In this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, take a look at several news stories that all investors should pay attention to. You'll hear about:
- The latest Federal Reserve rate hike and what it means for bank stocks.
- Venmo has surpassed ATMs in terms of transaction volume.
- How reliable are corporate forecasts from an investor's perspective?
- Projections of how bad the next recession will be, what could cause it, and how to prepare.
- Whether Visa (NYSE:V) Checkout and MasterPass are serious threats to PayPal (NASDAQ:PYPL) or not.
- Their latest stocks to watch.
A full transcript follows the video.
This video was recorded on Oct. 1, 2018.
Jason Moser: It's Monday, October 1st. Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. I'm your host, Jason Moser. On today's Financials show, we'll talk about what is disrupting the ATM, we'll talk about the good and the bad when it comes to forecasts, talk about the next recession -- yes, I know, not if but when we have the next recession -- we'll take a look at the week on Twitter. And, as always, we'll have One to Watch.
We're going to start today with something that makes you want to say hey, now, and that's right, I'm talking about interest rates, Matt! Joining me today, I have certified financial planner Matt Frankel. Matt, I'm not going to ask you about your Gamecocks this past weekend. It was a little bit of a bum deal, I know. Sorry about that!
Matt Frankel: No, I don't want to talk about it!
Moser: [laughs] On the upside, for me at least, Wofford stuck at the Gardner Webb. Way to go, Terriers! We'll see how things shape up this coming weekend.
Let's kick off the discussion this week with interest rates. On Wednesday, perhaps to nobody's surprise, the Fed continued its measured approach in our recovering economy, raising interest rates just slightly. I wanted to get your quick take on things. What'd you think about the move?
Frankel: Like you said, it was not a big surprise at all. In addition, nothing in the Fed's forecast was a big surprise at all. They're still planning to do one more rate hike this year and three more in 2019. For some context, this is the eighth time the Fed has hiked rates by a quarter point in the past three years since they started doing this rate height cycle. There's a little bit more to go. It looks like interest rates are going to go up by another 1%.
It's really important to note that not every interest rate is tied to the Federal Reserve. In other words, things like credit cards and home equity lines of credit, which have variable interest rates, are generally directly tied to the Fed's action. If the Fed raises rates, you can expect your credit card interest rates to go up by the same amount, for example. On the other hand, things like mortgages, auto loans, where the banks make the bulk of their money -- the majority of consumer debt is not directly tied to the Fed's action. For context, I mentioned that the Fed has hiked rates eight times, a total of 200 basis points. In that time, mortgage rates have gone up by about 80 basis points. These are not one-to-one. Longer-term interest rates have not quite caught up with the shorter-term ones.
From an investor's point of view, which is really what I wanted to get at, if you're a bank investor, you generally want higher interest rates, higher interest rates mean better spreads between what the bank has to pay customers for deposits and what they can charge for lending products. Generally, you want higher interest rates, but the interest rates that really matter to the bank's profitability -- mortgages, auto loans, etc. -- are not tied to the Fed's action and really haven't moved like many people would have expected them to.
At the beginning of this rate hike cycle, all you're reading, including from people like me, was, "Interest rates are going up, this should be good for the banks. It's a very positive catalyst." I think Bank of America (NYSE:BAC) actually put out something that says, for a 100-basis point shift in the yield curve, they would make another $3 billion in profit a year. But it really hasn't panned out. The reason is, when you look at long-term interest rates, particularly like the 10-year Treasury yield, they really haven't caught up with the Fed's rate hike moves. They've moved in the same direction, but not quite as much as people have thought.
Moser: Why do you feel like they haven't caught up, though? We're talking about that yield curve inverting. We hear on the news about the yield curve inverting, and oh, my God, the world's coming to an end. I mean, why haven't those long-term rates caught up with that short-term action yet, do you think?
Frankel: It's because, in my opinion, the market's not convinced that inflation is going to pick up and the Fed is going to have to raise much more than they think they will. The yield curve's getting very, very flat right now. It's between 2.5-3% across most maturities for a Treasury. It's gotten really flat because the market's not really sold that we're entering back into a normalized interest rate environment.
Moser: Inflation is that metric that has guided the Fed's actions, it seems like, a lot here, ever since the financial crisis took hold. And we haven't seen anything that has amounted to what I think a lot of people thought, maybe inflation was going to become somewhat rampant here. Is it something that we should expect? I mean, I don't know. I'm not an economist. I did some economics work in college, but this stuff all kind of kind of boils down to some speculation here, right, Matt? What can we expect on the inflation front, do you think?
Frankel: I personally think that in a couple of years, inflation is going to start to heat up a little more than the Fed wants it to. My personal opinion. Having said that, until the market's really sold on the fact that a stronger economy is going to lead to inflation... long-term interest rates haven't picked up that much. You saw it a bit today. When they announced the Canada trade partnership, you saw the 10-year yield jump today. The reason is because things like the trade deal make the market a little more optimistic that things will really get going, prices will start to rise. But, like I said, today's move is small potatoes. Until you see the 10-year really start to move, then you won't see mortgage rates, auto loans, things like that, get too overheated, and the banks won't get the big benefits of it, as I'll talk to a little bit more when we get to our One to Watch this week. A little preview.
Moser: If anything else, all of this tells us that the economy is on the mend. What we've wanted to see for some time is somewhat tighter monetary policy. Raise interest rates a little bit at a time, that is a sign, perhaps, that things are on the mend. We talked about last week, of course, FICO scores are at record highs, which means more people are capable of borrowing.
In the grand scheme of things, even with interest rates on the rise, they are still so low when you compare them to some of the historical norms. Going back to even my childhood, my mom and dad were getting mortgages on a house somewhere in the neighborhood of 14%. So, let's try to keep it all in context, right?
Frankel: Yeah, my parents bought the house I grew up in in 1982, and their first mortgage rate was 16.5%. It wasn't that they have bad credit or anything. That's just what the rates were at the time.
Moser: That was just normal.
Frankel: I think the Federal Funds rate actually peaked at about 21% at one point in the early 80s. I call a normal range for the Federal Funds rate around 4-5%. Right now we're at 2.25%. It's still very low from a historical standpoint.
Moser: I guess we'll eventually get there. In other news, I read this article last week, I thought this was pretty fascinating. It's in regard to Venmo. We know that Venmo is a property of PayPal, one of our favorite companies here. This article is talking about the fact that Venmo is now more popular than the ATM, the automatic teller machine, that changed the world back when I was a kid. I mean, that was the most unbelievable thing. All of a sudden, you could go to a machine and get your cash out of it? It was so convenient! No more checks, didn't have to worry about a thing. Now, here we are in this day and age where cash is essentially becoming an inconvenience. I found this to be fascinating from a number of angles, but the bottom line here is that Venmo is really taking over in a lot of ways where cash used to be king.
Frankel: Cash has become a lot more inconvenient when compared to the options. For example, I'm going to be at headquarters later this week. A friend of mine there and I will share an Uber from the airport. I'll probably pay for it, and he'll Venmo me his part. That's a lot more convenient than having our Uber drivers stop at an ATM, him getting cash out of the ATM, getting change somewhere and then giving me his half.
People are finding the convenience of this to be really, really useful. It's not just millennials. This is creeping into the older generations, as well, really seeing the value of this.
From an investor standpoint, one of the more interesting things I see in this story is that one of the big advantages that the big banks have are their vast ATM networks. This advantage may be going away. If Wells Fargo tells one of their customers, "We have you know 5,000 ATMs you can use for free around the country," someone who uses Venmo all the time would say, "So what?" So, this could be a big advantage going away for the big banks who have relied on their vast ATM networks. I actually think Wells Fargo has 10,000 or something.
Frankel: The point is, that was a big advantage. As you said, it was the coolest thing 20, 30 years ago, to be able to just get cash from an electronic machine outside of a bank. Now, not so much.
Moser: Yeah. I'm trying to figure out how to avoid getting cash. I rarely frequent an ATM anymore. I mean, I guess if I need to get a large amount of cash for whatever reason? But I'm finding more and more, if I need just a little bit of cash in my wallet, I'll take a little cash back when I'm at the grocery store or something. More and more, I find myself very rarely going to the ATM.
When it comes to Venmo, I think this is fascinating. One of the reasons why we like PayPal so much is because it's not just PayPal anymore. Everybody knows PayPal. But Venmo is also part of PayPal. I was reading through a recent investor call with PayPal. They were talking about Venmo monetization. Venmo is still a very young business in the context of what PayPal has to offer. It does skew younger, as you mentioned. They're working on that monetization model. They have three ways that they're doing that right now. One of them is instant cash withdraw. Another is using the Venmo debit card. The other is actually a Venmo customer shopping at a merchant. It seems like they're taking this somewhat slowly, somewhat methodically, in order to, first and foremost, provide the convenience that people are really after. If those three monetization strategies sound familiar, it's because they sound a lot like what Square (NYSE:SQ) is doing too.
Frankel: Yeah, with the Square Cash app. I was actually just going to bring that up. You have Venmo, Square Cash. The banks' answer to this has been Zelle, which has actually picked up a lot of traction on its own. But the whole trend, it's making ATMs obsolete. Like you said, it's not just Venmo. Square Cash recently surpassed Venmo in total downloads. Square Cash isn't quite as popular, in terms of check splitting. At least in my circles, it's not. But it does have the potential to amplify this non-dependence on ATMs even more. I think I've been to an ATM twice in the past year.
Moser: Yeah. Another thing I was reading up here earlier today, a company that just went public called Eventbrite has a relationship they forged with Square. That is something that's going to go on for the next five years as it takes hold in 2019. Eventbrite is basically ticket purchasing for live events. I can only imagine that we're going to see Square more and more get into that Venmo-like game, being able to break down finances, split finances and whatnot, particularly if they're in that market like live events, where friends might go together. Really interesting way to look at how finances are moving around.
Also with PayPal, a little while back, they acquired a small company called Xoom, which was one of my favorites here. We had it in Million Dollar Portfolio for a while before PayPal jumped in there and acquired it immediately. Xoom was in the business of outbound remittance, which is basically, anybody who works here in the United States but has family located in international locations -- Philippines, China, Mexico, wherever it may be. Xoom built this really terrific model for outbound remittance that PayPal snapped up quickly. That's really one of the attractive parts about PayPal, and I think Square, too. They have a number of different ways to win, and they're helping dictate this 21st century money moving around. I think it's amazing to see how things have changed in such a short period of time.
Frankel: Yeah, definitely. It's also worth pointing out that it's not just Venmo and Square Cash person-to-person payments that are killing ATMs. Square's payment processing hardware is also killing ATMs. It's used at all these places that you used to have to get cash for. When I used to go to a festival, I would have to stop and get whatever me and my wife needed for food and drinks while we were there. Now, everyone takes cards through their little Square readers. Between the two trends, ATMs might really be on the way out.
Moser: Yeah. It's fascinating. Even food trucks. We have all of these school events, and food trucks now don't even worry about cash. They take Square, and everybody pays with their phones and it just works out wonderfully.
Let's take a look here really quick at another article I was reading over the week. It's something from eMarketer. It was specifically talking about Snap (NYSE:SNAP), the parent of Snapchat. Anybody who knows me knows that I've been bearish on this company since they went public. There's just not a lot to like about it, really, in all honesty. I don't want to talk about Snap specifically. I want to talk about forecasts. Unfortunately for Snap, they're going to be the example here.
I'll go ahead and read here. "This year, we estimate that Snap will generate $662.1 million in net U.S. ad revenue, lower than the $1.03 billion eMarketer had projected last March. We now expect that Snap will not break the $1 billion in U.S. ad revenue until 2020."
Now, the reason why I wanted to bring this up is because there's a good investing angle here. I think there's a bigger lesson at play. I thought it'd be an opportunity for us to both share our opinions here, at least on how we look at these forecasts. I know from a personal perspective, when I'm looking at an investment, one of the bigger lessons I've learned in investing over the years is to take these forecasts with a really big grain of salt. It's very easy to look at these forecasts and make it fit your narrative and think, "Oh, man, the sky's the limit. There's so much they can do." But really, at the end of the day, these are just forecasts. Even companies that are focusing on those specific markets can get those forecasts dead wrong. eMarketer is stepping out in front here and saying, "Hey, we got this one wrong."
What do you look for, particularly when it comes to financial companies, when you see these types of forecasts? What are some of the thoughts that enter your mind when you first see them?
Frankel: Generally, I tend to put more stock in the near-term forecasts. It's mathematical fact that the further out you forecast something, the less accurate it's going to be. I tend to put a lot more stock in what's going to happen, say, next quarter than I do over the next three years.
In addition, I find that the newer and faster-growing a company is, the less reliable its forecasts are. With Amazon, for example, a lot of analysts got their sales forecasts completely wrong. Same with Square, one that we always cover.
When it comes to big, established companies -- if I see a forecast of what Bank of America is going to earn next year, OK, I probably will believe it's within a couple of percentage points. But a company like Square, a company like PayPal, take it with a big grain of salt. It's an analyst's best opinion, and analysts get things wrong all the time. Their educated guesses are probably a lot better than mine. That's why they're analysts. But no one has a crystal ball that can tell you what a company is going to earn, what competitive dynamics are going to creep up in the market, which I think has been Snap's big problem. The competition's really eaten into their market share. Especially a few years down the road. No one can tell you what the competitive landscape in an industry is going to look like two years from now. Dynamics like that can really make forecasts unreliable. Take them as part of the bigger picture. Use them in conjunction with a few other investing metrics that you rely on.
Moser: Yeah, I like that. They're not all created equal. I think you make a great point there in that the bigger, more established companies, it certainly depends on what market they're in, but those will be a little bit easier to forecast vs. some new start-up. Those businesses may very well look considerably different even in two to three years' time. We have countless examples of that.
When it comes to forecasts, I think, probably err on the side of being a little bit more conservative. I like to typically lop off about 30% of that estimate right off the top, just as a rule of thumb. But, again, to your point, that is workable, depending on the company and the size of the market.
Frankel: Yeah, it's definitely a valuable tool. Just use it in combination with other metrics that you like to rely on. Don't just look at the forecast and make your investing decision based on that.
Moser: OK, Matt, let's talk about recessions. It seems like we just came out of one. But that really was actually a long time ago now. It was just a really bad one, wasn't it? [laughs] We have a lot that we learned from that.
I was reading an article, and I had an interview with KABC Radio last week. We were talking about this article in The New York Post which posited that the next recession we hit is going to be worse than the Great Depression, and there's basically nothing we can do about it. Now, the reasons are myriad. Economists, as you and I know, love to prognosticate. But I found this to be a very interesting discussion. The first thing that came to my mind when we had this interview was, "Well, we're going to have another recession. It's not a matter of if, it's a matter of when." Does the size really matter? I don't know. What do you think?
Frankel: Continuing our discussion of forecast, remember that headlines like that, projections like that, are forecasts. Take them with a big grain of salt. No one can tell you how bad a recession is going to be. Two other things: no one can tell you when it's going to come. Could a recession happen later this year? Sure. Could a recession come two years from now, when the market's gone up another 20%? Of course. Don't stop investing in the meantime because you think a recession is going to come.
Second thing, no one can tell you what's going to cause it. If you had told somebody 15 years ago that mortgage derivatives were going to be responsible for the near collapse of the financial markets, no one would have believed you. There are a bunch of things that kind of look a little bubbly right now. A lot of the lending markets, auto lending in particular, the subprime auto market looks really dangerous right now. They're pretty much doing the same thing with subprime auto loans that they did with mortgage loans before the Great Recession.
Moser: Subprime auto loans? Good lord, man! That just sounds like the danger zone. [laughs]
Frankel: One out of every four auto loans made right now is made to somebody who's considered subprime or deep subprime. And they're packaging these and selling them as quality products, like they were doing with mortgages. There's other things, too. I don't have to tell anybody that student debt is becoming a real bubble. Cryptocurrencies, there's a lot of speculation that, if that market bursts, it could really kill the economy because the millennial generation is disproportionately invested in those. That could be a big mess. And, tech stocks that seem to go nowhere but up, some of them are starting to look a little bit frothy.
The point is, no one can tell you what's going to cause the next big market drop. Don't stop investing. Definitely don't sell your positions. But if you're worried that, yes, we've been in the longest bull market ever, it could be a good idea to play a little defense. Maybe keep a little bit more cash on the sidelines than you normally do. That's what I'm doing right now, and what I'm advising people who I advise to do. In my opinion, if you're worried about a recession, stay away from aggressive stocks. I tend to put more of my money in defensive names -- real estate investment trusts, dividend aristocrats, things like that -- if I'm worried that the stock market's a little overvalued. That's served me very well in the past.
Don't stop investing, but there are some good ways you can prepare for it.
Moser: I like all that thinking right there. I think you keyed in on a lot of good points there. Don't panic, obviously. That makes a big difference. We talked about last week a bright right spot for homeowners. Homeowners are a little bit richer this year than they were last year on average. We had mentioned that homeowners' equity had bumped up around 13%. Homeowners, on average, here in the country, are feeling about $16,000 richer.
But that led us into another discussion there. I think you and I both were an agreement there, that equity, don't spend that stuff on frivolous things. Don't tap your home equity and go travel. That's a great defensive position to hold if we ever run into a nasty recession. I mean, obviously, in a recession, housing valuations are going to go down. That'll be something you have to address, as well. But you certainly don't want to be caught in the position of that valuation going down, and then you have a lot of debt outstanding on a second, or, God forbid, even third mortgage.
Frankel: Let's say you own 40% of the equity in your home. If your house price goes down 30%, you still have positive equity. You're not underwater. Whereas if you only have, say, 10% equity on your house, and the market goes down 30%, you're really underwater. You can't afford to move if you want to move, not to mention being able to borrow from the home. It's a really big luxury to have a nice cushion, especially if you're concerned about going into a recession.
Moser: Always be prepared, folks. It's a matter of when, not if.
This week on Twitter, we have a couple of folks I wanted to spotlight here. First, we have @FadeOutAndroid, who asks, "After listening to your comments on Industry Focus this past week, what do you think about Masterpass from MasterCard and Visa Checkout from Visa as competitors to PayPal? I keep on getting promotions and seeing their logo next to PayPal on online sites that I shop on." I thought this was a good question. Thanks, FadeOutAndroid!
I did a little digging into both Masterpass and Visa Checkout. They're obviously very huge, very big networks in Visa and MasterCard. I wouldn't dismiss those companies as competitors on any level. I think where MasterCard and Visa have fallen short is, they haven't been able to make the investments in the mobile interface on the tech side like PayPal has been able to do. Furthermore, we were talking about Venmo earlier on in the show, there is an up and coming consumer that is very familiar with that Venmo interface, with that PayPal interface, with that Square interface. They are not familiar with that Masterpass and Visa Checkout interface. The numbers bear that out. You have a number of users there, but they just aren't gaining the same traction. While I wouldn't put anything past them on the competitive level, it doesn't seem like they are holding as much traction as these younger players. What about you, Matt?
Frankel: No. And to put the scale in perspective is really important in response to this question. To give you some perspective, PayPal has about 180 million active users. That's 10 times more than the nearest competitor. And the nearest competitor is not Masterpass or Visa Checkout. It's Apple Pay.
PayPal is much, much bigger than either of those two. PayPal estimated that about 70% of the market, in terms of those checkout features. So, while it's a competitor, like you said, yes, it's growing faster than PayPal, yes, just because of its size. PayPal can't grow at a 90% annual rate right now. But I don't think it's a competitive threat. PayPal was the first mover in the space. Like you said, people are familiar with it. I have several Visa cards in my wallet right now, I can't tell you what the Visa Checkout interface looks like. But I can tell you what the PayPal interface looks like and how to navigate it. They had the big first mover advantage, which in fintech, is everything. PayPal's lead is just too great!
Moser: Several Visa cards in your wallet! Matt, when you get here to Fool HQ later this week, I expect dinner to be on you.
Moser: [laughs] Second tweet here, we have @PGNaoum. I hope I'm saying that right. PGNaoum asks, "I don't know if you've ever talked about this on the show, but why isn't American Express in the MVP's basket or the War on Cash basket? My best guess is that it just doesn't work with the acronym."
Good question! Matt, you and I talked about this on Slack a couple of weeks ago. Honestly, it had nothing to do with the acronym. The war on cash and the MVP thing were all after the fact. Really, it just boiled down to having to make a cut somewhere. I was coming up with an idea for this basket, I decided it was going to be four holdings, and I really wanted to have two staid names in there, a couple of more growth-y names, one being a little bit higher on the risk scale than the other. So, it just worked out. MasterCard and Visa are the cards that are most widespread out there. Very attractive, high-margin businesses. American Express has done a whole heck of a lot with its business, especially ever since the financial crisis. We saw them turn into a bank holding company. They have that closed loop system, which really gives them the opportunity to learn more about customers. And, as merchants are demanding lower transaction fees, I think American Express has dealt with that pretty well.
It wasn't really anything against American Express. It was just, I had to make the cut somewhere, and American Express just didn't make it. But Matt, I know you want like American Express,
Frankel: I do. I'm a shareholder. But at the same time, I would agree that MasterCard and Visa have done a better job in the technology side of the business. They've definitely been the more fintech-y of the three. So, I can see why you would include them and leave AmEx in the boring stocks pile, or wherever you put it. [laughs]
Moser: [laughs] Maybe there'll be room to add them one day. I don't know. We'll see. I'm pretty protective of that MVP brand, though.
As always, we have One to Watch as we wrap up this week. A stock we have on our radar, for whatever reason. Could be good. Could be bad. Matt, tell me, what's your one to watch this week?
Frankel: I've mentioned it a couple of times so far on this show, Bank of America. The reason I like it, I mentioned that long-term interest rates really haven't caught up with short-term ones yet. If they do, Bank of America stands to benefit more than any of the other big banks. The reason is, they have a higher proportion of what are known as interest-free deposits, meaning in a savings account that doesn't bear interest. They have no cost of the money on those accounts and can loan it out at market rates. So, as market rates rise, you'll see the spreads widen faster for Bank of America, than any of the other big banks. I think that that's coming in the next few years. I think there's a lot of catching up to do for long-term rates. Pay attention to the 10-year Treasury, like I said. But I think when that catches up, Bank of America will be the big beneficiary out of the big banks.
Moser: And what's the ticker for Bank of America?
Moser: I'm going to dig back to a company we talked a bit about last week. We had the headline that broke this past weekend, Facebook (NASDAQ:FB), ticker FB. I know, this isn't a financial company, so to speak. But it really ties back to the subject that we covered on Facebook and banks. Facebook has historically, it seems, been trying to work more closely with banks, get a little bit more of banks' data. This data breach that we found out about on Friday, it was another 50 million or so accounts... to me, when it comes to Facebook, this is just something that you have to expect. Whether it's Facebook, or Instagram, or Messenger, or whatever, I think data breaches are just part and parcel of this market.
Looking a little bit further, and thinking about Facebook and their relationship with banks, on the one hand, banks have every incentive in the world to keep your data secure. That's really what they're in the business of doing, or at least trying to do. They have the incentive to try to keep your data secure. If you look at Facebook's business model, their incentive is completely the other way around. Really, their incentive is to get your data out there and try to sell as many ads as possible using that data.
So, to me, I just feel like, when you talk about Facebook and banks, you talk about two industries where the incentives are just never going to be aligned. That's why I would never, ever look at Facebook as a potential play in the financials space. Not to see it can't be a successful investment in other ways. But when it comes to Facebook and banks, I think that conversation needs to remain closed. That's just my two cents.
Matt, I think that's going to do it for this week. I appreciate you coming on, as always!
Frankel: Of course. I look forward to being up there later this week.
Moser: Yeah, man! Absolutely! Beer's on me!
Moser: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. The show is produced by Austin Morgan. For Matt Frankel, I'm Jason Moser. Thanks for listening! We'll see you next week!