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Why Investors Are Ignoring the Bad News · The Financial Exchange Show

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1:12
Speaker 2: Good morning, Happy Tuesday, Welcome back to the Financial Exchange.
1:16
Speaker 2: Hope everybody had a nice long weekend out there. Shortened
1:20
Speaker 2: trading week this week with the Memorial Day holiday and
1:25
Speaker 2: the unofficial kickoff of the summer season. My definition of
1:30
Speaker 2: the kickoff summer season is when the local ice cream
1:32
Speaker 2: place opens up, which was like a week and a
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Speaker 2: half ago, but you know, I know, everybody's got their
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Speaker 2: own terms, and Memorial Days is the unofficial kickoff. Here
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Speaker 2: days getting a little bit longer, and as a long
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Speaker 2: weekend comes and goes, we've got rumors of a deal
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Speaker 2: being made in Iran forcing oil prices lower in spite
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Speaker 2: of I don't know what to call it, additional strikes
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Speaker 2: in the Middle East, US defending itself apparently, and a
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Speaker 2: whole lot more so. We will see if this is
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Speaker 2: the time that the headfake on the end of the
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Speaker 2: war in Iran actually takes place or not. If you're
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Speaker 2: out there looking at markets, there might be a little
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Speaker 2: bit of confusion today because you're seeing that Brent crude
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Speaker 2: oil is up four and a quarter percent, whereas West
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Speaker 2: Texas crued is down nearly three percent. That's only because
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Speaker 2: Brent crude trades in Europe and was opened yesterday trading,
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Speaker 2: whereas West Texas CRUED was closed yesterday, meaning that's the
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Speaker 2: price moved from Friday's price. In either case, we've got
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Speaker 2: oil prices that have moved down substantially since Friday of
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Speaker 2: last week on the rumor of maybe a deal to
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Speaker 2: come here with the US in Iran. But all again
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Speaker 2: continue to say that it's logical to see prices move
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Speaker 2: like this. I understand why traders are betting on oil
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Speaker 2: prices coming down, but we have seen the story a
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Speaker 2: few times times now, and to this point still traffic
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Speaker 2: is not flowing. US is still striking Iran, and we
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Speaker 2: have not seemingly moved forward with an overall peace deal
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Speaker 2: that will get traffic flowing through the straightform moves again.
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Speaker 3: Yeah, even if the chances are small, and they might be,
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Speaker 3: we don't know. The story's changing like hour by hour.
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Speaker 3: Of course, markets have to price it.
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Speaker 4: Like you said, some.
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Speaker 3: Probability that what's being represented in like formal statements by
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Speaker 3: both the US and Iran are believable. I mean, I
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Speaker 3: don't know. Mike President says one thing on Saturday, contradicts
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Speaker 3: himself the next.
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Speaker 2: Day, Rubio says something else. The next day.
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Speaker 3: You know, it's bewildering.
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Speaker 4: It's par for the course. But in any case, this
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Speaker 4: doesn't have to be.
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Speaker 3: This is unusual. This is like the new way of
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Speaker 3: doing foreign policy. We'll see how it works out.
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Speaker 2: I guess the US military set of conducted self defense
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Speaker 2: strikes in southern Iran over the weekend, targeting launch sites
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Speaker 2: and boats. The Revolutionary Guard course set five fired at
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Speaker 2: an F thirty five jet and downed and unmanned MQ
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Speaker 2: nine Reaper drone. Again, this fog of war stuff is
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Speaker 2: interesting to read about, but I don't think I want
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Speaker 2: to give it a whole lot more lip service than that,
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Speaker 2: to say, interesting prices are moving on it. Stocks are
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Speaker 2: moving on it, Bond prices moving on it as well.
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Speaker 2: All of these things are moving as you might expect
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Speaker 2: should the likelihood, given that the likelihood of a continued
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Speaker 2: cease fire and maybe deal in Iran is progressing. But
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Speaker 2: I don't think I want to give it a whole
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Speaker 2: lot else because we've had this exact conversation it has
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Speaker 2: to be three or four times now since February twenty seventh,
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Speaker 2: and to this point, the important critical stuff about traffic
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Speaker 2: flowing through the straight of horn moves and fertilizer, aluminum
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Speaker 2: oil and other products getting through hasn't significantly changed in
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Speaker 2: spite of everything over the.
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Speaker 4: Course of the last few months.
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Speaker 2: So obviously we'll keep you updated as peace prospects continue
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Speaker 2: and negotiations happen. But to this point, that's the status
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Speaker 2: quo for the time being. I want to shift gears
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Speaker 2: and talk a little bit about feelings. Mark and I thought,
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Speaker 2: who better to talk about feelings than the guy who've
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Speaker 2: never seen express any Mark Fandaddy. So I want to
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Speaker 2: talk about feelings because we got another consumer sentiment survey
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Speaker 2: over the last week. We got a consumer confidence survey,
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Speaker 2: I think just this morning, and as we have talked about,
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Speaker 2: the feelings have never been so bad as they are now.
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Speaker 2: We got the worst consumer confidence index or sorry, consumer
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Speaker 2: sentiment from the University of Michigan since its existence seventy
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Speaker 2: years ago, the worst ever. The stock market has never
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Speaker 2: been so good when people feel as bad. And arguably,
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Speaker 2: you could make a pretty compelling argument to me that
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Speaker 2: it's never been so good period, right, Like what.
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Speaker 3: Do you mean, Like the level of stocks has never
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Speaker 3: been higher?
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Speaker 4: That's true level of stock's never been higher.
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Speaker 2: But even if you measure it by some other ways,
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Speaker 2: I think you can come up with a few definitions
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Speaker 2: of why this stock market has never been so good.
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Speaker 2: It's one of the longest runs that we've had. It's
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Speaker 2: the last fifteen years.
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Speaker 4: If you were to.
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Speaker 2: Measure the total price appreciation, I don't know where you'd land,
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Speaker 2: but I'm guessing it's pretty compelling, up there with some
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Speaker 2: of the best fifteen year stock markets that you've ever seen.
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Speaker 2: And as this article points out, though, the way people
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Speaker 2: are responding to surveys about how they feel is terrible.
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Speaker 2: So I'm We've said previously that this survey, especially the
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Speaker 2: University of Michigan Sentiment Survey, that is giving you readings
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Speaker 2: that are lower today than they were in two thousand
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Speaker 2: and nine when unemployment was over ten percent, don't make
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Speaker 2: a whole lot of sense to us. But I'm wondering
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Speaker 2: how we should be contextualizing this, because it is not
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Speaker 2: nothing to say that this is the worst survey we've
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Speaker 2: gotten on Americans feelings towards the economy in seventy plus years.
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Speaker 3: Right, I don't know how to read it other than
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Speaker 3: the obvious. It is hard to compare survey results over time,
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Speaker 3: you're comparing different people, the questions phrasing gets changed slightly.
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Speaker 3: It's probably not a good sign. But at the same time, spending,
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Speaker 3: even taking out energy related stuff, continues to grow at
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Speaker 3: a healthy clip.
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Speaker 2: Right, And I think that's the critical point here. We've
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Speaker 2: got another piece in the Financial Times this morning about
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Speaker 2: consumers facing a squeeze as the Trump tax rebates fade.
7:36
Speaker 2: You know, we've talked about the average tax return getting
7:39
Speaker 2: nearly thirty five hundred dollars this year after the Trump
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Speaker 2: tax cuts, and that's now you know, largely being spent
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Speaker 2: on gasoline and other increases and costs. But what I
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Speaker 2: don't buy is the idea that for some reason the
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Speaker 2: consumer is going to lead us into a recession. I
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Speaker 2: don't think that that's wholeheardly what this article is making
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Speaker 2: an argument on. But right now, more than any time
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Speaker 2: that I can think of in the last ten to
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Speaker 2: fifteen years, this economy does not seem to be getting
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Speaker 2: driven by the consumer. It seems to be getting driven
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Speaker 2: by corporate capex and excitement about AI.
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Speaker 4: I know you could say that that's partly.
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Speaker 2: Consumer driven, but you go to take a look at
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Speaker 2: the most recent GDP. You go take a look at
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Speaker 2: other measures of this economy right now, and it's business
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Speaker 2: spending that is keeping it afloat rather than purely hey,
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Speaker 2: the consumer continuing to spend and increase their spending quarter
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Speaker 2: over the quarter.
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Speaker 3: Yeah, recessions. The biggest contributors to recession are investment, specifically inventories,
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Speaker 3: which is a subcategory of investment. That said, consumer spending
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Speaker 3: in an accounting sense is most of the way.
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Speaker 4: We measure two thirds of GDP, right.
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Speaker 3: We measure economic growth, which is gross domestic products. So
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Speaker 3: it's yeah, I mean, it's always hard to look at
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Speaker 3: the various components of GDP and say, well, this one
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Speaker 3: looks fine, that one looks fine, that one looks fine,
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Speaker 3: therefore everything's going to be fine. Or I don't see
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Speaker 3: how this goes down. I don't see how that goes down.
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Speaker 3: Therefore the outlook for growth is good. That's usually a
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Speaker 3: fraught way of doing, you know, forecasting, because turns in
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Speaker 3: the changes in the direction of the economy are are unpredictable.
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Speaker 2: My main conclusion about the consumer, the American consumer, is
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Speaker 2: that consumers will stop spending once their income drops and
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Speaker 2: their credit card maxes out. If you go take a
9:40
Speaker 2: look at the data on you know, for instance, I've
9:42
Speaker 2: got personal consumption expenditures up here, taking a look at
9:46
Speaker 2: you know, year over year change in expenditures, and you know,
9:52
Speaker 2: in the Great Recession, for example, we didn't turn negative
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Speaker 2: year over year on consumer spending until November of two
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Speaker 2: thousand and eight. The recession was what like two thirds
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Speaker 2: the way through by November of two thousand and eight.
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Speaker 2: The unemployment rate I think had already climbed from four
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Speaker 2: to seven percent during that period.
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Speaker 3: Started in what December? I think the NBER has none
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Speaker 3: Decembers starting in December of seven.
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Speaker 2: Yeah, So I think my main conclusion is the consumer
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Speaker 2: is important to this economy. How they feel maybe telling
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Speaker 2: although how they feel has been seemingly broken about this
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Speaker 2: economy since COVID and arguably maybe before then, because in
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Speaker 2: spite of an extremely low unemployment rate and all time
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Speaker 2: high stock market, which typically drives sentiment up, the sentiment surveys.
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Speaker 4: Have been abysmal.
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Speaker 2: The consumer has the ability to dramatically reshape the economy
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Speaker 2: if they do, in fact pull back on spending, because,
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Speaker 2: as we pointed out, two thirds of this economy typically
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Speaker 2: comes from consumer spending.
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Speaker 4: However, the idea that.
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Speaker 2: The consumer is going to lead that in some way right,
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Speaker 2: that they are going to lead the US economy into recession,
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Speaker 2: It's just not something that I've found much evidence for
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Speaker 2: when looking at the big recessions that I've lived through.
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Speaker 3: I'll say again, excuse me. Consumer spending is the biggest part.
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Speaker 3: But inventories are generally the biggest contributor to slow downs
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Speaker 3: historically to slow downs and growth, So they punch way
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Speaker 3: above investment punches. Inventory specifically punch way above their weight
11:33
Speaker 3: when it comes to when you look at declines in
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Speaker 3: GDP relative to trend, the big contributors are inventory and
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Speaker 3: investment generally spending because a lot of it is just
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Speaker 3: not like, very elastic, it's not very sensitive. You can
11:49
Speaker 3: only cut back on so much you need food. But yes, yeah,
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Speaker 3: but even a small cutback can be enough to precipitate
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Speaker 3: a downturn.
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Speaker 4: Let's take quick break. When we come back.
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Speaker 2: I want to talk about this level of the stock
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Speaker 2: market right now, and people are writing a bit about
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Speaker 2: the risk premium for holding stocks at this moment in time,
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Speaker 2: given the increase in interest rates on bonds. A little
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Speaker 2: bit about that risk premium and what it might mean
12:13
Speaker 2: for stocks futures in the next On Financial Exchange.
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Speaker 2: So Mark, many people might be reading this journal piece
13:26
Speaker 2: today kind of wondering precisely what it means. The risk
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Speaker 2: premium for holding stocks over bonds is vanishing. So I guess,
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Speaker 2: first off, we all know that from evaluations perspective, the
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Speaker 2: stock market, or I think most people know, is near
13:42
Speaker 2: all time highs, depending on which way you measure it,
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Speaker 2: And one of the ways of doing so is that
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Speaker 2: earnings yield on the S and P five hundred, what
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Speaker 2: you're paying compared to what the companies in there are
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Speaker 2: earning in profits. There's other ways, there's price to earnings.
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Speaker 2: There's a number of different ways of measuring this. But
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Speaker 2: at the same time, we do have the interest rate
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Speaker 2: on what's generally considered to be the risk free asset
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Speaker 2: out there, which are US Treasury bonds, moving up mainly
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Speaker 2: because of inflation risks in the war in Iran. How
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Speaker 2: do we I guess, let's start off by the argument
14:23
Speaker 2: over that risk premium and the earnings yield and how
14:27
Speaker 2: it should and shouldn't be used when looking at stocks.
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Speaker 3: Well, I don't want to lose sight of the main
14:31
Speaker 3: point here, which is that stocks are expensive relative to
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Speaker 3: recent earnings, relative to prospective earnings, relative to long term
14:42
Speaker 3: inflation adjusted earnings, giving you all kinds of definitions of
14:48
Speaker 3: the pe ratio, the P is in the numertor that's easy,
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Speaker 3: you get that off the daily close. The E is
14:55
Speaker 3: where it gets a little more complicated. But let's suppose
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Speaker 3: we all agree on the E, and we all want
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Speaker 3: to use trailing twelve months and the trailing twelve month
15:04
Speaker 3: earnings on the sure S and P relative to the
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Speaker 3: Now I'm inverting it that the PE past twelve months
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Speaker 3: is twenty two to twenty Somewhere in there it's twenty yep.
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Speaker 3: So that implies an earnings yield of the reciprocal of
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Speaker 3: that you flip it, so one twentieth is five percent, right, yep. Okay,
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Speaker 3: So the idea behind this measure is when the earnings yield,
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Speaker 3: which is just the reciprocal the flip of the PE,
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Speaker 3: when that gets below what you could get on a
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Speaker 3: risk free bond, it doesn't really make any sense to
15:40
Speaker 3: buy stocks.
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Speaker 4: That's the that's rights.
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Speaker 3: Yeah, and it sounds straightforward in common sense, But go ahead.
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Speaker 2: I was just going to think about it, you know,
15:50
Speaker 2: thinking of this on a relative basis, right, you can
15:53
Speaker 2: justify taking all sorts of different risks when you know
15:58
Speaker 2: you have a CD that's paying zero percent or in
16:01
Speaker 2: some parts of the world even negative interest rates were
16:05
Speaker 2: a thing over the course of the last fifteen years.
16:07
Speaker 4: I forget which country we covered it.
16:09
Speaker 2: I remember someone in some country had a negative mortgage
16:12
Speaker 2: rate at one point in time, the bank was paying
16:14
Speaker 2: you to borrow the money. When those same rates move up,
16:18
Speaker 2: for a bunch of logical reasons, the premium that you
16:22
Speaker 2: should be willing to pay on a stock should be
16:25
Speaker 2: going down, right, because it's riskier than taking no risk
16:28
Speaker 2: and sitting it in a treasury bond at four point
16:31
Speaker 2: whatever it is now seven percent, And yet that hasn't
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Speaker 2: been the relationship this year, and in short periods of
16:37
Speaker 2: time it can break down. But I guess the question,
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Speaker 2: the sailing question that I think matters to people, is
16:44
Speaker 2: when the priciness of stocks gets to the levels that
16:49
Speaker 2: we have seen recently and have been seeing on and
16:52
Speaker 2: off now since twenty twenty one. The only thing I'm
16:56
Speaker 2: confident saying about that is that it historically has not
16:58
Speaker 2: spelled great news over or the what do you want
17:01
Speaker 2: to call that intermediate term five to ten.
17:03
Speaker 4: Years is where we're comfortable landing.
17:05
Speaker 2: Not anything about the next one to three years, not
17:08
Speaker 2: anything about the next thirty years necessarily, but in that
17:11
Speaker 2: ten year horizon. Historically it hasn't meant great things for stocks.
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Speaker 3: Yeah, and that to me is the main point. I
17:20
Speaker 3: wouldn't make too big a deal out of the earnings
17:23
Speaker 3: yield being less than the yield on a risk free
17:27
Speaker 3: instrument like a treasury bond, because it's tough to compare
17:31
Speaker 3: those two things. People buy stocks because they expect to
17:35
Speaker 3: get a higher price when they sell them, and that's
17:37
Speaker 3: probably because they expect earnings to grow faster than say,
17:41
Speaker 3: the economy, certainly faster than the risk free rate. So
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Speaker 3: I don't this is not a good tool with which
17:48
Speaker 3: to make investment decisions, comparing the earnings yield to the
17:52
Speaker 3: bond yield. That said, there is this very The larger point,
17:56
Speaker 3: which is good to keep in mind, is that when
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Speaker 3: pees are high, when people are exuberant and willing to
18:04
Speaker 3: pay more today than yesterday for a dollar's worth of
18:07
Speaker 3: future earnings, that doesn't bode well for future returns. That
18:11
Speaker 3: doesn't mean they're go to be negative, but it has
18:14
Speaker 3: corresponded pretty well with below average returns in the past.
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Speaker 2: I'll also point out for a moment, so one of
18:20
Speaker 2: the main things that investors have been pointing to over
18:24
Speaker 2: the course of the last certainly the last quarter, the
18:27
Speaker 2: earnings growth has been massive. According to factset, Q one
18:30
Speaker 2: earnings growth up twenty eight point four percent from the
18:33
Speaker 2: same quarter a year ago. Typically, when I think of
18:36
Speaker 2: earnings growing, I think of companies selling more stuff or
18:40
Speaker 2: selling the same amount of stuff at a higher profit margin.
18:43
Speaker 4: In the most recent quarter, that's not what drove a
18:45
Speaker 4: lot of the earnings.
18:46
Speaker 2: What drove a lot of the earnings is that companies
18:49
Speaker 2: like Alphabet, Amazon, Meta all have big investments in giant
18:53
Speaker 2: AI companies like Anthropic that increased in value dramatically compared
18:58
Speaker 2: to this.
18:58
Speaker 4: Time last year.
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Speaker 2: And maybe I'm getting into accounting nonsense that I shouldn't
19:03
Speaker 2: be spending my time on. But when we talk about
19:05
Speaker 2: that nearly thirty percent earnings growth, I like to point
19:08
Speaker 2: out that it did not come from Google selling more
19:10
Speaker 2: ads or more chips. They may have done that to
19:13
Speaker 2: some degree. A lot of the increase in the earnings
19:16
Speaker 2: came from the fact that they own these privately held
19:19
Speaker 2: AI companies that suddenly are worth a heck of a
19:21
Speaker 2: lot more money than they were a year ago.
19:24
Speaker 4: Let's say a quick break.
19:25
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20:00
Speaker 5: All the traders are returning from the holiday weekend and
20:02
Speaker 5: markets start mixed with another rally in tech amid the
20:05
Speaker 5: fragile ceasefire between the US and Iran after US and
20:08
Speaker 5: Iranian forces clashed overnight. However, hopes remain high in progress
20:12
Speaker 5: tore it in interim peace steal. Right now, the Dow
20:15
Speaker 5: is now down only twenty two points, mostly flat. SMP
20:19
Speaker 5: five hundred is up eight tenths of a percent, NASDAK
20:22
Speaker 5: up one point three percent, or three hundred and fifty
20:25
Speaker 5: eight points higher. Rust two thousand is up one point
20:28
Speaker 5: seven percent. Ten year Treasure reeled down seven basis points
20:31
Speaker 5: at four point four to nine percent and oiled down
20:35
Speaker 5: nearly three percent, trading right around ninety four dollars barrel BP,
20:40
Speaker 5: following nearly five percent after the Energy Giants board said
20:43
Speaker 5: it decided to remove Chairman Albert Manifold immediately over serious
20:48
Speaker 5: conduct concerns. Meanwhile, Dropbox CEO Drew Houston announced he will
20:52
Speaker 5: step down and assume the role of executive chairman. Houston
20:56
Speaker 5: found a Dropbox at the age of twenty four, nearly
21:00
Speaker 5: two decades ago. Dropbox shares it down about two percent. Elsewhere,
21:04
Speaker 5: Eli Lilly agreed to acquire three vaccine developers and deals
21:07
Speaker 5: valued up to nearly four billion dollars combined. Lily shares
21:11
Speaker 5: are dipping. AutoZone sinking nine percent after the car parts
21:16
Speaker 5: distributor said it's international sales word challenged and its latest quarter,
21:21
Speaker 5: and after surging seventeen percent last Friday ahead of its
21:24
Speaker 5: earnings this Thursday, dellstock is up another two percent today.
21:30
Speaker 5: I'm Tucker Silva, and that is Wall Street watch mark.
21:34
Speaker 2: Before the break, we were talking about corporate earnings, and
21:36
Speaker 2: specifically the statistic that I have personally cited several times
21:41
Speaker 2: over the course of the last few weeks, which is that,
21:43
Speaker 2: according to facts, that first quarter earnings are up twenty
21:47
Speaker 2: eight point four percent from that same quarter a year ago,
21:51
Speaker 2: which is well above trend line. I don't know what
21:54
Speaker 2: the average earnings growth rate is on the S and
21:56
Speaker 2: P five hundred. I'm guessing high single digits, low double digits.
22:02
Speaker 2: Somewhere in that general range, and clearly we are well
22:07
Speaker 2: above that trend for the most recent quarter. What I
22:11
Speaker 2: like to point out is something that we've pointed out
22:13
Speaker 2: several times, which is the interconnectedness of this whole AI trade.
22:17
Speaker 4: Over the course the last few years.
22:19
Speaker 2: Not only has it been private companies making deals with
22:23
Speaker 2: large publicly traded companies to secure chips in exchange for
22:26
Speaker 2: shares and future shares, and the ability to execute on
22:29
Speaker 2: these data plans. So there's all the interconnectedness there. But
22:35
Speaker 2: then when you dive in and actually look at the
22:39
Speaker 2: earnings growth and where it's coming from. When I think
22:43
Speaker 2: about earnings, I think the temptation is to think about
22:47
Speaker 2: it the same way you would a household. Right, If
22:49
Speaker 2: I'm thinking about earnings growth in a household, it means
22:52
Speaker 2: that you got to raise or if you're talking about
22:55
Speaker 2: net earnings, it could be that you cut your spending,
22:57
Speaker 2: but neither way, you had more to save at the
22:59
Speaker 2: end of the day. As a household, what you typically
23:01
Speaker 2: wouldn't include would be, oh, the value of my car
23:04
Speaker 2: went up because I drive an electric car and gas
23:07
Speaker 2: prices are high, or my home value went up and
23:11
Speaker 2: therefore my earnings grew. But when we take a look
23:14
Speaker 2: at publicly traded companies like Alphabet, Amazon, and Meta, that
23:18
Speaker 2: has been a huge driver of their earnings growth is
23:20
Speaker 2: their ownership of these privately held companies like Anthropic that
23:25
Speaker 2: just shot up in value year over years.
23:27
Speaker 4: So what are we to make of that?
23:29
Speaker 2: Because I don't think it's worth stripping it out given
23:31
Speaker 2: that it's always been a part of company earnings.
23:34
Speaker 3: What are we to make of what? I'm sorry, what was.
23:35
Speaker 2: The the structure of the earnings growth, the accounting of
23:38
Speaker 2: the earning Well, you'd.
23:40
Speaker 3: Have to get into it on a firm by firm basis,
23:42
Speaker 3: I would. My point was going to be that net income,
23:47
Speaker 3: you know, profit is might be useful on an aggregate
23:51
Speaker 3: level for comparing the value of the stock market today
23:57
Speaker 3: to previous periods. That's how we get p ease. But
24:01
Speaker 3: if you're looking to buy an individual company you're not
24:03
Speaker 3: necessarily excited about you probably are, but aren't necessarily excited
24:08
Speaker 3: about high profit growth. You care as a shareholder about
24:12
Speaker 3: cash flow from operations and then a derivative of that
24:15
Speaker 3: free cash. I want to make those adjustments for various accounting.
24:20
Speaker 3: I'll just call the maneuvers They're not inherently bad or
24:23
Speaker 3: good necessarily, although they can't add value, so I don't want.
24:26
Speaker 4: To dismiss them.
24:27
Speaker 3: But I care about whether or not the companies that
24:29
Speaker 3: I'm thinking about investing in can make the investments they
24:33
Speaker 3: need to make to continue to grow their profits.
24:35
Speaker 2: We got that from cash flow, not operating income would
24:38
Speaker 2: be your point.
24:40
Speaker 3: I'm going from net income to cash flow from operations
24:44
Speaker 3: to operate. That's sort of the textbook, at least the
24:47
Speaker 3: way you know they do in the CFA program or whatever.
24:51
Speaker 3: So I'm a little rusty here, but I guess my
24:53
Speaker 3: point was, you use net income for one thing and
24:56
Speaker 3: earnings for one thing. But if you're looking to buy
24:59
Speaker 3: a company, and I think to answer the question that
25:02
Speaker 3: you just asked quality of earnings, and to me, that
25:06
Speaker 3: turns on can they continue to make the investments they
25:09
Speaker 3: need to make to generate the earnings growth that they've
25:12
Speaker 3: experienced without necessarily, say, tapping capital markets because it may
25:17
Speaker 3: be unfavorable circumstances may be unfavorable in the future, or
25:22
Speaker 3: borrowing money becoming more highly levered. That's problematic. I guess
25:26
Speaker 3: what I'm getting at here is how high quality are
25:29
Speaker 3: their recent results? And that takes a more discerning approach
25:34
Speaker 3: than just oh wow, how much Tesla grew there, yeah,
25:39
Speaker 3: or Tesla grew their sales by x. That is not
25:41
Speaker 3: necessarily those things are often connected with some of those
25:45
Speaker 3: other measures I mentioned, but they're not the same thing.
25:49
Speaker 2: I do like the comparisons that Axios did here in
25:52
Speaker 2: this piece, just to kind of give some scale to
25:55
Speaker 2: these numbers, and you're welcome to shoot holes in them
25:57
Speaker 2: if you'd like. But Alphabet, for instance, Thans whose profit
26:01
Speaker 2: number included a thirty seven point seven billion dollars windfall,
26:05
Speaker 2: most of which was due to the rising value of
26:07
Speaker 2: ownership stakes and other companies. That non operating gain, which
26:11
Speaker 2: again you know we're describing the difference between the two
26:14
Speaker 2: operating gain would.
26:15
Speaker 3: Be okay, something different now, but okay, I'm with you.
26:19
Speaker 2: The size they're non operating gain was bigger than Walmart's
26:22
Speaker 2: entire net income last year, so just that portion of
26:25
Speaker 2: their non operating piece of value of assets going up.
26:28
Speaker 2: Amazon's anthropic windfall eclipsed Goldman Sachs annual profit in twenty
26:33
Speaker 2: twenty five.
26:34
Speaker 4: The scale of these things is.
26:36
Speaker 2: Truly massive, and I do appreciate that comparison of why
26:40
Speaker 2: right now, the only thing that matters to markets seems
26:43
Speaker 2: to be artificial intelligence, because the scale of the valuations
26:47
Speaker 2: that are being put on these companies is so unbelievably
26:50
Speaker 2: large that it's eclipsing pretty large companies.
26:52
Speaker 3: Yeah, these are one offs not likely to be repeated.
26:58
Speaker 2: Right you You maybe, but you're not likely to see
27:00
Speaker 2: anthropics value go up that much again next.
27:03
Speaker 3: That's sort of what I what I mean. So it's
27:06
Speaker 3: debatable whether or not that matters, unless it matters to
27:10
Speaker 3: me as someone who's considering buying the stock today or
27:12
Speaker 3: continuing to hold.
27:13
Speaker 4: It right right.
27:14
Speaker 2: Why I think it matters is if for some reason,
27:17
Speaker 2: the valuation that we all place on these privately held companies.
27:23
Speaker 4: Goes down.
27:24
Speaker 2: Like I'm trying to envision a scenario where Google's AD
27:28
Speaker 2: sales get cut in half and you have to have
27:30
Speaker 2: a pretty deep recession for their AD sales to you know,
27:33
Speaker 2: go down that fast to have the valuation on one
27:36
Speaker 2: of these privately held companies drop by a significant value
27:39
Speaker 2: in thereby bring down a company like Alphabet Shares. That
27:42
Speaker 2: seems a lot more plausible to me than a drawn
27:45
Speaker 2: out recession that affects actual sales of things like advertising.
27:50
Speaker 3: This is one of the problems with using PE is
27:54
Speaker 3: that it includes all the one offs the E does,
27:57
Speaker 3: so it can look more conservative, valuations can look more
28:02
Speaker 3: reasonable than they are, and you can't get at you
28:06
Speaker 3: can't get at the answer to the question, well, what's
28:10
Speaker 3: the p to say. I'm forgetting the right definition of E.
28:15
Speaker 3: But let's just call it sustainable E. The E that
28:18
Speaker 3: comes from these companies just operate nailing it yea in
28:21
Speaker 3: their core business, and that's something that's not readily available.
28:26
Speaker 2: Let's take quick break when we come back, talking a
28:29
Speaker 2: little bit about the new FED share and the I
28:33
Speaker 2: don't know, confusing firestorm that he's walking into at the
28:37
Speaker 2: FED at this moment in time with inflation moving up.
28:40
Speaker 4: Quick Break wash is next.
28:43
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28:49
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29:09
Speaker 1: you need to know. The face, he's the financial exchange.
29:22
Speaker 4: Mark.
29:22
Speaker 2: We have a new chair person at the Federal Reserve,
29:24
Speaker 2: confirmed last week, Kevin Worsh. We've expressed skepticism about his
29:29
Speaker 2: ability to run the Fed without the influence of the President,
29:34
Speaker 2: given his comments while seeking the nomination. Nonetheless, he's walking
29:39
Speaker 2: into I don't think what would be an enviable time
29:42
Speaker 2: for any Federal Reserve chair. The yield curve is indicating
29:48
Speaker 2: on the longer end that rates need to be higher.
29:50
Speaker 2: Many of the Federal Reserve members have expressed skepticism about rates.
29:54
Speaker 4: Moving lower anytime soon. How taking out.
29:59
Speaker 2: Your ski bapticism about Worsh himself and the role that
30:02
Speaker 2: he needs, the things that he needs to overcome in
30:05
Speaker 2: the role, how would anyone approach this moment in time
30:09
Speaker 2: for the Federal Reserve given the inflation concerns, the growth concerns,
30:13
Speaker 2: and what we are seeing at the moment.
30:17
Speaker 3: So okay, So mechanically, the question becomes, we've had a
30:23
Speaker 3: big shock. Inflation went up by a lot in just
30:26
Speaker 3: two months. It went up by one point five percentage points.
30:29
Speaker 3: That's as much as it went up in the entire
30:31
Speaker 3: year of like twenty sixteen. So inflation has spiked. What
30:37
Speaker 3: should the FED do well? That comes down to the values,
30:42
Speaker 3: if you will, of the Chair and the FOMC. What
30:45
Speaker 3: can the FED do well? They can hope that the
30:48
Speaker 3: wave passes. Oil prices will eventually stop going up, even
30:52
Speaker 3: if they stay high, and when they stop going up,
30:55
Speaker 3: even if they stay high, and I think they'll probably
30:57
Speaker 3: come down as soon as the crisis in the Middle
30:58
Speaker 3: East is resultved. But then inflation will stop going up,
31:02
Speaker 3: but prices will never come back down, similar to what
31:04
Speaker 3: we experienced after Covide. So one thing the FED could
31:08
Speaker 3: do is just sort of wait and see, and that
31:09
Speaker 3: seems to be the position that they've taken collectively. The
31:13
Speaker 3: other thing the FED could do is push back against
31:16
Speaker 3: the shock, and pushback means you raise interest rates to
31:21
Speaker 3: match the increase in inflation. When you do that well,
31:25
Speaker 3: you slow economic activity. That's the required sacrifice, but you
31:30
Speaker 3: also stand a greater chance of keeping inflation from becoming entrenched,
31:34
Speaker 3: embedded mainly via expectations.
31:37
Speaker 2: I don't mean to get too big picture on this,
31:39
Speaker 2: and this is not one of the federal reserves and mandates,
31:41
Speaker 2: but practically speaking, how do we as a nation finance
31:45
Speaker 2: or debt or successfully finance our debt at what's thirty
31:48
Speaker 2: year treasury now five percent long term?
31:51
Speaker 4: Like it doesn't exactly, Well.
31:52
Speaker 3: That creates at Yeah, there's monetary policy, there's fiscal policy.
31:56
Speaker 3: We were just talking about monetary policy, which is a
31:59
Speaker 3: fancy way of saying how much money we're gonna print.
32:01
Speaker 3: That's all monetary policy is how much money you want
32:03
Speaker 3: to print. FED prints money targeting short term interest rate
32:06
Speaker 3: FED funds, but ultimately the lever they pull is the
32:09
Speaker 3: money supply. So moving to fiscal policy, these two things
32:12
Speaker 3: are obviously related yep. And it's a relatively recent innovation
32:18
Speaker 3: to have separated the two, as as Western countries have
32:22
Speaker 3: done over the past roughly seventy five years. So your
32:25
Speaker 3: question is, so rates are going up, it's going to
32:28
Speaker 3: increase interest expense, and that's going to crowd out other
32:31
Speaker 3: stuff and that makes yeah, we have less we have
32:36
Speaker 3: no Okay, here's how i'd maybe connect the problems both
32:42
Speaker 3: monetary and fiscal right now, or that the challenges we
32:45
Speaker 3: have no monetary policy room. If the economy did dip
32:48
Speaker 3: into recession, I have no doubt the FED would try
32:50
Speaker 3: to ease, but they'd be constrained by relatively high inflation.
32:57
Speaker 3: Similar to it certain times in the nineteen seventies. So
32:59
Speaker 3: we've got very little monetary policy room right now insurance,
33:01
Speaker 3: if you will, a very little fiscal policy room right
33:04
Speaker 3: now too. We're running massive deficits. We have roughly since
33:08
Speaker 3: twenty seventeen, last time we saw improvement year over year.
33:12
Speaker 2: How do you spend your way out of a recession
33:14
Speaker 2: when you're already running deficits at six percent.
33:16
Speaker 3: And your interest expense is going up. But the main
33:20
Speaker 3: challenge for Warsh is, in a word, credibility. He has
33:23
Speaker 3: none because he's perceived as Trump's puppet. And the more
33:26
Speaker 3: he says I'm not, the more I want to believe that,
33:28
Speaker 3: the more I tend to think he is.
33:30
Speaker 4: Look, I don't know.
33:31
Speaker 3: I can't get inside his head. I do know he
33:33
Speaker 3: comes into this having accepted a devil's bargain. I don't
33:37
Speaker 3: know what he and Trump said behind the scenes. Obviously
33:39
Speaker 3: nobody does. But I have no doubt that the President
33:42
Speaker 3: will continue to put pressure on the FED to lower
33:45
Speaker 3: interest rates. Is any president who was sort of unrestrained
33:50
Speaker 3: as Trump just tends to operate. Maybe you like that,
33:54
Speaker 3: maybe you don't, But he's not censored. He doesn't censor himself.
33:57
Speaker 3: Every president wants lower interest rates. Nobody wants to impose
34:00
Speaker 3: there's a recession on their watch to get inflation down.
34:03
Speaker 4: Right.
34:04
Speaker 3: Question is will warsh be able to earn credibility, and
34:08
Speaker 3: that credibility is necessarily to keep inflation expectations low.
34:11
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35:25
Speaker 2: Back in twenty twenty two, mass justs approved a new
35:29
Speaker 2: tax on folks earning more than a million dollars four
35:33
Speaker 2: percent sur tax on annual income and excess of a
35:36
Speaker 2: million dollars. At the time, left leaning think tanks thought
35:39
Speaker 2: it could generate around or at least two billion dollars
35:42
Speaker 2: a year. It's repeatedly now top to that first year
35:47
Speaker 2: is collected with twenty twenty three, so we've got three
35:50
Speaker 2: full tax years of collections on this thing. And the
35:54
Speaker 2: sur tax has already produced two point six billion dollars
35:57
Speaker 2: in revenue in just the last fiscal year, consistently outpacing
36:03
Speaker 2: expectations in spite of plenty of pieces being written about
36:07
Speaker 2: high income earners in Massachusetts leaving the state. The total
36:13
Speaker 2: number of people, according to IRS data, that left the
36:16
Speaker 2: state between twenty twenty two and twenty twenty three was
36:18
Speaker 2: about thirty thousand. According to tax returns within that highest
36:23
Speaker 2: earning bracket, those who are earning more than two hundred
36:25
Speaker 2: thousand dollars. There are about eighty seven hundred individuals leaving
36:29
Speaker 2: the state during that time period, about twenty nine percent
36:32
Speaker 2: of that total, And in spite of that, the amount
36:36
Speaker 2: collected from this millionaire's tax continues to hold up pretty well.
36:42
Speaker 2: I think that speaks to a few things. One, there
36:45
Speaker 2: are just a lot of very wealthy folks in Massachusetts
36:48
Speaker 2: with business ties to the state that would find it
36:50
Speaker 2: difficult to relocate to a tremendous period of time for
36:57
Speaker 2: capital gains, earnings, business profitability from all sorts of different
37:01
Speaker 2: sectors recently, which is driving that tax collection rate up.
37:06
Speaker 2: Long term, I still hold the opinion that I did
37:08
Speaker 2: when it was passed, which is Massachusetts is geographically an
37:11
Speaker 2: incredibly small state, and if you are a new business
37:15
Speaker 2: considering starting up in one place or another, a nine
37:19
Speaker 2: percent total tax rate for very high income earners is
37:23
Speaker 2: one factor that is going to potentially drive you away
37:25
Speaker 2: from the Commonwealth.
37:26
Speaker 3: Maybe a little bit on the margin. Obviously, you're looking
37:29
Speaker 3: at net benefits and comparing those across jurisdiction, so you
37:33
Speaker 3: get access to a more highly skilled labor force here,
37:36
Speaker 3: better infrastructure, better healthcare, better education. I'm not defending it.
37:40
Speaker 3: By the way, I don't like them. I don't like
37:41
Speaker 3: any tax. I voted to eliminate the income tax in
37:44
Speaker 3: two thousand and what was that two which never had
37:47
Speaker 3: which failed? Excuse me, no, that was seven. That was flaky.
37:51
Speaker 3: I voted for it, nevertheless, and two we voted to
37:54
Speaker 3: reduce to five. I believe I voted for that never happened. Yep,
37:57
Speaker 3: of course seven was a fantasy. So anyway, I don't
38:01
Speaker 3: like any income tax, but I also don't believe that
38:04
Speaker 3: it's a huge driver of population flows.
38:06
Speaker 4: Let's take a quick break.
38:07
Speaker 2: When we come back, a whole lot to go in
38:09
Speaker 2: the second hour, including beef prices and the tough summer
38:15
Speaker 2: job market for teenagers.
38:16
Speaker 4: That's next on the Financial Exchange