as stocks and that's because they're not in the very best thing which is what happened with do with telecom media and technology specifically do things but everything kind of went more to those and away from other kinds of stuff. >> We have uh the uh yield spreads up here on the screen for people listening. Uh 102 is at 52 basis points 53 basis points. uh 10 year to three month is uh at 20.5 uh basis points. Um what are what's within your range of expectations for uh bank stocks? We talked about it at the beginning of the podcast that you know at least the large ones are trading um at their all-time highs got 15 times earnings. This is JP Morgan 2.4 times book. uh could look at sort of all the big ones and they you know look kind of similar. Bank of America of course Buffett has been selling or sold uh 13.6 times PE price to book 1.3 Wells Fargo one and a half times book 13 times >> uh Cityroup see 13 times under book but pretty crappy return on equity of 7%. Um but yeah, what what are your thoughts? And I think uh regional banks have sort of lagged a little bit, the KRE um ETF at least compared to the large ones. But yeah, what are your thoughts on banking where we are currently with, you know, the yield curve and and yield spreads >> and uh with the assumption that we are going into a rate cut cycle, >> you know, it depends on the bank, but I don't think that this will have huge effects for the most part. Um, I don't think the cycle is likely to be that large and from the point that they're at now and how long they've been there. I think this is very minor compared to when rates were first uh actually either when they were cut last time because it was so rapid and large and then um when they went up both because it was kind of rapid but also because of how long they they've been there. So even when we talk about something that is potentially harmed or some to some extent like a frost or something, I think it's very very minor if you do the calculations as compared from going from zero to three or something going from four to three, you know. Not that I'm predicting exactly four to three, but you know what I mean. Um I just think it'll be really small compared to to the other things that we've been seeing. And the other part of it is that so far, you know, with this being the the Fed funds rate that we're talking about, um, we haven't been sure that that translates 100% into movements in in other rates that also would be important to them. So if you're actually lending five to 15 years and it's fixed for five years or something like you know a lot of things might be in say mortgage things or whatever um I don't know if that necessarily will move as much as the um Fed that we just talked about. I mean it hasn't for basically this whole cycle you're not that that different. So I mean what if we call this cycle the cuts that they made before and then uh last year we're talking about it and then also um this. So if we kind of count if we count a cycle as since you last raised rates um it's been pretty flat for some things for for longer term things and that you can see that in the treasury is just the easiest way to see that is that for I don't know a year and a half or something it hasn't moved as much. Um. >> Mhm. >> So if you wanted to borrow as a business or something seven and a half% in a year and so going probably seven 7 and 12% this year, you know. >> Mhm. Mhm. What's going on with Fiser? Fiser down 36% year to date. PayPal is down 24. FICO, which we've talked about a lot, down 21%. Um Jack Henry down nine. Fidelity National Informational Information Services down 18. What's going on with this industry? I mean, if you look at this stock, I'm like, this is got to be one of the cheapest points >> that the stock has traded at in a very, very long time for a very dominant business. >> Mhm. >> 21 times earnings, 18 and a half times >> uh EV to free cash flow. They do have a lot of debt. Mark market cap 71 billion uh 97 billion enterprise value. Uh but look at the 10-year Kager on EPS 13.7% free cash flow 17% they buy back stock. Uh is this the meta moment for Ferf? >> Uh I don't know that's a good question. It's kind of same similar issue as with uh meta where people are predicting something and I don't not uh or people might be predicting something. I'm not smart enough to know because I think big change with uh Meta's you know at that time it was engagement and stuff with meta that meant that it was going to be bad for for ad things over time and likewise here it does seem like you said that anything that's related to payment things has not uh done well um and >> I was reading before like earnings calls and everything and they said that people basically the consensus is worried about Clover that growth is slowing for Clover. >> For Clover, which makes a lot of sense for Ferve. Yeah. >> And they compete with like um I guess Block for like Square and stuff, right? Um I mean it's complicated. I've read some of these companies or boards and things. They kind of have different parts that compete with everybody. So, but in terms of product to product, what we're talking about, that's probably what's competing is is Clover and Square. Um, yeah, and they're not I mean, but some of them are kind of I was going to say they're not exactly value stocks exactly and so they can fall between two sorts of um camps that way. But you you mentioned like PayPal or something. PayPal basically is like value now. So, um that's not exactly true what I was saying. I mean this is like a some of these are almost a what's the markets multiple? These things have never traded below the markets multiple really. And that they are I mean they did you mentioned FICO FICO definitely uh FICO yeah it traded below the market multiple I guess for a moment and the great recession so it's it's possible but I mean the markets P is very high compared to PayPal's right >> um 14 times >> that is is that the first time ever I mean look at this I think this is the lowest multiple that PayPal has ever traded at >> a multiple of earnings. >> Why is that? Wow. 12 and a half times EV to free cash flow. >> Mhm. Um well, it's interesting. Uh obviously very slow growth in the last few years that and um deteriorate and even slower growth in some of the other numbers that we talked about. uh when you know you can see here you can see the operating profit and all these other items down there it it's so the trajectory is not good that way right the decelerization the deceleration is not good and sometimes that can you know I was talking to someone about this that can sometimes be a really strong indicator and that what might be what growth investors pick up on and people who know the industry of competitive dynamics and that's what they're afraid of on an absolute basis it's not bad I remember this from many years ago talking about Alibaba with people that way. The argument the whole way down was always that well given its returns now and its price it's cheap and each year that would be true but its returns were dropping so much versus what it had once been that it's just an alarming thing competitively because it's if your returns on capital are are being you know haved every year or something then something competitively is not going well in the business for that to be happening. Um, but the interesting thing about all these companies is that they grow every year. I mean, I don't know that we could find one of these examples that doesn't grow. And I don't just mean grow in terms of revenue, but earnings are usually higher one year than the next. To have a PE of 14 or something is common enough among stocks that are somewhat cyclical, but if you have a stock of any kind, food stock, you know, a um payment stock, whatever stock, you don't have to grow very fast. you shouldn't really have a really low PE of every year. People expect your earnings to be a bit higher. So, the possibility is durability, right? So, like maybe people say things are going to change in in um payments and things. I can own American Express forever um but I can't own PayPal forever because I don't know what it's going to be five or 10 years from now for some reason. And that's where I just don't know enough about why one is very durable and one isn't. and I've tried reading some of them to understand it, but these are not the easiest things for me to understand um across their entire business. Um so the peak multiple earnings multiple it looks like was around 117 times >> and how fast was it growing back then? If we look at quick FS >> 20%. >> Yeah, it wasn't that. I mean, it was growing at 15 to 20% for like, you know, uh, seven years in a row or something. Um, yeah, I mean, there's I don't want to overstate that, but there also is something to Let's Let's just look at the stock's chart to see the price. Um, sometimes if the business Yeah. So, where are we back to in terms of the actual price? You haven't made money in the stock as a long-term holder for when was the first time you got here? back in 2017. Is that right? >> Well, looks like Yeah. 2017, 2018. Yeah. >> Okay. So, sometimes when you haven't made money in a stock for seven years, and of course, they made money for a while. They they um what is that quintupel? Uh no, they six or seven times their money at some point. Um but they've given all that back and are in the same place. So, sometimes um when the so the business performance is whatever it is, earnings have been growing for three or four years still, but obviously since what is that date? Four. Okay. Four years the stock is down and flat you know. Um so even though the business has been improving uh its earnings even though like by certain metrics it's not as good as it was um there's no progress in terms of the stock and so maybe you should focus in on the stock. I mean whoever was buying it at that multiple is not looking at the the quarterly EPS very hard. You know what I mean? So, uh, they're not they're not the kind of investor who's going to hold on to something that's going sideways for four years probably if they were getting in at that price, but it should attract a different kind of person to buy it now. You would think. So, you know, we're talking about um, Fundsmith or something. You would think that they'd be loading up on PayPal. And I don't know, uh, do you have um, I think Fundsmith is in data roma, so we could look at who owns PayPal like among funds and things if value investors have been buying it. Um, >> just one little point to point out. So the multiples contracted about 90%. And the stock is down call it 79%. >> Well, unfortunately that's how the math works because it's a product of the two factors combined. So yeah. >> Yeah. It's just fascinating to see. >> Let's see. >> If your multiple contracts 90% on almost anything, unfortunately the math is such that it doesn't work out well even if the business does really well. And it's hard for people to understand that. But >> Norbert Lou, >> yep. just >> card management buy. Yeah. Let's see who else. Anyone else you recognize? >> Yeah, I recognize some of these. >> Yeah. >> But let's see who's added those have added almost nothing to it. So, mainly it's Norbert Lou. So, Punchcard added in just this most recent quarter. And then um we have a couple large holders there. Yeah. And then insiders have been selling with no buys, you know, which is like every company out there basically. Um yeah, in fact some got out uh some did they get out? Yeah. So Dorsey Asset Management, that's a the former Morning Star person. Um yeah, big on Moes and things like that. And PayPal was not a huge position in the portfolio in the LA at least since the last few years we're seeing here, but that's selling out of that. Um, yeah. I mean, we'll see if it keeps going, but yeah, actually, if you look at the last quarter at least. Well, no, they're in and out. I was going to say those are more value investors that you see Mason Hawkins, Norberloo, a couple there. You do see the ones in red there are more super high quality to what I would just say is outright growth stuff. And then the ones you see in green are more value. So, you might be seeing a shift from from growth to value. who owns it. Yeah, that's possible. The percentage change the portfolio unfortunately is not big enough except for like an Orberloo which is not a big portfolio to matter that much. These are not big positions um for some of them. >> Mhm. >> Yeah. >> Interesting. Yeah. I didn't even realize that that was down to about 14 times. >> Yeah. And while it is a PayPal issue there, what you mentioned is like some of the others, it's not unique to just PayPal like you said that that's kind of it's more extreme in that case that the P is that low of like 14 and how big the drop has been. But it seems to be something across most of these uh newer payment technology companies. Um >> why is that the past wave I guess change that people are expecting on that? I really don't know. It's really fascinating. I I mean I literally have I mean it's interesting. So I've read some of these companies filings and things and um I don't think the business is that hard to figure out and figure out what's really going on. It is true that they make money in a bunch of different ways and so it is a little tricky to understand what's happening in each individual case but it is across all of them. And then you also don't see in the final financials companywide things that would necessarily be that concerning to you. We just went over some of them. Why would you have a company trading at 14 20 times earnings, whatever, if it has results that are that good? There has to be expectations about the future being so much worse. >> Um, >> but is that like a macro type thing or is that an individual company type of call? >> It's got to be an industry thing. It's got to be I think payment stuff is going to be upended and the big losers are not the cutting edge companies of today or the legacy companies of a long time ago. They're not Visa and Mastercard and American Express and you know they're um the companies that are from the internet era but not the um newest things. That's I mean that's the easiest way to I mean we talk about Fer and stuff. It's a much older company. Some of these others are much older, but their technology for some of the things they're doing, I think the reason why they're dropping is the stuff that's internet and post internet stuff. Some of those companies have roots going back to the middle of last century, um, doing things for banks. But yeah, I mean, what's the market up? I mean, literally, even the best of those was like Jack Henry or something. I mean, everything is down on a relative basis. You got to be 25% behind the market or something even in the best of them. >> Yeah. The price return for the S&P up 12%. >> Okay. And the best of the ones we just looked at was down 9 or 10 or something. >> Yeah. >> Yeah. >> Interesting. >> Yeah. >> So, it's not something that changes that much year by year for the economy. I mean, the volume of payments and stuff really doesn't move much. So, it's a market share and durability thing. It's not, you know what I mean? Like, when you talk about consumer things, well, some of them have credit risk. If you were some fast growing restaurant, you know, pot belly is getting bought out or something, but say you were a pot belly or something and you're about to go into a recession and your credit is what it is, then that makes sense that those could none of these have any credit risk or anything and none of them are that sensitive to a recession. So, it's a longer term industry issue. >> Yeah. Pop Elli's game purchased acquired $17 a share. >> Yeah. By a gas station basically, right? >> Yes. Yeah. That's right. Yeah. Interesting. >> Was it racetrack? I thought it was but I didn't. >> Yeah, they're racrack. Yeah. >> Yeah. Racetrack. Interesting. >> So, so where do we go from here, Jeff? I mean, what's going to happen to small caps, the Russell, right? So, it's like, okay, generally speaking, those companies should be sensitive in a good way >> to interest rates coming down, right? Um, but of course, if it's, you know, they're also probably more sensitive to a recession as well. Uh, so I've just, you know, it's like the Russell just you just get hit on both ends. Um, what's going to happen here? Are we just in one big debase? Are we just one big uh boiling frog in a world of a debasement? You know, like what what's going on? It's like, so they tried cutting Doge. Obviously, that didn't work. >> Now they're going to try stimulating and and growing us out of this, right? Cut rates. >> Um, it's pretty clear Fed independence. anyone that's not in line is going to be kicked to the curb. Uh, and if that doesn't work, think it's going to lead us to some sort of form of yield curve control. Maybe that's 5 years from now or 10 years from now. I don't know what. But what do we do? What what what are your how you feel? >> Well, we didn't we didn't even get into that topic. But that's my big the bigger thing is um >> we're all a boiling frog, huh? the the the big change is not >> which means if that's true you should just own stocks, gold, Bitcoin. >> Yeah. Um I I mean I think the big issue is the is the debt the deficit basically. not not even necessarily the debt but the deficit which is that since the financial crisis um I mean almost there's like one or two exceptions but almost all the biggest percent of GDP deficit years have happened since the financial crisis except for during World War II. So sometimes we have higher deficits, sometimes we have lower deficits, but cumulatively we have almost all high deficit years are years between then and now. And that doesn't seem to be changing and that's significant. It becomes more significant if you already have a lot of debt. So I do think that in the long run when you're talking about what the Fed will do and Fed independence and all these things, it's it's the debt. It would be totally different if you had 30% debt to GDP and a balanced budget. That's going to feel very different from what it is now. And so if people get worked up about the Fed and Fed independence and what should interest rates be and all this stuff in the long run it's going to be because people are concerned about things that they're seeing happening with um with that. Um I can um uh let's see um uh so in terms of the risks of recession and things like that um honestly I think it's hard to predict because okay so you have federal debt total public debt as percented gross me product yeah the the bigger concern for me is really the deficit thing about changing it um so it's not like this has caused is by having um although it's captured pretty well in here how much it's gone up from from 2008 period to now um but it's just it's the fact there's so few years that are not oddly large deficits um is more the concern. If you had really high debt but you had a year where you had a surplus, you know, or something then I would have a different attitude because it's like oh government policy changes all the time on this and who knows. But if you're consistently running deficits and it's not big news, um that that's more of the long-term issue. Um and that's really noticeable. I mean it's oddly I mean it's basically COVID but it's really noticeable in that you know if there hadn't been COVID and who knows different person won in 2016 or different party or whatever maybe it would have started to get more restrained after that right it makes sense after the financial crisis you can understand why there'd be huge deficits and things but sometime in the mid2010s you would have expected something changing there um it's mainly just yeah there was a lot during COVID, but there's just been no reductions in those things along the way that you'd expect for having what 4% unemployment at times. I mean, if you you know, if you're ever not going to run a big deficit, it should have happened by now in the last few years, right? Like um if you think you're having inflation problems and unemployment is low, you shouldn't be running a big deficit. um whereas it would make sense to run a big deficit after that housing crisis and stuff. So you can see why people would do that. But um yeah, that's the big thing I think longer term. Um, in terms of what's happening right now, I think the big thing that's interesting is, um, I think it's really, really hard to predict what the future will be for the economy because, uh, I think that the possibility of acceleration in growth and things is because of like business spending and stuff. Basic basically what we're talking about is directly AI stuff. Um, higher multiples on stocks and things. sure has some impact on kind of their thinking in terms of those and um then all the related stuff about energy commodities whatever things some of those are pretty big and the things that I've looked at where they say how much will be needed um that requires a bunch of capex um eventually you spend too much and you have a bubble and it bursts but if when people say like oh the consumer is slowing down or whatever they can slow down a lot as long as everyone's willing to build um AI uh data centers and power plants or whatever ever. It takes very little of that to make up for all the difference in in GDP. Um I mean really little. You might be surprised but like uh the amount of increase possible under what projections had been versus now in say AI things could make up for very big declines in consumer stuff and and even out in like already even though consumer is what like many many times bigger because consumers don't alter their spending as much as capital spending changes things because it's capitalized. So um that's why it has such a big effect. That's also during the housing bubble and then the bust it has such a big effect because building a house just causes so much more um is so much more stimulative uh just as a car is or anything a durable thing where there's a huge impact that way. So it somehow people say, "Oh, it wasn't that much more houses we built than we needed." But it it doesn't take that many more to make it on a capitalized basis be such a big impact in the years where it happened, you know, and same thing here. If you end up building more data centers and things than you need, it'll have a really big impact um for the years in which you build it. So it could be really stimulative at the same time that consumers don't feel great. Um the the catch with that is so far we haven't seen evidence that it's increasing productivity or people like it or it benefits them, right? But I don't know how big a deal that is. I mean honestly in the early part of the internet people were really into it but it wasn't helping with anything. It took a long while before anything useful could be done on the internet. people were obsessed with the internet before they were able to utilize the internet in a way that was actually productive in any sense and maybe the same thing will happen now you know I don't know what do you think about the uh AI um spending that will happen and like what would cause it to stop and what would cause it to accelerate >> what will cause it to stop is is the returns that they get on it I think I mean the prices of these things is just going to get competed down clearly Um, it's an enormous amount of money that they're spending on this like AI buildout. I do think AI is obviously going to be around and and be a very big part of our lives, but the sums that people are spending and that companies are investing is crazy. And not only that, but I mean, how much of that's actually going to be able to be utilized because of like the timeline of all this stuff? I mean, isn't it just become obsolete within a few years? >> That is the part that's fascinating about it. So, my feeling on this because I was talking to someone about this before is um and I don't know if I'll stop, but these are giant public companies um with the exception of some that are private companies, but then they're partnering with giant public companies and even the private companies sell tiny parts of themselves and have some awareness of what that valuation should be. So what I mean is they're not controlled by individuals who are trying to take cash out of them or to fund it with cash or anything. They're basically thinking either I'm valued in the public markets or if I need to I could sell part of myself to get the money that I need. Now they have started talking about debt in just like the last few weeks uh and stuff um where we were talking about. But generally that's more the problem is if you have debt or you need cash. Absent that it's really a multiple issue. if if the market rewards you when you announce Cap X and if you get higher multiples. This was kind of my whole thing about streaming stuff and where I was like, well, people would always be like, why would Disney Plus or whatever pursue something that they know doesn't make as much money as doing it a different way. Well, the market is saying now you're more like Netflix, so it's rewarding you now. Then it stopped doing that. And at some other companies that had debt, obviously the market was concerned when they would do that. And so it would reward free cash flow or something. So um eventually that would stop I guess but right now if a dollar of AI related revenue is valued in some ways higher than dollars of other kinds of revenue then uh it it makes sense to keep doing it for them. Um, and you wonder about that even if it makes sense. um even if they don't believe that themselves, if it if it if they're being rewarded for it. The the one thing that's really interesting and different about it to me is um a lot of this is funded right now by really big companies that have a lot of money. And um that's interesting both in that it could go on longer and get a lot more funding. that could benefit society from this um than it otherwise would, but also that it might not result in as high returns for them because um it becomes less likely to result in, you know, a wide moat for somebody because literally you might end up in a situation like you had with um XM and Sirius, uh Uber and Lyft, whatever. um you have backers and you have a lot of money that you're willing to keep putting into something that's competing with something else, which is very different from being the only one that will survive or something. The just possibility that they'll survive for a really long time might be different and would be so radically different from do. Had huge numbers of competitors come in, go broke, and a few survive, which resulted in a different outcome um here. So, but the other thing is they could change their attitudes and and not pursue that. But I do wonder if it's like if there's a perception of winner takes all in some things if that keeps investment higher than it otherwise would be. You know, I don't know. I just think that if it was funded a different way from much smaller companies then maybe we'd be seeing something different than the involvement of these very large companies on the capback side of it at least because that's where we've seen the huge difference is um if you look at those cash flow statements I mean these companies the mag seven type companies used to be spending very little on capex and now they spend a lot on it. Yeah. So can remember people complaining they that they only buy back their own stock. They only sit on the cash. They don't do anything. They don't contribute to society and everything, you know. Um now they plow it back into building out stuff. >> Interesting. Cool. Well, I want to thank everybody so much for tuning in with the both of us on the Focus Compounding Podcast. This is the first time you're joining us, be sure to check out all of our content that we put out into the investing universe. If you're interested in learning about our money management services, you can reach out to me at andrewfocuscompound.com. And be sure to hit the subscribe button wherever you are listening or watching us here today so you can be notified every time we upload a podcast. I want to thank everybody so much for all the support and we will see you in the next podcast. Take care.