In this week's episode of Industry Focus: Financials, host Dylan Lewis and Fool.com contributor Matt Frankel, CFP, discuss two recent news stories. As expected, the Federal Reserve held interest rates steady but opened the door for a rate cut in July. On the more unexpected end of the spectrum, PayPal (NASDAQ:PYPL) announced the unexpected departure of a key executive. Here's what investors need to know about both of them.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on June 24, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, June 24th, and we're checking in on some major news in the Financials sector. I'm your host, Dylan Lewis, and I've got fool.com's Matt Frankel with me in the studio. Matt, so many differences here in this episode already! You're in the studio. I'm hosting the show. We're throwing a lot of listeners.
Matt Frankel: Yeah, we are! This is not the Technology show, just in case you're wondering. You're not tuned into the wrong podcast. This is indeed the Financials show. My first time in studio with Dylan.
Lewis: What a treat!
Frankel: It is! I've worked with Dylan for, what, four or five years now?
Lewis: I'm actually coming up on my five-year Fooliversary later this month.
Frankel: I remember. Your hair's changed a bit in those five years.
Lewis: I like to keep everybody guessing, especially the people watching these videos.
Frankel: Is he going to have hair? Is he not? Will it be long, short? You never know!
Lewis: It's the inner con man in me, trying to run away from the law. [laughs] Trying to keep myself from being recognized. Yeah, we're doing J-Mo solid here today. I'm hopping into the studio because he's doing a little traveling. He's taking some time off. We're going to give him a chance to take a break and take over the Financials show.
Frankel: I think he's actually doing the show tomorrow. It'll be a whole toss-up this week.
Lewis: Listeners aren't going to have to wait long to get him back.
Frankel: He'll be here!
Lewis: Matt, the summer is typically a sleepy time on Wall Street. You don't tend to see crazy news coming out. A lot of people are taking vacations, like our friend Jason Moser. One group that is not taking a break is the Federal Open Market Committee from the Federal Reserve. They stick to the job.
Frankel: Right. They have eight meetings per year. Four of those meetings are the especially big ones, June was one of them, where they release, in addition to an interest rate decision and their general statement, all their economic predictions, which is the big deal at the June meeting. March, June, September, and December, I believe, are the big ones. This was one of the bigger ones where they released their economic projections. This was the first one in a while where there was a big question of whether they were going to keep rates steady, cut rates. In recent meetings, it's pretty much been a foregone conclusion. The market was pricing in a 98% chance that they would hold rates steady in the last meeting. Similar for the one before that. This time, it was pretty certain that they were going to keep rates steady, but they were pricing in about a 25% chance that there was going to be a rate cut. This is the first time where there was uncertainty going into the rate decision.
Lewis: Let's get into a little bit of why people are specifically watching these moves and the way that rates moving as a result of the Federal Open Market Committee's decisions may affect either the markets or just the average investor.
Frankel: Sure, well, when the Fed raises rates, you can generally count on stocks going up, at least in the short term. Rate hikes are generally designed to curb inflation, things like that. You'll see the cost of corporate credit go up. It's generally a negative catalyst for the stock market. The Fed's trying to pump the brakes on growth. Bad for business. When the Fed lowers rates, it generally is a bullish sign for the stock market. It means it's going to be cheaper for companies to borrow money. The Fed's trying to encourage economic growth. Right now, there's almost no inflation, so the Fed's trying to keep their economic prosperous times going, if you will.
People were waiting to see that. With an important meeting like this, I mentioned four meetings a year, the important ones where they release economic projections, people want to see what might be coming next. Obviously, nobody has a crystal ball, including the 17 voting members of the Fed right now. But these are the policy makers, so people want to see where they see things like unemployment, GDP growth, going in the future so we know if a recession could be in the cards, if more rate cuts could be in the cards, or rate hikes, especially right now, because we have a lot of conflicting economic data. Unemployment's at, what, a roughly 50-year low, but there's no inflation, which are kind of contradicting signs. So, a lot of people want to see what the Fed's planning to do going forward with these economic projections, and the dot plot, which I'm sure we'll talk about in a little bit.
Lewis: I will not let you get off without talking about the dot plot. We will be talking about the dot plot. What came out of the Federal Open Market Committee meeting?
Frankel: No rate cut. No big surprise there. Rates are held steady. Rates have not been cut in over a decade. The last time they cut rates was to zero in the wake of the financial crisis. But there were a couple of significant developments. There's four main things that happened in the Fed meeting. There was no rate cut. The rate decision is the first one. The Fed's statement -- I can't think of a document anywhere in the world that is as closely dissected as the Fed statement. Every word is carefully chosen and very important because they know the market is going to be hanging on their every word. The key word in this one was "patient." In recent Fed statements, they've been saying how patient they were going to be when it comes to interest rate policy, which the market generally interprets as, they're going to keep rates the same. This one, it was expected that they were going to remove the word "patient," and they did. Now they're saying the economy's softened, things have deteriorated over the past few months. This clears the way for a rate cut at their next meeting, which happens at the end of July. That's No. 2.
No. 3, you have the dot plot. Want to get into the dot plot?
Lewis: Let's talk dot plot!
Frankel: Let's talk dot plot! The dot plot shows where the 17 voting members of the Fed see interest rates going at the end of 2019, 2020, 2021, and over the long run. Recently, the dot plot showed that there were not going to be any rate cuts this year. The median projection is still for no rate cuts. However, now 7 of those 17 people see two rate cuts coming this year, which is the big development. That's why we saw the market rally after the Fed meeting. The dot plot was the big surprise. So now, 7 out of the 17 see two rate cuts coming, one sees one rate cut coming, and eight of them see no rate cuts, one sees a rate hike, which is why you get the median of the same, but now it's generally a more dovish outlook.
Lewis: If we tried to sum all of this up into a nice, tidy, jargon-free sentence, let's try to do that --
Frankel: I know I'm rambling.
Lewis: [laughs] It's hard not to invoke all of these really industry-specific terms when we're talking about this stuff because it is an academic, very heady topic. But it seems to me, as someone who does not cover financials all that often -- this is me reading the tea leaves here -- there may be rate cuts down the road. The stock market generally benefits from lower rates. Borrowing's easier, money's easier, so the market has responded very favorably to that possibility.
Frankel: Yes. In a one-sentence summary, the Fed gave the market exactly what it wanted. Now we can expect a rate cut in July. Now the market's actually pricing in several rate cuts this year. This definitely gave the market a reason to be happy.
The fear is that if rates are held steady or held high for too long, it could trigger a recession or trigger poor economic conditions. This gives the market some relief that the Fed is going to try to do their part in keeping the economic good times going.
Lewis: I think with a lot of economic indicators, interest rates are one, the cost of a gallon of gas is another one, where, when it's high, there are good things; when it's low, there are good things. You can't look at any of these in an absolute sense. Money being cheap is helpful. But you also generally want to see the market chugging along, and the economy chugging along, in a way that forces this committee to decide to raise rates as well. It's this constant weighing machine.
Frankel: Right. Ideally, the economy would be doing so well that the Fed needed to raise rates another two times this year, another three or four times over the coming few years. Unfortunately, that doesn't seem to be the case. But the economy will go up and down. It's tough to predict. You want to see the Fed being proactive, which is exactly what we got this time. I think that's why everyone's so happy.
Lewis: We got news that we were generally expecting from the Federal Open Market Committee. The market responded pretty favorably.
All right, Matt, on the back half of the show, we're going to be talking about PayPal, because we got news last week that COO Bill Ready will be leaving the company at the end of 2019. This was not news that investors were expecting.
Frankel: No. It's never expected when a key executive like that, especially one in charge of something as high-growth as Venmo, leaves. You've heard the expression, people like to abandon a sinking ship. This guy's abandoning a ship that's chugging ahead at full speed. That's why this catches investors off guard a little bit.
Lewis: I think that this move makes a little bit more sense when you understand how Ready got to PayPal, and maybe how he generally thinks about his career and his path in the corporate world. He was acqui-hired back in 2013 when PayPal bought his company, Braintree. He has largely been in charge of Venmo during that time. To me, he seems like he's someone who's a little bit of a serial entrepreneur, someone who likes to take on high-growth opportunities. The reason that the company gave for him leaving was that he was going to be doing just that. He is pursuing other entrepreneurial efforts. Certainly better than something bad coming out about him, and the company having to deal with that. But it is tough to lose someone who is so key to the efforts of maybe the highest growth opportunity for them.
Frankel: Sure. I mean, PayPal is a tremendous machine right now. $16 billion in revenue over the past 12 months. $100 billion in payment volume, they're on track to do this year. Venmo is not a big, profitable machine yet. It's the highest growth machine. It accounts for a lot of that $100 billion in payment volume. But they haven't really been able to monetize it yet. As we were talking about a little bit before the show, when you're going from something that's currently free to trying to monetize it, it's very touchy. There are a lot of products right now that are growing rapidly that people use because they're free.
Lewis: Yeah, I think it's very easy to throw a party and tell people to come over, they don't have to pay for beer or snacks or anything like that, we'll cover the cost of that! You just have a good time! It's a little tougher to get people to come to a bar where drinks are $10.
Frankel: Sure. That's the tricky part. It can be done. This is a trendier area than I live in, I'm sure you know of a lot of bars with very expensive drinks that you can't even walk in. So it can be done. It's just a matter of figuring out the way to add value to consumers that make sense paying for. It can be a very touchy process with a lot of growing pains. So, when you lose a leader like this, who's owned this thing since day one, essentially, running Venmo, it throws a lot of uncertainty into the equation. Markets hate uncertainty, is the key thing to know when you see an executive leave and the stock takes a dive.
This happened not that long ago with Square. CFO Sarah Friar decided to leave. She accepted a CEO role. Great for her. But she was really the rock star of the company. She had been the public face of Square, emphasizing what they were going to do in the future, owning their future vision of becoming a one-stop financial institution for Americans. So when she left, the stock took a dive. It was about $100 when she announced her resignation. Now it's at about $70. It adds a lot of uncertainty. Is PayPal's business inherently worth less than it was before this announcement? No, absolutely not! But it brings up a lot of unanswered questions.
Lewis: Yeah. You look at his resume in his time at PayPal/Venmo, however you want to categorize it, pretty darn impressive. They've gotten this peer-to-peer payments platform to the point where they have 40 million users that are fairly active on there. And he has done quite a bit to position them well in the space. One of the big things that he really prioritized was getting some collaborative efforts out there with the credit card companies, and having something that was...we're not totally competition, we're not totally friends, we're in this frenemies space. I think there are a lot of people that maybe wouldn't have done that.
Frankel: Right, and integrating with a lot of these other free payment platforms. Just in the past few days, they announced Google Pay would start integrating PayPal. Someone else might have thought of that as a competitor and something to stay away from. But now Venmo's everywhere. I was one of the late adopters. I'm a little older.
Lewis: [laughs] I was a little earlier than you, but still a little bit on the tail end here.
Frankel: He's a millennial!
Lewis: So it's really my fault. Wait, you're not a millennial?
Frankel: I'm an older millennial. I'm a millennial by like three months.
Lewis: You and Brian Feroldi are both trying to separate yourself from the millennial tag. I think you're firmly millennials!
Frankel: We didn't grow up with technology, is the difference between older millennials.
Lewis: This is true.
Frankel: I didn't have my first cell phone until I was 19. That was common. I had a beeper in high school. You probably remember that from when you were 5.
Lewis: I've only ever seen them in ER and Scrubs. That actually queues up something interesting here with Ready. He was one of the younger members of the executive team as well. I think a lot of people were looking at the success that he's had and thought, "This might be the guy that runs this company down the road."
Frankel: Right. People don't want to see, especially with a product like Venmo, an old-school financial executive running this. That's why Jack Dorsey is such a highly regarded CEO. He's a younger guy. He's actually my age.
Lewis: There you go! You could be running Square!
Frankel: [laughs] I could! But people don't want to see an old-timey financial guy running something like this. They want the young, motivated guy who's growth oriented, willing to grow at all costs, doesn't have traditional views of competition, like you were just mentioning. So the question is, what do they do now?
Lewis: Yeah. Matt, when you see all of this, and, and we saw how Square tried to navigate this with Sarah Friar, who was very similar to Bill Ready, do you look at this and say, "OK, they have to go out there and get somebody else"? Do you think that this is a situation where they hire internally? What do you think of that?
Frankel: In order to calm the market's fears, they need to hire someone who's either integral to Venmo right now, maybe his second in command or something; or someone who's been an absolute rock star in the financial industry. Hire Sarah Friar for the role, something to that effect.
Lewis: [laughs] "You know how you left this role that you're doing a great job in to take an executive role? Want to be a COO again?"
Frankel: You're right. But, someone who's had that kind of financial stardom in the space, if you will. They need to make a statement with whoever they have replace Ready.
Lewis: Yeah. That's a tough challenge.
Frankel: Big shoes to fill.
Lewis: Big shoes to fill. To your point, this is not something that dramatically changes the PayPal that we know right now. I think they are set for $300 million in annual revenue. I think that's the run rate they're on for 2019. In the grand scheme of the $16 billion that they've pulled in over the last 12 months, not that consequential. But over the next five years, this is what you expect to be a very large component of the revenue mix for PayPal. Anything that throws that off its trajectory is going to have people scared.
Frankel: Absolutely! I'm optimistic because it's not just one person who's behind Venmo. I don't know how many employees they have that are working exclusively on Venmo right now, but I'd have to imagine it's in the hundreds, at least.
Lewis: I would think so. I hope so, as someone who loves the service, uses the service, and is a shareholder.
Frankel: The point is, the success doesn't just rise and fall with whoever's the captain of the ship. It takes a whole crew to do it. I love buying companies on dips like this. I was very tempted to add to Square when they let Sarah Friar go, but I couldn't stop talking about it, so I wasn't allowed to buy anymore. We've run into similar issues constantly.
Lewis: Yes. That's the issue that you run into with having strict trading guidelines.
Frankel: Right. I don't have any PayPal in my portfolio right now. I used to, I inherited it in the eBay spin-off. But after a move like this, if we still see depressed prices, I'd be very tempted. These are good situations for long-term investors. Will they get over this uncertainty? Will they figure out how to move forward and carry out their vision? I believe they will. I love investing in situations like this where the only X factor is the departure of a key executive.
Lewis: Yeah. And you have to think, he's been at the company now for something like five and a half years, he's not leaving for another six months, so he has the opportunity to lay out the blueprint for where things should go and make sure that the people that they bring in to help him execute on that do that. It's not like, "OK, here's the bag, I'm running off." There is time to set up all this stuff and for them to create a pretty solid roadmap. Hopefully they can execute on that.
Frankel: Right. That's roughly 10% of his entire tenure of the company that's still ahead of him, when you look at the numbers. So yeah, he still has a lot of time to get them in a good place to move forward.
Lewis: All right. I think we're going to wrap it up there. Matt, thanks for hopping on today's show! So great to have you in the studio with me for the first time!
Frankel: Of course! We'll have to do this again! Maybe I'll hop on your show next time!
Lewis: You want to talk fintech?
Frankel: We could!
Lewis: There's tech in the name, we can make it happen.
All right, listeners, that does it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, you can shoot us an email over at firstname.lastname@example.org, or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes or Spotify. Or you can check the videos from this podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Dan Boyd for all his work behind the glass today! For Matt Frankel, I'm Dylan Lewis. Thanks for listening, and Fool on!