In this podcast, we zoom in on comments from central bank leaders at the recent ECB Forum on Central Banking to see what insights we can glean. Motley Fool analysts Dylan Lewis and John Rotonti discuss:
- What Fed Chairman Jerome Powell had to say.
- Why experts have so consistently been wrong about inflation.
- The types of companies you want to own in an inflationary environment.
- Why Shopify's (SHOP 2.58%) stock split is less important than its share-structure changes.
Motley Fool producer Ricky Mulvey and Motley Fool analyst Ron Gross discuss the ins and outs of investing in a bear market and what types of companies you should be keeping an eye on.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on June 30, 2022.
Dylan Lewis: We've got comments from Central bank leaders and a stock split from a Fool favorite. Motley Fool Money starts now. Dylan Lewis sitting in for Chris Hill, joined by Motley Fool premium Analyst John Rotonti. John, inflation is one of the inescapable stories of 2022 for investors and consumers alike. Yesterday, we got a little bit of an update on how some of the Central Bank leaders around the world, especially the US own J. Powell, are thinking about the current environment right now.
John Rotonti: Hey, Dylan. Thanks for having me on the show. Chairman Powell's comments yesterday were definitely interesting. What concerns me, I think is that we're at this generational inflexion point and very few investors have truly invested in an inflationary environment. Dylan, you and I were barely born the last time we had real inflation in the US. The Motley Fool had not been founded yet. Interest rates have been falling for 40 years, which was a massive tailwind for stocks by the way. Inflation has been benign for 30 years. Money has been pretty much free since coming out of the GFC, the global financial crisis in 2009. Now all of that is changing. Even Fed chair Jerome Powell admitted that the Fed really doesn't understand inflation or what it will truly take to fight it. Because we are in a fight, 8.5, 8.6 percent inflation is real and households are anxious and they're angry when the price at the gas pump is going up. Prices at the grocery store is going up. That really affects people's way of life and so we're in a fight.
Dylan Lewis: John, I want to zoom in on that comment that Powell made. It made the rounds on Twitter yesterday. I think we now understand how little we understand about inflation. That got dumped on a lot on social media yesterday because you would think of all the people to have a good finger on the pulse for what's going on. It would hopefully be our Fed chair. The reason for it, though, it gets back to a lot of things you were just talking about before. Where so much of what we've seen over the last couple of decades is so different than what we're staring out at going forward. Especially because the force is driving a lot of those things are things that not necessarily have been a part of the macro picture over the last couple of decades.
John Rotonti: I think you're right, Dylan. There's recency bias here and by recency, I don't mean the last few years or the last few months. Thirty years, we've had benign inflation and then more recently, we couldn't even hit our two percent inflation target. We were constantly under that. No matter what Chairman Powell and the Fed did, they could not get up to two percent. This is a new problem we really are at this generational inflection point. The other thing that concerns me, and it's related is that Chairman Powell and the Federal Reserve understand even less about how to wind down a nine trillion dollar balance sheet, because that has never been done before. At least we can look back at history and learn about inflation and how rising interest rates impact the economy. There's some history lesson there, but there is no history lesson. There is no precedent for scaling down a nine trillion dollar balance sheet. What concerns me, it's not a large concern, it's just what concerns me or what I'm starting to factor into my analysis more and more is the uncertainty and inexperience that virtually all of us have with us, even Chairman Powell. I do think that the stocks that worked in a period of inflation below two percent and when we had free money, like I said, really dating back to 2009, are not necessarily the stocks that will work in a high inflationary environment. That's where we stand today.
Dylan Lewis: I think that's an interesting point, John. There are a lot of feelings of what got us here may not necessarily be what gets us to move forward with this. Even zooming in on the comments that Powell made. One of the things that he had talked about in his ECB form comments was that when you look at how we've been approaching inflation, how we've been measuring inflation, how we've been anticipating inflation. The models that we've been using didn't have us above four percent. From the prognosticators that tend to look at these things. A year out, you said 34 out of 35 professional forecasters a year-ago had inflation below four percent. The reason for that was the model they use without getting too far into it. It's called the Phillips curve. It assumes that inflation and unemployment are inversely related. What we've seen, especially over the last 12 months, 18 months or so, is that isn't necessarily the case. We've seen unemployment is trending downward. We've seen the job market be relatively strong. Yet we've continued to see a lot of inflation and a big part of that is because of supply side issues that are much harder to anticipate.
John Rotonti: I think that's part of it, Dylan. I think it's also that these curves completely breakdown when you've had a decade plus of free money. I think that's the Number 1 thing that everyone is under-estimating. Is what happens when money is free. Going back to 2009 and then on top of that, we were in a very scary time. We were in the pandemic. Unprecedented amounts of liquidity we're pumped into the market. Then free money was given out as handouts, these transfer payments to households. After 12 or 13 years of free money, we layered on more free money, which we needed to do. We needed to do it. But now after 13 years of that type of liquidity, these curves start to break down. It's not just the Phillips curve and inflation and unemployment.
Its stocks and bonds typically didn't move in the same direction, and now they're moving in the same direction. There's a lot of strange weird things happening because of a decade plus of unprecedented fiscal stimulus, monetary stimulus, any type of stimulus that you can think of. All these curves start to break down. Although I have never invested during an inflationary environment, I do try to consider myself a student in history. I didn't notice this generational inflection point very early on, even last year. I arranged for 12 outside experts to come in and speak to the Motley Fool investing team all in the first quarter of this year Dylan, on the first quarter. I feel like our team is ready and we got a jump start on our educational sessions for the current environment that we're in.
I front-loaded. I purposefully front-loaded these educational sessions all into the first quarter because of macro is going to demand so much more of our attention. In a world of higher inflation Fed tightening cycle, higher interest rates, liquidity being siphoned from the economy, high oil prices of potential de-emphasis on globalization and the Fed attempting to slowdown in the economy without causing a recession. What I'm very positive about Dylan, I'd like to end this session, this little part on a positive note is the strength of the US consumer, the strength of household balance sheets. Like you said, unemployment is still very low, we're at maximum employment in this country and I'm also very positive on The Motley Fool's ability to pick the best stocks for this environment in our ability to guide our members through whatever the markets and whatever macro throw our way.
Dylan Lewis: I appreciate you bringing some of the positive stuff in there, John because I think it can be hard to stare at the headlines that are just pumping the inflation news and talking about the impact that's being felt and it's real. But there are a lot of positive signs on what we're seeing in the broader macro picture. Knowing all this, seeing all this, and looking at some of the comments from yesterday, it's pretty clear they are going to be focused on getting inflation back down to two percent. It was reiterated as a main target for the Fed and Powell said the risk would be in failing to restore price stability, not so much in going too far with rate hikes, if they're going to overshoot on one, the focus should be on restoring price stability. In this environment where we have all these forces, what are you looking at for companies? What are you looking for in companies? What do you want to be owning?
Dylan Lewis: I love that question, I'll answer that in a second. I'll just say really quickly, Fed chair Powell is saying time and time again, we're going to fight inflation and we're going to get back down our two percent target, no matter what it takes. The market doesn't necessarily believe in doing, the market is playing chicken with Fed pallet at points and that's when you see these massive updates, these massive up weeks, and then they're followed by these massive down weeks. I think the reason is that despite chair Powell saying time and time again, we are going to do whatever it takes. I think the market is worried that every one percent increase in interest rates increases the debt service on US debt by $300 billion. I think the market is predicting that Fed chair is going to have to backtrack on interest rate hikes at some point in time. Now, I don't have an opinion on that, that's above my pay grade, but it's interesting this dynamic of chair Powell constantly saying we will do whatever it takes and the market constantly not really believing him so that dynamic is going to be interesting to watch play out.
What do you want to own? I think first and foremost, Dylan, we need to remember that stocks are the best long-term hedge against inflation. If you look at the Deutsche Bank long-term asset returns study or work by Professor Jeremy Siegel or Morgan Housel, or so many other people, stocks have provided higher real returns than US government bonds, high-rate corporate bonds, junk bonds, real estate, and gold, going back very long periods of time. Such first thing, stocks are the best hedge against inflation, secondly, you want to invest across the growth spectrum and diversify, diversify, diversify, diversify by industry, sector, market cap and geography. Then getting more specific, you want to own companies with high returns on invested capital because these businesses tend to be not capital-intensive, meaning they don't need to spend a lot of capital to maintain and grow their assets at a time when input costs for those assets are rising.
Inflationary investing 101 is really to own businesses that generate high ROIC and that don't need to invest a lot of new capital to grow because of the cost of that capital is rising. Then you also want to make sure you have companies that have a long runway of free cash flow growth and you want free cash flow that you expect to grow faster than the rate of inflation. Then the same with dividends, look for companies that have a long history of consistently increasing the dividend every single year and that you expect will continue to increase the dividend at an annualized rate higher than inflation. Then finally, real estate has historically been a great place to be during inflation because one, a lot of real estates has long-term contracts with annual pricing power written into the contracts and two, the replacement cost of real estate goes up. The input costs go up, so becomes more expensive to build new real estate, so this increases the value of current real estate because it means less new capacity comes onto the market.
Dylan Lewis: John, I have to ask the question because I'm sure listeners are thinking it. Are there any specific names that you throw out there as something that is worth checking out? Maybe a business that wouldn't necessarily be beyond someone's radar following some of the more growth-oriented strategies that The Fool has tended to follow over the last 10 years or so.
John Rotonti: I love to The Fool's growth oriented strategy, I support a one-for-one balancing, so for every earlier stage growth company that The Fool loves, you balance it out with The Home Depot, so that's one example right there. Then for every earlier-stage group growth company that The Fool loves you, balance it out with a Visa, you balance it out with a Berkshire Hathaway. Those types of really high return, high free cash flow, moderate growth but the highly resilient type of businesses, Dylan.
Dylan Lewis: Speaking of high-growth names in The Fool universe, Shopify shareholders saw a bit of shuffling in their portfolios. Yesterday, the company completed a 10-to-1 stock split, bringing the price per share down to 30-ish dollars down from the 300s pre-split. John, we know in the academic sense, we're staring at the same thing here pre and post-split. Stock splits have gotten a lot of attention over the last couple of years apart because we've seen some high-growth names really dramatically appreciate in value and they've looked to make shares more accessible to the average investor, what do you see in the trend with stock splits in Shopify, deciding to make this move? I know you're a Shopify shareholder, how do you think about all this?
John Rotonti: Yeah. Just to reiterate what you just said, the value of what you own fools has not changed by one penny, the value of what we own has not changed by one penny. Dylan, I think this one is a joke, I think this is a bad move on Shopify's part. I'm not selling my shares, it's not overly concerning to me, but this is poor judgment. I understand that this decision was made a couple of months ago or whatever it was, but I had to speak out on this one, Dylan, I tweeted yesterday was a drop from 1,700 down to 300 and not enough for Tobi and company, like honestly, I would've reversed course if I was Tobi. I know they announced this split, but when they saw that their stock was continuing to fall, virtually every day. Dylan, 82 percent off a tie from 1,700 down to 300 at one point, is that not enough to attract retail investors? I think this is really poor judgment, I think this is followed by the leader because Amazon did it and [Alphabet's] Google did it and I don't know who else did it.
It's all poor judgment in my opinion, I think this is pandering to option traders. This is encouraging margin, it's encouraging options, and it's encouraging stonk traders. Honestly, I think this is poor judgment, I don't think it changes the thesis, but it's a game of follow the leader. I think Tobi should be focusing on Amazon fulfilment, I think Tobi should be focusing on improving its product suite, honestly, there's I've been reading a lot of reviews recently that Shopify doesn't have everything that entrepreneurs need to succeed as a lot, but not everything, they've struggled with fulfilment. Then finally, as we all know, this is a power grab by Tobi, but Tobi is not the only one doing it, a lot of founders are doing this type of thing.
Dylan Lewis: To unpack that a little bit, you mentioned that they announced this a couple of months ago. As a part of that announcement, they also made some updates to their corporate governance and some of their share structures. I think, if anything, the stock split for me, it's an example of paying attention to this, not that. Don't pay attention as much to the number of shares or the price of the share and what we're seeing pretty post-split. But pay attention to the fact that when they made this decision and when shareholders were voting on things, they also approved nontransferable founder shares, which increased Tobi Lütke's power to 40 percent prior to this, I think his voting power was around 33 or 34 percent of the company. John, the story with this business, basically the entire time that it's been a public company has been, if you are buying shares of Shopify, you're investing in and right alongside Tobi Lütke. So far that's generally been a pretty good proposition for people. I as a shareholder, I'm happy to see that his incentives in his stake are there and we'll represented, I think he is a pretty good vision for where the company should be heading in his road map has been pretty strong so far. I'm curious how you feel about it.
John Rotonti: I'm invested alongside Tobi, I intend to be a long-term share-owner of Shopify. I feel like 33 percent ownership and control is probably enough, Dylan. I come at this from an ESG angle to my dear friend and colleague, Alyce Lomax, I know she's like probably fuming over this because this is something that we tend to see as not a red flag, but maybe like almost red flag. When looking at corporate structures and corporate governance, it's like when does it stop? Does it ever feel like he's going to need 45 percent voting control? I don't know, 33 percent seems like a lot to me. If I had my druthers in an ideal world, I'd want my vote to matter and I feel like my vote does it matter at Shopify, but overall, Tobi has proven himself to be a visionary, he's proven himself to be someone that can build great teams, great product. If we take them out as where they just trying to build a 100-year business, then maybe controllers is the right move here. It's just not super comfortable with me, but I do intend to be a long-term shareholder.
Dylan Lewis: Yeah. I think wanting to vote and being a tech investor or growth in the fixture can sometimes be a little bit mutually exclusive.
John Rotonti: Actually, the good point though. [laughs]
Dylan Lewis: Just a reality of the space. I mean, what's interesting about it is even at 40 percent is not a controlling voting stake, there's still needs to be agreement, some consensus so far, anything dramatic to the past, but I see your points there, John, they are good ones. I mean, you make a point though when you are investing in founder-led tech you're giving up some voting power.
If you've been investing for a few weeks, for even 10 years you haven't been through an extended bear market before, fear not. Producer Ricky Mulvey and TMF Analyst Ron Gross are here with a bear market boot camp.
Ricky Mulvey: Welcome to bear market boot camp. If you've been investing since 2020 or even 2012 you have not seen a long bear market, so we don't know when the bottom will come. But if you're a stock investor you might want to pack your bags for a longer ride than the last one. Joining me now is Ron Gross, thanks for being here.
Ron Gross: Hey Ricky, always a pleasure.
Ricky Mulvey: Ron, this is not your first bear market. For investors heading into their first bear market boot camp, what are they packing? What should they bring?
Ron Gross: I think it's pretty much the same two things you should bring to investing in general. That is time and temperament. They are the most important tools an investor can have. The proper temperament will make sure you don't make unnecessary mistakes, and the proper time horizon will make sure you can compound your wealth over long periods of time. It will ensure that you can ride out whatever lens the bear market happens to be. Time and temperament.
Ricky Mulvey: Whatever length is the key phrase there. [laughs] The last bear market lasted exactly 33 days. I think that's the shortest one on record. Why are some investors expecting this one to last much longer?
Ron Gross: I did a little research for you, Ricky and I came up with that since 1966 the average bear market has lasted about 15 months, much shorter than the average bull market by the way. They do often end pretty quickly with a rebound that is very difficult to predict, as you mentioned 2020, 33 days. That's why long-term investors are usually better off just staying the course and not pulling money out of the market and trying to time it because you don't know when that quick rebound is going to occur. The COVID-induced bear market was caused obviously by a very specific reason, the pandemic, it was short-lived. But if vaccines didn't make it to the market as quickly as they did, it's likely we would have been in for a much longer and scarier ride there. Now the one we're in now has a different cause although it has some of its roots in COVID, namely supply chain disruptions and some fiscal stimulus that COVID did require.
But we've lived with interest rates that are basically zero and quantitative easing for a very long time now. The chickens are simply just coming home to roost. We've had some very good years. Now it's time for a bit of a correction. That's the way the market works in cycles. Hard to predict how long it will take the Fed to get inflation under control. We don't know how high-interest rates will go. We don't know if we're in a recession actually right now, as some are saying, or if we're going to be going into recession as a result of Fed policy, or if the Fed will be able to engineer a soft landing. I have no way to predict how long a bear market will last. At the heart of COVID, I certainly wouldn't have guessed 33 days so that's really the reason for staying the course.
Ricky Mulvey: I've seen some comparisons to the bear market from the '70s with high oil [laughs] prices and inflation. I've seen some comparisons to the tech or the dot-com bubble with tech stock prices collapsing. What are the similarities you're seeing in this bear market to previous ones?
Ron Gross: Even though all corrections and bear markets are different, they do have certain very fundamental basic things in common. Chief among them are stocks go down, you get nervous. That's really what it boils down to. The different reasons during 2008, 2009 great financial crisis, great recession whatever you want to call it, the fear was pretty palpable. We were actually concerned that the financial markets could be significantly or even permanently impaired, and we could end up in depression. In 2000 it wasn't like that at all. Most everyone knew that there was a .com Internet bubble forming and that it was going to burst at some point. Then I have developed a rule of thumb, Ricky, maybe you can use this at home. If people you meet that don't know that much about investing are coming up to at a party or a backyard barbecue and telling you about how much money they are making and how easy it is, then you can be relatively sure you're in some kind of a bubble. That's how it was with dot-com stocks in 2000, and real estate speculating in 2008. Ricky, how about this year? Can you think of anything perhaps that people would come up to at a party and tell you that they're making gobs and gobs of money at least a few months ago?
Ricky Mulvey: Cryptocurrencies.
Ron Gross: That could be Ricky, yes good answer. Crypto and maybe even NFTs would be a little bit even more suspect. It's not to say that there weren't good Internet stocks back then or good real estate investments back then. Perhaps good cryptocurrencies right now. It's the excess that we have to watch out for. It's tulips in Holland in the 1600s that we need to be wary of. All corrections in bear markets are somewhat different but they all really have that in common stocks go down, we get really fearful and we sometimes don't know how to react.
Ricky Mulvey: Let's talk about the Fed for a sec, Fed chair Jerome Powell recently said in a congressional testimony, "We're not trying to provoke and do not think we will need to provoke a recession. But we do think it's absolutely essential that we restore price stability really, for the benefit of the labour market as much as anything else." What he's talking about here is the buzzwords, the soft landing. Is there any historical precedent of the Fed achieving this or is a recession bear market inevitable whenever the Fed hikes interest rates?
Ron Gross: I love the word provoke in that sentence. It's like a bear, a wild animal. Maybe it's actually appropriate. A couple of different times where perhaps we did see a soft landing. Alan Greenspan, Fed Reserve chair, has been credited with engineering a soft landing in 1994, '95. Fed reserve chair Jerome Powell has also suggested that Fed achieved soft landings in 1965, back in the day and 1984, but it is a difficult thing to do. In contrast, a recession followed the last five instances when inflation peaked above five percent: 1970, 1974, 1980, 1990, 2008, possibly 2022. We will see when the next GDP results come out. A soft landing would be wonderful. But it is not the easiest thing to achieve.
Ricky Mulvey: Going to skip ahead a little bit. You're a stock investor, you're looking down your brokerage account. What are some signals that the companies you own are ready for a long bear market? Is cash on the balance sheet more important right now, should we be focusing on companies with high ROIC. What are you looking at?
Ron Gross: For sure, companies that actually generate cash flow are profitable and generate cash flow and have strong balance sheets, will be able to weather a bear market or an economic downturn. Now that doesn't mean every company you own has to have those characteristics. If you're well-diversified you'll likely have a mix of companies, some that do better during boom times and some that hold up better during bust times. During difficult times. The stronger the company, the likely the better it will perform or the better you'll be able to sleep at night knowing that you are an owner of it. But sometimes these great companies also get their prices bid up and then during bad times, they just come back down. I think Isaac Newton taught us that what goes up eventually must come down at least for certain periods of time. But listen, you couldn't never go wrong in any market or any economy by buying really strong profitable companies with great balance sheets.
Ricky Mulvey: Any really strong profitable companies with great balance sheets coming to mind for you?
Ron Gross: Oh, guys. I mean, there's so many. I've always been a fan of Costco and Nike, although Nike is getting smacked around a bit this week, as a result of higher shipping costs. Home Depot is a great company. Disney, Apple and Microsoft probably go without saying, despite the pounding that Target has taken this year. I'm a big fan of that business model. Lots of wonderful companies out there that not only make a ton of money, but have great balance sheets as well.
Ricky Mulvey: Any final tips for newer investor? Maybe this is your first bear market, maybe this is your second traversing these lands.
Ron Gross: I think I'll go back to where we started. It always comes back to me to time in temperament. One hundred percent of the time the stock market has rebounded and moved higher after a correction or bear market, 100 percent of the time. I see no reason to think this time would be any different if it is by the way [MUSIC] we've got bigger problems on the stock market. Stay the course, keep a long-term perspective and it'll all be just fine.
Ricky Mulvey: Ron Gross, thank you for your time and your temperament.
Ron Gross: Thank you for Ricky, my pleasure.
Dylan Lewis: As always, people on the program may have interest in stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis, thanks for listening. We'll see you tomorrow.