The Fed & BoE divergence and what it means for markets

Transcript:

For this week’s Market Maker podcast, we were joined by Piers who gave us his verdict on the big tech earnings and explains why despite their weak performance the S&P continues to hold up. We also delved into the monetary policy decisions this week from the Federal Reserve and Bank of England. We then spoke about Elon Musk taking the helm at Twitter and whether his strategies will turn the social media company around.

Here’s what we talked about

There has been a lot going on with big tech lately, what are your thoughts on the recent numbers from these firms?

So Amazon got chopped in terms of share price reaction much more aggressively. But the nature of that business, even though their AWS side of things is the jewel in their crown and is the fastest growing part of their business and has been for years. Of course, it's still not there yet in terms of size compared to the global retail network. So with Amazon still I wasn't expecting such a bad report on the share price to drop 20%.

Google has been incredibly resilient. Google, of course, has a large part of its revenues in advertising. And so you might think traditionally then, that is vulnerable as a revenue stream heading into a recession. Historically, businesses tend to when they're looking to trim costs and tighten the belt, then often the advertising budget is the easiest and the quickest thing to turn off and on. But Google is a bit different to normal advertising or companies that generate revenue through advertising. Obviously, for Google, it's a destination for people to go to, to very specifically search for something, and then it's a slightly different, much more resilient advertising revenue. And they've been very resilient throughout this year so far and through the energy crisis and the inflation situation. YouTube was hit more than that core search side, of course, but given their resilience this year, I wasn't expecting quite the negative report that we saw. So, yeah,  out of all of them, probably the Google one was the one that was most interesting. And actually a real heads up to say, whilst a lot of this data we're seeing is showing that the economy is resilient you're now starting to see things turn. 

And then just looking at the actual share prices, these tech giants are here for the long haul. And so considering where were we prior to the Pandemic, how much have we pulled back now? 

So just before we talk about the individual big-name share price moves, I just want to make another point. Like take an index like the S and P 500. You take the big five tech firms; Apple, Amazon, Microsoft and Google- (Let’s leave out Facebook for now)  About 25% of the S and P index was those five companies. It's crazy how big the giants have become and how they dominate now in terms of market cap on these massive indices.

But what is the story of this year? I would say has been up until now, it's been the smaller guys, that have been hit quite badly through quarter two, quarter three and through the summer. So you've had some stocks, particularly on the tech side, small tech, and they're down like 70%- 80% from their highs from the end of last year so there have been big cutbacks. But during that time period, the big tech giants were resilient. Yes, they did come down, but really only 20%.

What happened last week is almost like the exact opposite, where now you've got the big guns that have been chopped back, but actually, all the other little guys underneath have been quite relatively stable. So whilst this tech earnings pullback has been interesting, the whole index hasn't really suffered. And we're still trading above the June lows. So it's quite interesting. We've now seen the big guns get pulled back whilst the majority of the smaller guys have stayed steady. 

This is quite an interesting sign and gives us a segue into talking about the Fed. Mike Wilson who's the chief US. Strategy for equities in Morgan Stanley was talking about how the stocks could go up and about a short-term bullish call. The rationale he put there was about the end of Fed tightening is near where a lot of that came from a journal article from one of these informed sources that were talking about the Fed is just about ready to pivot now and start stepping down the increments of 75 basis points.

Before we discuss further about the Fed, can you tell us more about the share prices of these big tech giants?

Let’s talk about Facebook - This year has been just an absolute monster collapse in February, March and downward trending ever since then and then took a big nose dive last week; Net-net is down about 75% year on year and just looking back longer term, Facebook shares are back to where they were trading summer of 2015. Now, not far off a quarter of the value of where they were sat this time last year. So obviously Facebook is a particularly extreme situation.

In terms of the other big four; Apple, Microsoft, Amazon, and Google - Amazon is trading below 90 now, so sub 90 for an Amazon share and they're down about 48% year on year. So they're the next worst with regard to year-on-year figures. Amazon now trading back is quite interesting. They were trading at 90 back in July 2018. So we got Amazon now at a level we haven't seen for four and a half years giving back all of the pandemic bump. So certainly if you're looking at which of the big tech firm's share prices are currently trading at the largest discount relative to all-time highs, then Amazon is that. But you got to think about they're not just for tech businesses, they're not just the same business. Often people just push them into this bucket, they're just massive tech, but clearly, they are very different businesses. And so as we've already said, Amazon is perhaps a little bit more vulnerable to like a macro downturn, just from a retail point of view. And they got much thinner margins. So Amazon is looking very attractive but could go further.

If you take the next worst, which I believe is actually Google, they're trading at $85. Well, I say Google Alphabet class A shares trading at $85 and that's off a $150 high that we saw back twelve months ago. So yeah, they're back to levels seen at the end of 2020. So they haven't given back like pre-COVID where they were trading at 60. So Google is still above pre-COVID levels. Microsoft year on year down 35%.  These are big numbers now, right? 35% and trading back to levels since in the summer of 2020.  So Amazon 48% down, Google 40%. Microsoft 35% and Apple is only down 7% year on year. So out of all of this, Apple is still the biggest one from a market cap point of view and actually, they're the last man standing if you want to call it that in terms of avoiding monster pullbacks. They're trading at levels we were seeing the start of 2021. But I guess what happened to Apple was that they didn't quite have the COVID explosion that these other businesses had. You know, Google and Amazon of course, particularly had massive upside during COVID, Apple not so much. So whilst they didn't bump so much in COVID, it makes sense they're not pulling back so much post-COVID, so there is that to factor in. But yeah. So out of all of them from just a year-on-year share price point of view, then these big guns have finally turned and slumped. The whole index hasn't gone with it, which for me is a pretty interesting behavioural sign because if you wanted a reason for another big leg lower in these indexes, then we had it last week, especially if you heap on top the hawkish Fed from yesterday. It's like if this thing wanted another big leg lower, the whole index, then it probably would, this was the time and it hasn't happened.

Discussing further on the Fed

If you actually were to look at a chart of the S and P 500, the October low is pretty much we hit 3500 through a bout of volatility. And even with the sell-off that we've had in the last 24 hours or so, still training at 37 and a half. So, the Fed has come out and they've been quite clear, about their intention that, there's more pain to come. But the big forces here, from a top-level perspective, down have come out and are clear. From the bottom, going from a micro level, they've come out. The biggest influential factors on these indices have come clean. And yet here we are. We're not smashing down through 35. We're far from it. 250 points off it. What else needs to happen? Midterms come out, but that's not going to shift the needle in that way. And if anything, history would tell us that actually indices tend to perform better because they come out of it at least with, again, clarification of what the latest status is so you move the uncertainties away from the table. So, definitely interesting right now.

Mike Wilson at Morgan Stanley may hope that the Fed would come out, hike 75 basis points again for the fourth meeting in a row, but then signal that they are going to take the foot off the accelerator; not to stop hiking, but to hike at smaller increments, with potentially the last hike being maybe in December. But the flip card that Powell slipped in there last night to turn the whole thing on its head was, that they expect the terminal rate to be higher than is currently being priced. And what was being priced was 4.6%. Right. So if rates are at 4% now, you could have said 150 basis point hike in December, maybe slide in a 25 hike inend of January and then done, finishing around about four and a half to 4.75%. But now markets are pricing, they're going to have to break 5%. So that terminal rate is the peak of the hiking cycle. And basically, Powell said last night, “look, guys, it might be as high as five, if not more” He didn't say the number precisely like that, but that's what markets are interpreting. So, yeah, just that higher peak in the hiking cycles, that curveball last night because the S and P rallied 1% initially off the back of Powell, saying, “ look, we've gone 75 today, most likely it's going to be 50 in December, we're going to start to slow down” Bang, big upside, 1%. Then he said, “ bad luck, guys, the terminal rate is going to be higher. And it all flipped and the S and P finished down 2.6%  on the day.

Another point he made, which then starts to link to the bank of England said the policy needs to be more restrictive. And that narrows the path to a soft landing, because one of the things the bank of England was saying, is that they now believe the British economies are already entering a challenging downturn this summer that will continue next year and into the first half of 2024. That will not be the UK's deepest downturn ever. But it does date back to, the 1920s, so it goes back to the longest since records began in the 1920s. So there's a hugely challenging period ahead. And one of the things I thought was interesting there was that it leads us into the next election. And so Rishi's come in, we're about to be sat in a recession for his entire period. It's not like when Obama came in when Stanley smashed between him winning the election. In three months,  the SNP fell something like 20% . That was ridiculous because he was coming in on the back of the previous administration and central bank decisions that had taken place. He came in then rates got slashed and everything happened and the stock market bounced back. He'll take credit for that, of course. 

With Rishi, we're in a completely different cycle. The whole reason for the powerful Obama bump when he came in was because none of the creative stuff in policy-ing sense was really deployed until that point. We've already gone through all of that post, COVID you can't really go into that because we've got an inflation problem. Rishi's got his work cut out. Talking about setting conservative prime ministers setting all-time worst-ever records, Rishi sets a record where the worst-performing economic conditions under any tenure of a prime minister ever. But going back to the bank of England, on the one hand, they did exactly the same thing as the Fed. On the other hand, their message was the exact opposite. So they both hiked 75 basis points and the Fed said hiking 75 and peak in the hiking cycle though is going to be higher. It's going to have to be higher than markets are currently expecting. That was the Fed. The bank of England hiked 75 basis points and said, “you know what, we're probably going to stop here”. Secondly, the peak in the interest rate hiking cycle is actually going to be lower than what markets are currently expecting. Super dovish. So the Fed did a hawkish 75 hike and the bank of England did a dovish 75 hike. By the language  they use about what's coming next and further down the track, The bank of England, basically came out with two scenarios from an economic forecasting point of view. One was like the doomsday worst case, where, they said interest rates would have to rise to 5.25%, so bear in mind they've just hiked to 3%. So doomsday is like inflation carries on being a much bigger problem than we currently think. Rates go up to 5.25% and we enter into a recession that lasts for eight quarters and that's just unimaginably bad. Their positive scenario was, and this is their main theme, this is the peak for inflation, it's going to peak in quarter four, we don't need to raise rates anymore. 3%, this is the top. And if they're right, then fine, inflation drops back down; They said 5.6% inflation by the end of 2023, 2.2% by the end of 2024, and it all just slowly comes back down and rates don't have to go above 3%. In that scenario, though, they're still predicting five quarters of contraction. That's a crazy length of time. Even that is just crazy for how long a recession might last. Normally recessions last like nine months max. So even their positive scenario is pretty ugly. But because of all the mortgage debacle from the mini-budget, from people out there on the street point of view, freaking out, panicking; there are 2 million mortgages that are up for expiring or the deals are expiring in the next twelve months, So people are freaking out quite rightly about. If you rearrange your mortgage now, you'd be paying £3000 a year more in interest payments. That's a lot of money. And so people are quite rightly freaking out. So one clear message from the bank of England was, rates aren't going to go above 3%. We're here, we're done, inflation is going to peak, it's going to come back down. Basically sending a message to the banks, the mortgage rate setters and the people out on the street saying that this big spike you've just seen in these mortgage rates, you're not going to have to rearrange your mortgage at this spike, it's all going to come back down.

So the key assumption that you're making there, is that Rishi Sunak is fiscally prudent. He will have learned from the lesson of what just happened right?

All of these forecasts from the bank of England are from mid-October. Rishi's plan is obviously much less inflationary, and some might argue deflationary compared to Truss’s super uber inflationary thing. Right. So when the bank of England says they think inflation is going to peak in quarter four and then it's going to start to come down, that's even before the Rishi effect, which should make that even more likely to happen. 

It was just about the idea of if you're looking to guide certainty into the market and you're releasing economic forecasts without the government actually having decided anything really, at this point. Or then what good are these forecasts present moment in time?

Yes, but my point still stands. The direction of travel from a fiscal point of view now under Sunak should not contribute to the inflation problem.

Okay, well, looking at the pound, I just had the chart up, talking of reversals from where we started. We're trading just under a 112 handle at the moment to Sterling. But what is trust low is obviously way lower. 104. What are your thoughts on this?

It is. But look, there's a lot of UK political volatility in that sterling dollar chart in the last month. Step back then, it's been trending lower. When you cure, if you want, you want to go all the way back, it's been trending lower for like 15 years. But now the political noise has gone, then you're still left with this scenario that, A, the Fed are more hawkish than the bank of England. That has just been absolutely, clearly reconfirmed in the last 24 hours. That should lead to the Sterling devaluing against the dollar. Secondly, the UK recession, it's going to be a lot worse and probably a lot longer than the US recession. So probably the economic divergence should also lead to the currency exchange rate continuing to go down. So whilst the noise on the political side in the UK has perhaps been put to bed, don't now think, “oh, Rishi's here. Great. Sterling is now going to rally back to 120” No, the big giant macro forces, I believe, are actually still probably suggesting the exchange rate goes lower back below 110. 

Elon Musk has taken control of Twitter. They have announced plans for a premium $8-a-month subscription service. So before, there used to be a process where you'd have to submit. It would be the same on Facebook for Instagram as it would on Twitter. You need to be in a category of some influence. So politician, sports person, a music person; you need supplementary material to suggest your influence, so an article in a major publication, so on and so forth, or a volume of following on a certain platform to authenticate. And this is the key for me to why this model doesn't work. It's because I know that certain political circles will say, well, freedom of speech, everyone can pay. And the problem they have is about who is actually setting out the parameters for who gets selected, which is their key problem with the way it used to be done. Right. My problem is if you give everyone access to having a Blue tick, which obviously still equates to a previous anchoring psychologically, of someone of relevance, that what they're saying has been fact-checked and verified and is authentic, Now, any man and his dog can have that ability, and I know this is the opposite view because his thing is about freedom of speech, but I feel like the problem is going to be exacerbated because misinformation will spread far easier through issuing an ability to have a low barrier to getting verified. And actually, there was some research I saw about if you were to convert all of the current verified users of Twitter into an $8 sub,  it equates to something like $50 million. What are your views on this model?

I heard that there are hundreds of thousands of Twitter users that have been verified, so only hundreds of thousands. So I just plucked a number. Let's assume that's $500,000. That's $4 million a month. So $48 Million a year, which, for A company the Size Of Twitter, strikes me as not moving the needle...

So if every single currently verified user signed up to Pay but no Others yeah. That would be worth $40 million a year, right? Yeah, right. So it's less than 500,000. If the company successfully convinced 10% of its 229,000,000 active users to pay the proposed $ 8-a-month charge, it would generate circa $2 billion in revenue. That's a substantial sum, obviously, but it's still less than half of what they make in just standard ad Revenue. But that's contingent. They've got to flip 10% of their hours of users.

There was a big poll done by Jason Calcanis. He did a poll on his Twitter handle and he had 1.2 million respondents and which was very insightful. The sample size is huge, and the results and he asked, would you pay? He actually said, would you pay $5 a month?  And 80% said they would. 80% said they wouldn't pay anything. They're not prepared to pay Anything. 11% said they'd pay $5.05.5%. Said they'd pay $15. So obviously Elon's going to try a whole bunch of stuff here to try and turn this thing around and on the cost-cutting side of things as well. But from what further revenue streams?

He's getting the developers working through the night. He's pulled engineers from Tesla. Tesla. I don't know how that makes me feel if I were a Tesla shareholder. What do you think?

This is a weird scenario, isn't it, that you've got two companies that are not related in any way whatsoever in terms of the businesses that they are and yet you've got this weird scenario where you got a dictator sat at the top of the tree and can pluck people from one to the other. And now, from a shareholder point of view, you're holding Tesla shares. You're like. “Hang on a minute. I didn't sign up for this” and so it will be very interesting to see what happens to that Tesla stop in the weeks to come as Elon messes about with his new toy. 

Yeah, it's interesting because Tesla hasn't really moved a deal.  One thing is I passed judgment on what I thought about Elon's latest moves. And my LinkedIn got attacked by the Elon followers who've come out in force to put me in my place. It's such an interesting situation because the common theme in their posts is similar to the atmosphere that surrounded the GameStop situation whereby a lot of people are saying, “what's so different between what a private equity firm does as to what Elon is doing other than he's a public figure and talks about it?”  It seems to cut at the core of this philosophy of there's us, the people which Elon represents, and then there are the suits who've been robbing people since the beginning of time. I do find it incredibly hard to see how you can manage multiple one being a trillion-dollar business in a leadership style, which is very much dependent on a single individual, because, he has sacked the entire management team and I wonder how in the long term,  short term,  it's remiss to think that Tesla would have a negative impact. But as he goes on, one of my concerns about him as a business owner or operator is that I feel he's very ambitious. So he's not going to stop and go reverse and think, “actually, I better just see to it and improve and make sure what I have is firing”. He's going to accumulate more and more Twitter to current fascination. He'll move on to the next thing and then at some point, literally, metaphorically, the wheels will come off.

Here's a counterargument; this could be good for Tesla, because, look, there are four companies now, right, that he's got Tesla SpaceX and then Twitter, right? But it could be that these are massive companies. We've argued on this podcast in the past that Elon should step away from Tesla. It's too big now, it's too mature. Let's get a proper team into got experience in running a multinational publicly listed business and do it properly. Maybe this is Elon now stepping away from Tesla and now concentrating on this new toy, which is Twitter. So who knows, maybe governance can now improve.

The problem you have there, as another counterargument, is that he walks away but that current stock price. The reason why I'm saying it's not moving at the moment because of what's happening is because of the type of shareholder who buys a Tesla stock now, the rest of the EV pack will surpass Tesla. It's not, I don't think, a question of if, but when. Then it comes down to the pure fundamentals of that company, which are not sufficient.