Motley Fool Hidden Gems Investing - "When in Doubt, Zoom Out"

Episode Date: August 29, 2023

Credit card debt and interest rates hit all time highs this year. (00:21) Ricky Mulvey and Bill Barker look at the implications for companies and investors. They discuss:  - Macy’s and Nordstrom charging 32% APRs for retail cards.  - Historical context on rising delinquencies.  - Best Buy’s quarter, and sales slowdown.   Plus (12:34) Robert Brokamp and Matt Frankel discuss what to do if your consumer debt is getting more expensive. Companies discussed: BBY, M, JWN, DFS Host: Ricky Mulvey Guests: Bill Barker, Robert Brokamp, Matt Frankel Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

You'll love to see an all-time high, except when it involves credit card debt. You're listening to Motley Fool Money. I'm Ricky Mulvey. Joining us now, it's Bill Barker. Bill, good to see you. Good to see you. Well, Best Buy reported earnings this morning. Always a good chance to see the appetite for those big-ticket purchases. Also completing the earnings triple, sales beat expectations, the company lowered guidance, and the very first analyst question was about artificial intelligence. Best Buy seeing a drag from appliances down 16%. But Bill, anything stand out to you about

the consumer electronics retailers quarter? Well, they've been essentially in a little bit of a micro-recession for Best Buy. Of course, that's attributable to the fact that a lot of in-home electronics and appliance purchases were made in the 2021-2020 era. A lot of sales were pulled into those years. The last two years, you've seen a decline in sales, which is really returning the company back to a normalized level. In terms of the A little bit of a bump up today in the stock price, that's mostly attributable to a company saying that it sees a light at the end of the tunnel. There will be continued declines this year from last year. Last year, sales were down about 10% for the company as a whole,

but they see next year maybe showing a little bit of growth. That's enough to make the market happier this afternoon than it was last night. About a 5% rise this morning. CEO Corey Berry would very much like investors to focus on those upgrade cycles, saying, quote, natural upgrade and replacement cycles in the normalization of tech innovation has basically pulled forward demand, which they are now at the bottom in. I don't know. I think there's also a consumer debt story that might be playing out with this company that they are not addressing. What say you? I think at the margin, maybe a little consumer debt situation, although consumer debt, while certainly up from where it was at the bottom

when everybody was buying from Best Buy and a few other places that were celebrating everybody staying at home. I think that that is a little bit of a headwind in terms of people taking down their discretionary spend on goods. The discretionary spend is more catching up on all those vacations and travel plans and experiences that have been foregone for a couple of years. I think it's a headwind, but the economy is in reasonable shape. Consumer debt is certainly higher than it was, but not high by historical means. Let's get into that in a sec. Best Buy is basically signaling that they are at the bottom of a cycle, especially with those computers and cell phones, that kind of thing. It pays about a 5% dividend and trades below a market

multiple. Do you think that this is worth a look for investors who like to play cyclical games? Well, the stock is not at the bottom of the cycle. It's about where it was five years ago. As you mentioned, they pay a reasonably healthy dividend, a little bit north of 4% on the yield right now. They take their extra money and both pay the dividend and knock down their shares. They've done a pretty good job of buying shares back. It's not a growth story as a whole for the company. It's probably going to do a little bit less this year than it was doing in 2019 in terms of the fiscal year total sales. It gives you a little dividend. You're buying back shares, maybe that pumps the earnings per share up over time, certainly knocking shares down to about

$225 million from $300 million in the last five years. They're buying back shares at a below market rate, which is, I think, what they should be doing rather than trying to grow in a retail situation that is not really going to help them out too much. Also, on a little bit of defense, with shrink Corey Berry and the earnings call addressing how they're focusing on that, you can imagine that might be a problem for an electronics retail company, basically saying that they're pulling off a lot of these, they called it items that are more susceptible to shrink off the floor and replacing those with more end caps. Be interesting to see how they address that moving forward. I want to move on to this consumer debt

story, though, which I think is something I'm watching with the overall economy. I don't know how it ends, but I think it could be significant for some of the companies we watch. Three things. One is that credit card debt hit an all-time high of about $1 trillion this quarter. Credit card interest rates also hit an all-time high of about 20%, which is up from 15% about a year ago. And there is another $1.7 trillion in student loan debt that is about to come back online. We like the bottom-up investing stuff, focusing on companies and their future earnings. But is this macro stuff, is that meaningful to you as a stock investor? Well, the headline that credit card debt is both past $1 trillion and is at an all-time high

isn't on its own problematic. That is, as the economy grows and in terms of inflation driving the nominal price of $1 trillion, that's a nominal figure. You would expect credit card debt to keep growing over time as the economy grows and as the population grows and as inflation kicks in a little bit of a tailwind on that nominal number. I'm not sure that debt is yet at a real all-time high. Certainly, in terms of credit card delinquencies, it's nowhere in the vicinity of the all-time highs, which were back in the 2008-2009 era. It is returned to what you might call a normalized rate. Delinquency rates are 2.77% according to the St. Louis Fed for the end of last quarter, and that's right about where they were in

2019, 2.6%. That's up off the floor. The delinquency rates were very, very, very low two years ago and they're up. The trend is not good. If it keeps going up from here, that is going to be a big headwind, especially for discretionary spend. Some retailers are already noting it. Macy's noted that they had an, quote, increased rate of delinquencies within the credit card portfolio across all stages of age balances, end quote, within their latest quarter. Nordstrom, which also charges a similar APR for their credit cards, said they saw revenues rise in the first half of the year, but it's gearing up for more delinquencies. I don't know. I think this might just be a self-inflicted wound for these retailers, though, which are charging like a 32% APR.

So, I don't know. You tell me. Is this maybe more of an isolated problem for those retailers? Well, yeah. I mean, it is a quite usurious rate. It's kind of akin to payday loans, practically. And I think that they're taking on lower credit quality accounts, and that is going to come back bite them. Who it really bites are those people who can pay off these credit cards and are unaware of the astronomical rates that are being charged, that you actually want to pay this kind of thing off first, even if your student loan seems like it's more important. But people default to the the student loan, to the mortgage, to the things that are more their car, much lower rates in all those categories, but they seem more important, so they get paid first when people are making

some of these decisions. It's incredible that they can get away with rates like that, but they do, and that helps the business. That's been a part of the business for a long time. One of the reasons I think they get away with it is because they don't really make it visible. I use a Discover card. Before this recording, I was like, well, I should check what my APR actually is. Then, essentially, you have to double-click on your statement, go to a month, and then go down to page four, where it will actually tell you what your APR is. I think this might be a problem. A lot of people don't know what they're paying, and these companies aren't exactly eager to tell them right up front.

Absolutely the case. The Motley Fool has been singing the song of, pay down your credit card balances and know your APR for the entire history of the company. Things don't really change in terms of consumer education about these issues. But it's an opportunity for the credit card companies and they've maximized it. These rates are findable, but as you point out, They are not obvious. Yeah. Discover is getting plenty of grief with their regulatory missteps, a very quick exit for their CEO. They are also expecting those delinquencies to normalize to pre-pandemic levels. They're counting it at about 3.5%. Do you think there's a disconnect between these more, I would say, larger credit card issuers

and these more specialty retailers that are charging, as you would say, the usurious rates? Well, it's not as if 20% and that ballpark is all that much better, better than 32%. Discover is doing well as a whole, despite the regulatory issues, just because these have grown. These interest accounts have grown. I think 70% of Discover's business is the interest off of credit card balances. So, it's good times for them. If they can keep delinquencies below, as they still are, the 2019 rates and the balances up and the rates up, they do pretty well. But there's a danger that things get out of hand. Delinquency rates were typically 4%, even 5% for the 90s and the early 2000s, peaked almost during the

worst part of the Great Recession, closer to 7%. So, below 3%, we're a long way from those days. The economy is in good shape. Some people will carry a credit card balance, and it's the job of Discover and others to make sure that the right people, that is, the people who will keep a balance, but pay it off, or never pay it off, but always be paying off enough of it, are the ones that are the customers, rather than the ones who just never end up paying. All right, Bill, I'm taking my hand off the panic button then, as I was doing research. I was going down a rather dark rabbit hole on how this story could end. I appreciate your realism and your optimism on this.

Well, if you just look at the last two years, three years, the chart for delinquency rates will alarm you. But if you look at the last 35 years, perspective will calm you. When in doubt, zoom out. Bill Barker, appreciate your time and your insight. Thank you. That's consumer debt from the investment side. Robert Brokamp and Matt Frankel continue the conversation with some actionable advice if you've been carrying some credit card or student loan debt. The Federal Reserve has been hiking interest rates since March of 2022, and the cost of our money has risen right along with it. There were hopes that the Fed would slow

down and rates would moderate this summer, but instead rates began to spike upward toward the end of July and into August. Here to help us sort through what's going on and what consumers can do about it, is Motley Fool contributor Matt Frankel, a certified financial planner and a loan expert at The Ascent, a Motley Fool website. Welcome, Matt! Matt Frankel. Hey, thanks for having me! I wish we were talking about rates going down, but that's obviously not going to be the case for a little while now. That's true. That would be happier news. Matt, what's your take on this late-summer jump in rates? Why is it happening? It looks like, one, inflation is a little

bit harder to control than the Fed had expected. And number two, the Fed seems to be willing to be a little more aggressive than the market expected they would be. And we all know that consumer interest rates, especially those that are not directly tied to the federal funds rate, are more based on expectations than what the Fed's already done. And the expectations have increased, and so have mortgage rates and auto loan rates and all that good stuff, unfortunately. Yeah. Another thing going on, too, is that when we look at the beginning of the year, many people expect a recession either this year or next year. If you think a recession is coming, then you go in and you buy bonds, which drives up prices and lowers rates.

But people are thinking, you know what, we might manage to pull off this so-called soft landing, which means people are starting to sell some of their bonds, driving up rates. The 10-year yield now is the highest it's been since 2007. You have all that together, and you see rates of all types going up. Let's get into some individual types of loans, starting with perhaps the biggest for most people, and that is a mortgage. 30-year mortgage rates around 7.4%. That is the highest level in 23 years, pushing mortgage demand from homebuyers to the lowest level in 28 years. Matt, what's your take on the mortgage market these days? Matt Frankel. There's a lot to unpack there. It's not just that rates are higher

and home prices are higher, that's making mortgage demand drop. They're making homes unaffordable, for sure. But there's always people who need to buy homes. People get transferred for their jobs. They can't rent for one reason or another. I have two large dogs, for example. A pet-friendly rental is tough to find in a normal housing market, let alone right now. A lot of people need to buy homes for one reason or another. But you're also seeing a lot of people stay in place who otherwise would move, which is creating a historic lack of supply. Supply is actually the lowest on record right now in modern times. The reason is, a lot of people like me, my mortgage rate is 3% flat. I'm not going to give that up and take a mortgage that's

7.5% if I want to go somewhere else. I'm going to wait it out until rates start to moderate. rate. You're seeing that happen all over the place. For the first time in a long time since the Great Recession, it's become a lot more affordable to rent homes than to buy homes in the United States. It's a pretty big difference now. Rent has risen, but not to the extent that mortgage rates and rising home prices have pushed up the cost of ownership. You're seeing it's more affordable to rent, so a lot of people are deciding to rent for a while and stay put, or keep their options open. And you're seeing a lot of homeowners stay put, which is limiting the supply on the market. Yeah, it's something like, I don't know,

more than 80% of current mortgages are below 5%, and 60% are below 4%. Those people are not going to want to move anytime soon. Mortgage rates are higher than you would think they would be. Normally, the difference between the 10-year Treasury and 30-year mortgage rates is like 1.5% to 2%, but today, it's 3%. So, something else is going on. Could be the greediness of the banks, which we might get into a little bit later, too. So, yes, home affordability is very difficult to get a reasonably priced mortgage. What should people do right now? Well, if you need to buy a home, I would suggest looking at the new home builders, because they have some relief from these issues. They have not unlimited inventory,

but they have the ability to create inventory, which the private market does not. They also have the advantage that they can offer what everybody wants, which is lower mortgage rates in a lot of cases. One builder I know, these are called rate buy-downs. Essentially, the builder is paying the bank to give homeowners better rates. It's being baked into the home price. But people see that you can get a 5% mortgage rate through a new home builder. One builder in particular, I know, is offering a 5.99% permanent rate and buying it down to 3.9% for the first year, keeping people's initial payments low. People are in their mind, they're thinking, OK, I get a 3.9% for a year, eventually rates are going to drop,

I'll refinance, this sounds like a great deal. In a way, it is. I would say, if you need to buy a home, definitely check out some of the new home builders, because they're offering some pretty nice incentives right now. They've realized that this is a very homebuilder-favored market. If you can wait, it might be a good idea to wait, especially if you can rent and have an affordable living situation for a while. The mortgage market right now is tough. The home selling market is slow to a crawl in most markets in the U.S. I don't know if that's going to change anytime really soon. I'll just double-click on your renting versus owning. It can be much more affordable. You'll find calculators online that will help

you do the math. But do not underestimate the maintenance costs of owning a home. By the time this summer is over, the Brokamp household will have spent over $15,000 on repairs in our home. And you can't really predict those things, but it's something that I think a lot of people don't appreciate in terms of the overall cost of owning a home. Yeah. And that's another thing with new homes, you have less of that maintenance expense. Not none, it's still unpredictable to some degree, but it can help alleviate that variable expense. Yeah, very good point. All right, let's move on to another type of debt, and that is credit cards. According to creditcards.com, the average rate on a credit card is 20.9%, and according to

LendingTree, the average rate is now 24.4%. These are all-time highs, and lenders keep pushing them higher. Consider that credit card rates are generally based on the prime rate, which is currently 8.5%. That's the highest level since February of 2001. Back then, the average credit card rate was less than 16%, much lower than the current average rates of 21% to 24%. Matt, what the heck is going on here? Well, it's not just about what the prime rate is. That's what dictates the variable credit card rates. That's why your credit card rates have risen by about 5% in the past couple of years, because that's the prime rates directly tied to the federal funds rate, and you're seeing that rate rise as well.

It also has to do with lender perceptions of the economy. If lenders see a recession coming, that's an added credit risk. A lot more people could be in default, they could have trouble keeping up with their bills, things like that. So, they will adjust their new interest rates according to how they see the economy and how they perceive risk. If the average person is taking on more credit card debt, I saw credit card debt recently topped $1 trillion in the U.S. for the first time ever. That's a risk factor to lenders. If people have more debt, more people are going to get in over their heads. If we see unemployment start to rise, which it probably would in a recession, we really haven't seen a spike in unemployment

yet like a lot of people thought we would. But in lenders' minds, that's a risk, and rightly so. It's never a good idea to borrow money at 24%. But hopefully, if we see rates go the other way, we'll see that turn around a little bit. The average credit card rate was 17% not that long ago. It's cyclical. Yes, we can hope. We can hope, right? For those people who are among the contributors to this $1 trillion in overall credit card debt in the U.S. You have a balance. What should people do about it? Well, surprisingly, while credit card companies have been raising their interest rates, and they've been raising naturally with the federal funds rate, the 0% APR introductory

offers are still surprisingly common. It's surprisingly easy to get a card that will give you a 0% APR for, say, 18 months on balance transfers. If you have credit card debt and you are tired of giving 24% interest to a bank every year, one of these offers could be a good way to help you get out of debt. Then at least every penny you're paying your credit card issuer is going toward the principal, not interest. That's one option right now. The personal lending market has really exploded in the past five or six years. There's never been more competition against personal lenders. That's a good thing for people who owe money. The primary use of personal loans is debt consolidation, getting rid of credit card debt and things like that.

And the average personal loan interest rate is something in the 13% to 14% range right now. Not fantastic by any means, but definitely better than a 24% APR you're paying on a credit card. And they have higher but set monthly payments, so it could be a nice way to plan your way out of debt and avoid the minimum payment trap on credit cards, which a lot of people get themselves into. All right, let's move on to our third and final type of debt, and that is student loans. After three years of a pause on student debt payments, interest begins once again accruing on September 1st, in other words, this Friday, and payments resume on October 1st for 44 million Americans. The rates range from basically 5% to

8%, but up to 15%, depending on the borrower and whether the loan is from the government or a private bank. So, Matt, what can borrowers do to manage their student debt payments? Well, first of all, I consider federal and private student loans completely different types of debt. They're almost nothing in common. A private student loan is essentially a personal loan. It's a personal loan that you can't get rid of through bankruptcy. It's really the only difference. With federal student loans, they're actually one of the lower interest forms of debt you can have. They're probably the most flexible type of debt you've had. That's about to get even more flexible. For No. 1, the student loan payment, I'd call it a soft restart.

They've already announced that it's going to be a 12-month on-ramp to restart payments. That will last through September 2024. That means, if you can't afford your payments and you don't make payments right when payments restart, technically, you're missing payments. but they won't be reported to the credit bureaus. No adverse effects will happen for the first year. The administration is telling you to start repayments if you can afford it. But if you can't afford it and you need a little extra time, it's not going to count against you for the first year or so. That's number one. Number two, they're launching what's called the SAVE plan. This is replacing what's called the REPAY plan, which is the most popular income-driven repayment

plan right now. It's designed to lower people's payments significantly, to eliminate the accrued interest trap. We've all heard the horror stories of someone who borrowed $80,000 to pay for their undergraduate and master's degree, has been paying on their loan for 10 years, and now owes $90,000. That's because, in a lot of cases, the payment doesn't cover the interest that's building on the account, and it's tacked onto the balance. The save plan eliminates that. It also sets an easier path to loan forgiveness. 20 years of on-time repayment for undergraduate loans, and that's actually reduced to 10 years in repayment for loans that had original balances of $12,000 or less. That's designed to essentially make community

college a lot more affordable. The action plan is to apply for the SAVE plan. If you're already enrolled in the repay plan, you'll be automatically enrolled. But do that If you haven't done that, if you're not enrolled already, find out who your loan servicer is, because a lot of people don't realize the three biggest loan servicers for federal student loans exited the business during the COVID pause. Your loan servicer, I know mine's different. Your loan servicer is not likely to be who it was before. Student loan refinancing is not as good of an option as it was before the payment pause. You used to be able to get a student loan refinancing through some of these private companies like SoFi or Discover with a 3%

interest rate. That's not the case anymore. You're not likely to really save a lot of money, and you're losing all that flexibility that comes with federal student loans. Yeah. Some features of the SAVE program take effect immediately, others not until next July. Definitely look into it. The best source of information for all this is studentaid.gov. program is open. I think they opened it last week. And as you might expect, the service loan providers and the Department of Education have been swamped with calls and stuff like that. So, it is definitely a good idea to take care of this sooner rather than later, because it's just going to get more complicated as time goes on. All right, Matt, so do you have any final

thoughts on what's going on in the borrowing market these days and what people can do about it? One thing that's more important than ever, not with student loans, but with all these other types of debt, is to shop around. When it comes to mortgages, when it comes to auto loans, which we really haven't talked about but are in the same boat, essentially, it's easier than ever to check your rates from different lenders. A lot of lenders will even let you check your rates without a hard credit pull, even in the mortgage industry. It's easier to check your rates than ever. There's a provision in the FICO scoring formula that encourages rate shopping. You can apply for a dozen mortgages. As long as you do it

within a normal shopping period, which is considered about two weeks, it won't count against you other than just a single loan application. Rate shopping, you have very little to lose other than maybe a couple hours of your time. You'd be surprised at how much you could save by getting, say, a 7% mortgage rate as opposed to 7.1%. It's a big difference over time. Shopping around matters more than ever. I would definitely encourage anyone who needs a new car, a new house, or anything to do that. As always, people on the program may have interests 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. I'm Ricky Mulvey. Thanks for listening! We'll see you tomorrow. you