Motley Fool Money - Powell and Inflation, Shopify's Stock Split

Episode Date: June 30, 2022

Inflation has been the story of 2022. We zoom in on comments from central bank leaders from yesterday’s ECB Forum to see what insights we can glean.   (0:14) Dylan Lewis and John Rotonti discuss: - Fed Chair Powell’s comments yesterday from the ECB Forum - Why experts have so consistently been off on inflation - The types of companies you want to own in an inflationary environment - Why Shopify’s stock split is less important than its share structure changes   (18:57) Ricky Mulvey and 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.   Stocks mentioned: HD, COST, NKE, DIS, AAPL, MSFT, TGT   Host: Dylan Lewis   Guests: John Rotonti, Ron Gross Producer: Ricky Mulvey Engineers: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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And you can get unlimited expert help at no extra cost, even on nights and weekends during tax season. Visit turbotax.com to get matched with an expert today, only available with TurboTax full service experts. We've got comments from Central Bank leaders and a stock split from a full favorite. Motley Fool money starts now. Dylan Lewis sitting in for Chris Hill, joined by Motley Fool Premium analyst John Ratante. 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's own Jay Powell, are thinking about the current

environment right now. Hey, Dylan. Thanks for having me on the show. Yeah, Powell's comments yesterday, Chairman Powell's comments yesterday were definitely interesting. What concerns me, I think, is that we're at this generational inflection 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 U.S. 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,

and money has been pretty much free since 2009, since coming out of the GFC, the global financial crisis in 2009. And now all of that is changing. And even Fed shared 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. Eight and a half, 8.6% inflation.

is real and households are anxious and they're angry when the price of the gas pump is going up, prices of the grocery store is going up. That really affects people's way of life. And so we're in a fight. John, I want to zoom in on that comment that Powell made. It kind of made the rounds on Twitter yesterday. I think we now understand how little we understand about inflation. That got dunked 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 decades is so different than what we're staring

out at going forward, especially because the forces 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. I think you're right, Dylan. You know, there's recency bias here. And by recentcy, 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 2% inflation target. We were constantly under that. And no matter what Chairman Powell and the Fed did, they could not get up to 2%. And so this is a new problem. We really are at this generational inflection point. The other thing that concerns me and is related is that Chairman Powell and the Fed's

Federal Reserve understand even less about how to wind down a $9 trillion 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 $9 trillion balance sheet. And so 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 this, even Chairman Powell. And I do think that the stocks that worked in a period of inflation below 2%, 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. So, you know, that's where we stand today. Yeah, I think that's an interesting point, John. And there's a lot of feelings of what got us here may not necessarily be what gets us to move forward with this. Even kind of zooming in on the comments that Powell made, one of the things that he had talked about in his ECB forum 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 4% from the prognosticators that tend to look at these things a year out. He said 34 out of 35 professional forecasters a year ago had inflation below 4%. And the reason for that was the model they use without getting too far into it. It's called the Phillips curve. And it assumes that inflation and unemployment are inversely related. And 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, and 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.

I think that's part of it, Dylan. I think it's also that these curves completely break down when you've had a decade-plus of free money. I think that's the number one thing that everyone is underestimating is what happens when Money is free, going back to 2009. And then on top of that, we were in a very, very, very scary time. We were in a pandemic. And so unprecedented amounts of liquidity were pumped into the market. And then free money was given out as handouts, these transfer payments to households.

And so 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. It's stocks and bonds typically never moved or 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. And so although I have never invested during an inflationary environment, I do try to consider myself a student history. I did notice this generational inflection point very early on, even last year. And so 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. on, all in the first quarter. And so I feel like our team is ready, and we got a jump start

on our educational sessions for the current environment that we are in. I front-loaded. I purposefully front-loaded these educational sessions all into the first quarter because 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, a potential de-emphasis on globalization and the Fed attempting to slow down the economy without causing a recession. So what I am very positive about, Dylan, I'd like to end this session, this little part on a positive note, is the strength of the U.S. 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 and our ability to guide our members through whatever the markets and whatever macro throw our way. 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 of 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 2%. 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 and what do you want to be owning? 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 are going to fight. We're going to fight inflation and we're going to get back down our 2% target no matter what it takes. The market doesn't necessarily believe him, Dylan. The market is playing chicken with Fed Powell at points. And that's when you see these massive up days, these massive up weeks. And then they're followed by these massive down weeks. And I think the reason is because despite Chair Powell saying time and time again, we are going to do whatever it takes, I think the market is worried that every 1% increase in interest rates increases the debt service on U.S. debt by $300 billion.

And so I think the market is predicting that Fed share 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. So 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 return 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. So that's the 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. And 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. So inflationary investing, 101, is really to own businesses that generate high ROICs and that don't need to invest a lot of new capital to grow because the cost of that capital is rising. And 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. And 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. And then finally, real estate has historically been a great place to be. be during inflation because one, a lot of real estate 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 it becomes more expensive to build new real estate. So this increases the value of current real estate because it means less new capacity comes on to the market. John, I have to ask the question because I'm sure our listeners are thinking it. Are there any specific names that you throw out there as something that you're

is worth checking out. Maybe a business that wouldn't necessarily be on 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. You know, I love the Fool's growth-oriented strategy. I just, you know, I support a one-for-one balancing. So for every earlier stage growth company that the Fool loves, you balance it out with a Home Depot. So that's one example right there. And then for every the earlier stage growth company that the Fool loves, you balance it out with a visa, you balance it out with a Berkshire Hathaway. So those types of really high return, high free

cash flow, moderate growth, but highly resilient type of businesses, Dylan. 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, in part because we've seen some high-growth names really dramatically appreciate in value, and they've looked to, quote, quote, 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. And I know you're a Shopify shareholder. How are you thinking about all this? Yeah. So 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 of a couple 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, not enough for Toby and company? Like, honestly, I would have reversed course if I was Toby. I know they announced this split, but when they saw that their stock was continuing to fall virtually every day, Dylan, 82% off its high, 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 Follow the leader because Amazon did it, right, and 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. I honestly, I think this is poor judgment. I don't think it changes the thesis, but it's just a game of follow the leader. I think Toby should be focusing on Amazon fulfillment. I think Toby should be focusing on improving its product suite, honestly. I've been reading a lot of reviews recently that Shopify doesn't have everything that entrepreneurs need to succeed. It has a lot, but not everything. They've struggled with fulfillment. And then finally, as we all know, this is a power grab by Toby. But Toby's not the only one doing it. A lot of founders are doing this type of thing. To unpack that a little bit, You mentioned that they announced this a couple 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, with the stock split, for me, it's an example of pay 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 pre-post split. But pay attention to the fact that when they made this decision and when shareholders were voting on things, they also approved non-transferable.

founder shares, which increased Toby Ludke's power to 40%. Prior to this, I think his voting power was around 33 or 34% 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 are investing in and right alongside Toby Lukka. So far, that's generally been a pretty good proposition for people. So I, as a shareholder, am happy to see that his incentives, and his stake are there and well represented. I think he has a pretty good vision for where

the company should be heading and his roadmap has been pretty strong so far. I'm curious how you feel about it. I'm invested alongside Toby. I intend to be a long-term share owner of Shopify. I feel like 33% ownership and control is probably enough, Dylan. I come at this from an ESG angle too. And my dear friend and colleague, Alice Lomax, I know she's probably fuming over this, because this is something that we tend to see as not a red flag, but maybe like a almost red flag when looking at corporate structures and corporate governance.

You know, it's like when does it stop? Does he ever feel like he's gonna need 45% voting control? I don't know. 33% seemed 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 doesn't matter at Shopify. But overall, Toby has proven himself to be a visionary.

He's proven himself to be someone that can build great teams, great product. If we take him at his word that he's trying to build a 100-year business, then maybe control is the right move here. It's just not super comfortable with me. But I do intend to be a long-term shareowner. Yeah, I think wanting a vote and being a tech investor or growth investor can sometimes be a little bit mutually exclusive. That's a good point.

That's a good point, Dylan. Yes. Just a reality of the space. I mean, what's interesting about it is, even at 40 percent, it's not a controlling voting stake. There still needs to be agreement and some consensus for anything dramatic to be passed. But I see your points there, John. Yeah.

Yeah, I mean, you make a point though. When you're investing in founder-led tech, you're giving up some voting power. If you've been investing for a few weeks or even 10 years, you haven't been through an extended bare market before. Fear not, producer Ricky Mulvey and TMF analyst Ron Gross are here with a bear market boot camp. Welcome to Bear Market Bootcamp. 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. Hey, Ricky. Always a pleasure. So Ron, this is not your first bear market. So for investors heading to their first bear market boot camp, what are they packing? What should they bring? I think it's pretty much the same two things you should bring to investing in general. And that is time and temperament. They are the most important. 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 and it will ensure that you can ride out whatever length the bear market happens to be, time and temperament. Whatever length is the key phrase there. 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, much longer? You know, I did a little research for you, Ricky, and I came up with since 1966, the

average bear market has lasted about 15 months, much shorter than the average bull market, by the way. And they do often end pretty quickly with a rebound that is very difficult to predict, as you mentioned, 20, 303 days, right? 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, you know, we've lived with interest rates that are basically zero and quantitative easing for a very long time now. And 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. And we don't know if we're in the recession actually right now, as some are saying, or if we're going to be going into a 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. I've seen some comparisons to the 1970 bear market from the 70s with high oil prices, hot oil prices and inflation. I've seen some comparisons to the dot-com bubble with tech stock prices kind of collapsing.

What are the similarities you're seeing in this bear market to previous ones? You know, even though all corrections and bare markets are different, they do have certain very fundamental basic things in common. And chief among them are stocks go down and you get nervous. That's really what it boils down to. Now 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 a depression. In 2000, it wasn't like that at all. Most everyone knew that there was a dot-com internet bubble forming, and then it was going to burst at some point.

And then I've 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 you 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 insubes. some kind of a bubble. That's how it was with dot-com stocks in 2000, real estate speculating in 2008. And 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? Oh, cryptocurrencies. That could be, Crickie. Yes, good answer. Crypto and maybe even NFTs would be a little bit even more suspect. You know, it's not to say that there weren't

good internet stocks back then or good real estate investments back then and 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 bare markets are somewhat different, but they all really have that in common that stocks go down. We get really fearful and we sometimes don't know how to react. Let's talk about the Fed for a sec. Fed Chair Jerome Powell recently said in a congressional testimony, quote, we are 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 labor market as much as anything else. End quote.

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 sort of bare market inevitable whenever the Fed hikes interest rates? I love the word provoke in that sentence. like it's like a bear or a wild animal. Maybe that's maybe actually appropriate. A couple different times where perhaps we did see a soft landing. Alan Greenspad Fed Reserve Chair has been credited with engineering a soft landing in 1994-95. Fed Reserve Chair Jerome Powell has also suggested the Fed achieved soft landings in 1965 back in the day in 1984.

But it is a difficult thing to do. In contrast, a recession followed the last five instances when inflation peaked above 5%. 1970, 1974, 1980, 1990, 2008, and possibly 2022. We will see when the next GDP results come out. So a soft landing would be wonderful, but it is not the easiest thing to achieve. I'm 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 longer 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? You know, for sure, companies that generate, actually generate cash flow are profitable and generate cash flow and have strong balance sheets will be able to, to whether a bare 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 bus 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're an owner of it. But sometimes these great companies also get their prices bid up, up, up, up, 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 could never go wrong in any market or any economy by buying really strong, profitable companies with great balance sheets. Any really strong profitable companies with great balance sheets come into mind for you?

Oh, gosh. I mean, you know, there's so many. I've always been a fan of Costco and Nike, although Nike's 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. So lots of wonderful companies out there that not only make a ton of money, but have great balance sheets as well. All right. Any final tips for a newer investor? Maybe this is your first bear market. Maybe this is your second traversing these lands. I think I'll go back to where we started. It always comes back to me to time and temperament.

100% of the time, the stock market has rebounded and moved higher after a correction or a bear market. 100% of the time. I see no reason to think this time would be any different. If it is, by the way, we've got bigger problems than the stock market. So stay the course, keep a long-term perspective, and it can all be just fine. Ron Gross, thank you for your time and your temperament. Thank you, Ricky. My pleasure. As always, people on the program may have interests 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.