Enlightenment - A Herold & Lantern Investments Podcast
Enlightenment - A Herold & Lantern Investments Podcast
Will the Fed's Next Move Change Everything?
September 16, 2024
Season 6 | Episode 34
Can a disciplined investment plan save you from costly mistakes? Join us as we navigate the turbulent waters of market volatility and the looming Federal Reserve interest rate decision. We spotlight the invaluable role financial professionals play in guiding investors through emotional traps, backed by insights from a recent Morningstar study. This episode also addresses the housing market crisis, examining its roots and exploring promising sectors outside of technology. Plus, we draw a fascinating parallel between a 1980s market darling and today's NVIDIA, offering a fresh perspective on why this historic stock might still be a gem.
Get ready for a comprehensive analysis of central bank decisions and their ripple effects across various economic sectors. Discover the surprising impact on the premium coffee market, with Arabica bean prices soaring due to supply disruptions. We'll dissect upcoming economic reports and the Federal Reserve's potential interest rate cuts, assessing their broader economic implications. Finally, we tackle the future of AI, spotlighting Oracle's recent earnings and strategic partnerships, and the ongoing housing crisis with potential solutions like the adoption of a value-added tax (VAT). Tune in for a thorough exploration of market behavior, economic consequences, and future opportunities.
** For informational and educational purposes only, not intended as investment advice. Views and opinions are subject to change without notice.
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And now introducing Mr Keith Lantn.
Keith Lanton:Good morning. Today is Monday, September 16th, about halfway through the typically challenging month of September. We've certainly seen our share of volatility so far this month. Last week was a recovery week. We had a strong upside to equity markets. Bond markets continued to also perform well, with yields declining. And that's all ahead of the big event this week, which is the Federal Reserve's decision on interest rates. This decision is more significant than any decision that we've seen in the last couple of years. Widely expected that we're going to be at an inflection point, a change. So we're going to see a change in the direction of Fed policy, most likely see an interest rate drop, and the question is if that drop would be 25 or 50 basis points. And as usual, perhaps most significantly is not necessarily what the Fed does although that does carry more weight this time, significantly more weight but what the Fed has to say about their thoughts and what they think about the economy going forward. So we're going to talk about that. I'm going to start out with a commentary and discussion regarding investor success and investor behavior in investing in markets and perhaps what we can do as individual investors to think more rationally and talk about a recent study that came out from Morningstar, highlighting how the emotional nature of investing continues to get the best of most investors. And then we'll talk about what else has taken place in the markets. This morning, also, barron's talked about the housing market and what they call a housing crisis. So why we have a crisis, how we got here, what we may do to alleviate this crisis and what the opportunities are as a result of this crisis, and we'll also talk about sectors outside of technology that may offer a positive upside potential, a potential that could be perhaps on par historically with financial markets, with arguably less volatility. And then we'll talk about what was a market darling in the 1980s, what Barron's is calling the NVIDIA of the 1980s. Take a look at where that stock is today and discuss why Barron's is calling the NVIDIA the 1980s. Take a look at where that stock is today and discuss why Barron says that that stock may be a buy in today's market environment. All right, so let's back all the way up.
Keith Lanton:Let's talk about successful investing, and obviously successful investing requires a plan and it requires discipline, requires discipline, and often, to achieve discipline, many of us whether it's financial services or any other aspect of our lives we need an expert, or perhaps even just a sounding board to hold us accountable. And that's why professional and non-professional athletes looking to improve their endurance, their athletic performance, will hire professional trainers, even though they're more than capable of training on their own. They need somebody to say you know, this is what you've got to do, here's how you got to do it. Today is not a day to take off. Today is not a day that we're going to sit and not push as hard. We need somebody to be there and to set the guide rails for us and keep us mentally accountable and just like professional athletes, when it comes to perhaps staying in the peak fitness shape, investors, in order to stay in peak financial shape, often benefit from the advice of a financial professional that can serve as a sounding board, many times just a barrier perhaps, to some of the actions that they want to take. Obviously, a financial professional can be a lot more than that, offering an overall plan and stick-to-itiveness to a plan, but at the very least, they can be a buffer to minimize costly mistakes.
Keith Lanton:And that brings us to Barron's article that discussed a very interesting Morningstar report entitled Mind the Gap 2024. And what this report showed is that the former Google chairman, jack Bogle back in the 1990s, when exchange-traded funds were being created, just in the infancy of starting to replace mutual funds. At the time, vanguard and its CEO at the time, jack Bogle, declined to offer exchange-traded funds and his concern was that the exchange-traded fund buyers would trade them too much and induce sowing sacrifice some of the long-term returns in the marketplace. And, interestingly, as it turned out, jack Bogle turned out to be prescient and correct, based on this recent Morningstar study. So, when looking at investor performance and let's say, two identical investment vehicles that track the exact same investments, what Morningstar found is that when investors purchased investments in mutual funds and they took actions to buy and sell those investments, when the exact same investment was done in a mutual fund wrappers as opposed to an ETF wrapper, individual investors underperformed the performance of that investment by two-tenths of one percent. And what that means is they either bought at the wrong time, they bought high, they sold low, they went back in at the wrong moment in time and therefore they suffered underperformance in that individual investment by two-tenths of one percent. But when it came to exchange-traded funds and again, 1%. But when it came to exchange-traded funds and again this is a recent study it shows that individual investors underperformed by 1.1%, and there may be a number of reasons for the gap. Again, these are identical investments and one of the main reasons that the Morningstar concluded for this divergence is that mutual funds are largely held in set it and forget it. Retirement accounts ETFs are more often owned in investing accounts and it's easier to trade those assets. We view them as more accessible money that we can more easily get our hands on and therefore we tend to be more active. It's also cheaper to trade exchange-traded funds often than mutual funds, and we have our friends at different firms, like Robinhood, making it sound very exciting to buy and sell individual investments.
Keith Lanton:Now I know that many of you are saying to yourself that is true, that makes sense, I get it, but that is not true of me. Think again. Think about perhaps this in a different context. Think about how would you rate your driving ability. What do you think? Are you better than average? Are you an average driver? Are you worse than average driver? Would it surprise you to know that 80% of drivers think they are better than average? Right now we are coming off of a busy college weekend of NFL and college football to wagering on some of these games.
Keith Lanton:I think most people who place a wager think that they are better than the other gamblers out there. They've studied the charts, they know who's playing this week, they know who's injured, they understand the matchups, they have knowledge. But most gamblers not us, of course, but most other gamblers often suffer the consequences of poor returns, and you can see that in another metric the states that have legalized gambling and sports gambling have seen bankruptcies increase 28%. So investing is no different. Most of us think we're above average drivers. Most of us think we're better than average in terms of being able to spot the trends in sports and in investing. Again, most of us probably think that we are better than the other folks, that we can know when to sell and then we can know when to get back in better than the average person. But the odds of doing that, if you really think about it, the odds of timing that correctly, are not in your favor. The odds of deciding when to sell and when to buy two decisions that you need to make at precisely the right time extraordinarily difficult to do.
Keith Lanton:Now, this doesn't mean that you should never sell or you should never rebalance your account. It means that you should act with a rational should never rebalance your account. It means that you should act with a rational, unemotional, preset plan. This way, you're not reacting out of fear or greed or from information that you just heard on a whim. You were just listening to the radio. You heard that the economy grew by 3.2 percent, or you heard that the unemployment rate went up or down, or whatever it is. You were at a cocktail party and you heard something from someone and it triggered in you a desire to move and hopefully you can resist that temptation. Or, if you know yourself as well as you do, you can put up a barrier between yourself and that action that you might be tempted to make, whether it's with a financial advisor, whether it's with a financial plan that you can stick to. But the proof is in the pudding. The results speak for themselves. When the ability to trade quickly and cheaply is there, the performance for most people perhaps not you, but for most people is that they will underperform.
Keith Lanton:All right, let's take a look at where we are this morning in the financial markets, and we are seeing right now markets trading relatively muted as we await the Fed's decision on Wednesday. Last I looked S&P futures down about four points, just about one-tenth of one percent below fair value. Nasdaq futures down about 80, and that's due to Apple predominantly, which is down two and a5%. After a report indicated that iPhone 16 pre-orders are lower year over year than iPhone 15 pre-orders at this time Dow Jones Industrial Futures bucking the trend, they're up about 90 points or three-tenths above fair value. As I mentioned, participants in wait-and see mode expecting the first rate cut by the Fed since March 2020. That's going to happen on Wednesday. Fed funds futures market is now pricing in a larger probability of a 50 basis point cut than a 25 basis point cut. This morning, the probability of a 50 basis point cut is all the way up to 63% from 50%, according to the CMA FedWatch tool. We'll talk a little bit more about that. Barron's talked about it over the weekend. Ten-year yield is down two basis points to 363. Two-year note is down three basis points as well to a 355. You can see not much difference between the two and the 10-year Individual stocks other than Apple that are in the news.
Keith Lanton:Intel received a $3.5 billion military contract. Stock is up about 1%. Micron Technology symbol MU, down about 3% after Morgan Stanley cut its price target by a whopping $40 to $100. Morgan Stanley's new target implies less than 10% upside from Friday's close. Less than 10% upside from Friday's close. Bausch Lomb, the contact lens provider, jumped 11.5% after Financial Times reported the company is working on a possible sale to private equity.
Keith Lanton:Trump Media and Technology shares are up, extending gains from Friday. The stock had jumped as much as 25% in the previous session after President Trump said he's not selling. And then over the weekend, of course, there was a shooter in the bushes at Mar-a-Lago and a possible additional attempt on President Trump's life. And that is perversely leading to some strength in Trump Media and Technology Group. This morning it's up about another 2%.
Keith Lanton:Equity indices in the Asia-Pacific region began the week on a slightly higher note. Overall volume reduced due to holiday closures in China, japan and South Korea. Worth noting that Chinese gross domestic product estimates being brought down by both Goldman Sachs and Citigroup overnight. Major European indices basically trading flat, near unchanged this morning. According to Bloomberg, former Federal Open Market Committee Vice Chair Dudley said he expects a 50 basis point rate cut. This morning. We are seeing weakness in the dollar. We're seeing the dollar this morning dropping to its lowest level in more than eight months, that move being driven by strength in the Japanese yen, which touched the highest level it's seen since July of 2023.
Keith Lanton:Amid speculation, this week's slew of central bank decisions will lead to a-year highs on concerns about the supply disruptions, pushing costs for premium coffee Arabica beans up to about $2.65 a pound. Prices are up roughly 40% this year as shortages of the cheaper Robusta beans stoke demand for the Arabica variety favored by specialty chains like Starbucks. All right, what else is going on this week? Tomorrow, the Census Bureau reports retail and food services sales for August. The estimate is for retail sales to be flat month over month, after a 1% gain in July, excluding autos. Sales are expected to increase four-tenths of 1%, matching July. Wednesday, of course, federal Open Market Committee announces monetary policy decision all but certain to cut the Fed funds rate at five and a quarter to five and a half for the first time since March of 2020. And, as we discussed right now, a little bit more than a 50% expectation being priced into the futures market of a half a point cut. We will, of course, find out on Wednesday. On Thursday, the National Association of Realtors reports existing home sales for August. We'll talk some more about the housing market. Economists forecast a seasonally adjusted annual rate of 3.9 million homes sold roughly even with July.
Keith Lanton:Talking about inflation, if you look overseas and take a look at China, you will see that China's producer prices index in August year over year fell 1.8%. That is the 23rd straight month of deflation or producer price drop in China, something that is certainly something that the Federal Reserve is aware of as they think about inflation here in the US and the slowing economy in China. Also interesting statistic in Russia the number of births in June was 98,600. That is the first time that number has been under 100,000 in the first half of the year and it is the lowest number of births since 1999. As we've talked about before, you don is the lowest number of births since 1999. As we've talked about before, you don't have births, you have population decline and this can lead to all sorts of economic woes in the future. So war may be taking a greater toll on Russia in the future than it is here in the present. So again you see where things are going. Think about the long-term implications of things. The war in Russia and the Ukraine can clearly have implications decades from today that we're not necessarily thinking about day-to-day here in 2024.
Keith Lanton:Talking about the Federal Reserve and Barron's saying the Fed could make a larger interest rate cut. That's what we're talking about 50 basis points instead of 25 basis points. Future odds continue to increase. They were at about 25 percent at the beginning of last week. They moved up to 43 percent, then 50 percent, now it's 60 percent. What are the implications of a jumbo half-point cut? Well, it would demonstrate that the Fed is getting decisively ahead of further labor markets softening, while a smaller quarter-point adjustment would signal that officials are trying to balance a higher unemployment rate with an inflation rate that remains above the Fed's 2 percent target. A larger cut would get policy out of restrictive territory fast, but could send the message that the Fed is panicking about the economy's health. Either way, what happens after the first rate cut of the cycle will matter much more than the magnitude of the first move. Also, fed officials will share their forecast for the US economy, inflation and the multi-year Interest Rates on September 18th and a quarterly update to their summary of economic projections. Today, the interest rate futures are pricing in the greatest odds of a percentage point decrease by the end of this year, with another reduction of a point and a half for 2025. Of a point and a half for 2025. If you're looking at the big picture right now, you're let's call it five and a half by the end of the year, market's pricing in four and a half by the end of next year, all the way down to three percent. That's at least what the market thinks today.
Keith Lanton:Speaking of interest rates, that's one factor that strongly influences the amount of debt or the deficit in this country. The higher the interest rates are, the greater the cost to service the national debt, and the cost of servicing that debt and the amount of debt that we have is one thing that we have not heard much about from either presidential candidate. It's something that so far in this election cycle has been largely ignored, and this is something that we, as investors, need to think about. In the longer term, arguably we, the Americans, or Uncle Sam, can no longer get away with paying 0% on our borrowings and now interest expenses running at over $1 trillion a year, with a normalization of interest rates, and now the amount of money that the government is paying to service its debt exceeds its military budget. The implications of that fact go beyond the budget. As economic historian Niall Ferguson observed on X recently any great power that spends more on death service than on defense will not stay great for very long, and he points to previously powerful empires that have crumbled once this level has been breached. Of course it's not an overnight process. Habsburg, spain, ancient France, ottoman Empire, british Empire all saw inflection points when their spending on their deficit exceeded their military spending, and the US is putting this to the test this very year. Now. This may not matter until it matters. You may remember, earlier this year, british Prime Minister Liz Truss, who was a very short-serving prime minister of the United Kingdom, found out that the markets there in the UK, they will matter when the bond market does rebel. If and when that happens and it'll probably happen suddenly, perhaps almost out of nowhere, but suddenly there'll be this crisis that the deficit suddenly does matter.
Keith Lanton:One way out of the deficit dilemma this being proposed by David Rosenberg, also a veteran of the bond market, who runs Rosenberg Research is for the US to adopt a value-added tax, which some say is one of the worst taxes of all because it's regressive. But perhaps it's one of the worst taxes of all except for all the other taxes. What would stabilize the US debt to GDP at about current levels would be a VAT or value-added tax on 1.5% of all transactions, while a 10% VAT would make the huge deficit disappear. Obviously, that is a big number, but it is about half of the VAT that our friends in Europe have. No one's talking about a VAT, or the possibility of one, but if you were to get a crisis in the bond market, in crisis of confidence, suddenly people would start coming up with ideas on what to do about the deficit. So it pays to think about this ahead of time in case this does become a more serious problem in the immediate future.
Keith Lanton:Speaking about a problem that we know that we have currently is our housing crisis, meaning that we don't have enough housing units to house the people who are looking for homes. This is clearly an election issue and clearly a factor for younger Americans who are struggling to be able to afford buying a new home. Some relief is coming as interest rates decline, but Barron's suggesting this is not nearly enough. Currently, builders are only putting about 850,000 single-family units a year onto the market in order to replace the homes that are aging out or adding to the existing stock of homes. So we're adding 850,000 homes a year, but we need 7 million homes to alleviate the shortages that we have now, and this is not even factoring in any future population growth and Barron's suggesting, if you're looking for a group of stocks that's already performed extremely well, that may continue to perform well, well, that would be the home building stocks. They suggest taking a look at ITB, right at Tango Bills Bravo, which is the iShares Home Construction Index. They suggest that the falling interest rates and Washington whether it's future President Harris or future President Trump in office the implications are likely that either candidate would try and stoke demand and provide support to the first-time homebuyer and this could be a further benefit to the homebuying stocks out there. Existing homes are selling for $422,000 on average or the median, I should say, and that's up from $266,000 in 2020, making it extremely difficult currently for individuals to buy a home, and rising rents are making it more difficult for those younger people to be able to build up enough of a nest egg to be able to afford a new home.
Keith Lanton:Why did we get here? Well, interesting confluence of events. You may remember that during COVID, the Federal Reserve talked about their interest rate policies, took interest rates down to near 0%. Lots of folks locked in mortgage rates at 2.5%, 3%, 3.5% Now with mortgage rates coming down, but still 6%. Well, those folks don't have much incentive to sell or leave their homes, incentive to sell or leave their homes. At the same time we didn't get a lot of new homes being constructed because the price of raw materials went up, prices of workers to build those homes went up, so the marginal cost to add workers and materials is expensive, so you're not getting a lot of new supply. So we had this very unusual quick turn of events where we suddenly had a situation where there wasn't much supply of homes, not a lot of at the same time. Not much supply, lots of demand, and it's all happening very quickly, you know, in the course of just a couple of years, where this all played out, where interest rates went all the way down. Tons of people, due to the benefits of technology, could refinance very quickly and at the same time we can't get the supply up very quickly. And therefore we're right now in this situation where we are short in terms of the number of houses that are available and we continue to have very high demand and for the foreseeable future, even with the benefit of a drop here in interest rates, it doesn't look like the situation is going to improve. Looks like the politicians, may try and come up with some solutions that may be a benefit for the companies that have already moved up a lot housing stocks up almost 100% in the past 12 months but Barron's suggesting we could see a continuation of that trend.
Keith Lanton:All right, let's talk AI, Artificial intelligence. Last week Oracle joined the crowd of AI heavyweights and if you're thinking long term again where the puck is going, ai has certainly gotten lots of attention. Some would say it's overhyped, but Barron's suggesting perhaps some stocks or many stocks are out over their skis, but the long-term implications for AI over the long term still look very favorable and they point to a recent commentary from Oracle last week. If you had asked fund managers a few months ago about the big winners from the latest earnings season, I doubt anyone would have said Oracle. But here we are. Last week, on Tuesday, oracle jumped 11% after reporting solid earnings. But perhaps most importantly, they announced a new database partnership with Amazon Web Services and then the stock rose later in the week when they provided a new long-term outlook.
Keith Lanton:Perhaps most eye-popping was the bullish commentary from Oracle co-founder Larry Ellison about AI demand and the company's pipeline. He said there are a few large technology companies and possibly even one country that will battle it out for the AI model technical supremacy in the next several years, and each of those companies will spend $100 billion each. So you've got more spending to come if Larry Ellison is correct and there are no signs, he said that the AI boom is waning anytime soon. He said if your horizon is the next five years, maybe even the next 10, I wouldn't worry about the AI boom subsiding in the near term. In fact, the demand is so strong that other cloud leaders are signing up to use Oracle's AI computing capacity, even though they have their own data center. So they can't even meet their own demand. So in June Microsoft and OpenAI announced they would use Oracle for their AI workloads. And Oracle is going nuclear on AI. Literally On the earnings call, ellison said Oracle is building an 800-megawatt data center that would have acres of NVIDIA's GPU clusters to train one of the largest AI models.
Keith Lanton:The company is already in a design phase for another data center that will require one gigawatt of electricity and use nuclear power in order to satiate and meet the demand for the power. To power that investment At Oracle's investor. On Thursday Ellison confirmed the nuclear point was real. We're building data centers. He said my God, we're building nuclear reactors. He said you're kidding me. That sounds completely made up, but it's not.
Keith Lanton:Perhaps the biggest news of all is that Oracle's AI infrastructures have the support of NVIDIA. On Wednesday, oracle announced that NVIDIA and Oracle would deploy the largest ever GPU compute cluster available in the first half of 2025. In the first half of 2025. This will be comprised of 131,000 NVIDIA Blackwell GPUs for customers to train and run AI workloads. To put that into context, this is six times bigger than what Meta has used to train their AI large language model. They're currently using 16,000 NVIDIA GPUs. This is 132,000 of the latest chip and NVIDIA's chips, for this very reason in this arms race, remain in heavy demand across the technology space.
Keith Lanton:To source the products for his new AI supercluster, ellison appealed directly to NVIDIA's CEO during a dinner joined by Tesla founder Elon Musk, and this is the way that Ellison described the dinner. It was me and Elon begging Jensen, the CEO of NVIDIA, for GPUs Please take our money. No, take more of it. We need you to take more of our money, please. And he said you know what? In the end, jensen agreed to take more of his money. So it all worked out, he says. And now they are going to be building these huge data centers. They're going to power them with nuclear energy, assuming all goes according to plan. But here the long-term implications are and the future implications are that there is an arms race going on and that NVIDIA is still at the center of that arms race and you're going to see these technology behemoths continuing to invest, in all likelihood something unforeseen doesn't happen, to become the leaders in artificial intelligence. All right, I said Brad's not on the call, so I'm going to continue for a few more minutes.
Keith Lanton:Now, if you're concerned about valuations and technology, which many are, one other place to look at in the financial markets that could offer returns and we kind of touched on this just when we were talking about the needs for electricity to power these AI super centers for electricity to power these AI super centers, barron says to take a look at the utilities Bank of America in this article saying tech looks egregiously expensive. Bank of America saying an earnings growth there is impressive but decelerating. And they say they favor utilities which pay close to 3% in dividends and remain cheaper than average relative to the S&P 500. Utilities also tend to benefit when rates are being reduced, and Bank of America notes that utilities aren't as sleepy as filled. Since 1980, they've returned 11% a year, which is close to NASDAQ's 12% a year. And, as we just discussed, utilities are quiet tech beneficiaries, as AI data centers create soaring demand for power.
Keith Lanton:Stephen Bird, who once worked in the power industry and now heads sustainable research at Morgan Stanley, says in this article he sees a severe shortage of US data centers brewing, and power is a key constraint. Some markets have a shortage of electricity being generated. Others see long delays for new hookup. One key county for data centers in Virginia sent notices to prospective customers saying the timeline to be able to hook up to the grid could be seven years. Seven years in the world of AI is a lifetime, so these companies are going to probably go looking elsewhere, but they're going to try and find a place that they can get that power that they need. All right.
Keith Lanton:So we did a lot of talk about technology and how technology has certainly performed well in a darling of the marketplace. Barron suggests looking at a previous darling, perhaps to consider as a portion of your portfolio. This company, they said, was the NVIDIA of the 1980s, and the beaten down stock could still produce NVIDIA-like gains. In their opinion, this stock is Schlumberger symbol. Is SLB. Maybe hard to remember now, but Schlumberger was one of the market's hottest stocks as the leader to the then dominant energy industry and at one point had the world's fifth largest market capitalization. Schlumberger is still the world's leading oil services company with operations in 100 countries.
Keith Lanton:But energy matters little in the S&P 500 and the out-of-favor stock isn't trading much higher than it did 40 years ago. Market value of under $60 billion it doesn't crack the top 100 stocks in the S&P 500, and they say SLB or Schlumberger is worth a fresh look. Despite fears of obsolescence, the oil and gas business will probably be around, they say, for the rest of the century. Demand continues to rise, globally stands at 100 million barrels a day and the industry needs expertise in assessing and developing energy deposits. And that's what Schlumberger provides. And they say that shares don't reflect that possibility.
Keith Lanton:Schlumberger, trading currently around $40 a share near its 52-week low, has dropped 23% this year, fetches a reasonable 11 times 2024 estimates and is trading under 10 times 2025 estimates of $4.13 a share while yielding 2.8 percent. Barron's saying they think it's an attractive entry point for the oil services company. Schlumberger is the industry's technology leader, says James West, an oil services analyst at Evercore ISI. It is the entrenched go-to company in every major international market. West carries an outperform rating, $74 target, which is almost double the current price. He doesn't view his target, which is about 14.5 times 2026 estimates, as overly aggressive. He says this was a 20 multiple stock and now it's trading close to high single digits.
Keith Lanton:That's everything I've got.
Alan Eppers:Thank you for listening to Mr Keith Lanton. This podcast is available on most platforms, including Apple Podcasts, Spotify and Pandora. For more information, please visit our website at www. heraldlantern. com.
Sophie Cohen:Opinions expressed herein are subject to change and not necessarily the opinion of the firm. Past performance is no guarantee of future results. The information presented herein is for informational purposes only and is not intended to provide personal investment advice. It is important that you consider your tolerance for risk and investment goals when making investment decisions. Investing in securities does involve risk and the potential of losing money. The material does not constitute research, investment advice or trade recommendations.