Watch First Republic CIO Christopher J. Wolfe discuss how big tech regained its footing, what’s next for the U.S. job market and what we can learn from certain industries in the pandemic economy. i
Read below for a full transcript of the conversation.
Host: Let’s turn to the market close. I do want to bring in Christopher J. Wolfe, Chief Investment Officer at First Republic Private Wealth Management. Christopher, great to have you on the show. Strong day for the market. We do see record highs after the major indexes. What do you make of today’s action?
Christopher J. Wolfe: I think it’s a little bit of relief. I think more than anything else, job numbers are actually pretty good, inflation numbers not so bad, so a lot of concern had been brewing very rapidly over the summer that we were going to see much worse than expected inflation, and as a result, things like the Fed would have to taper early, we’d see more commentary from the Jackson Hole meetings coming up, and a lot of that expectation got built into markets. With a few data points, those expectations were reversed.
Host: It is interesting, Christopher, that the jobs market, yes, does continue to improve. Certainly, the July jobs report’s stronger than expected, but I think holistically, still some concerns that it’s not improving as quickly as economists had expected and then this delta variant spreading as well. What should investors prepare themselves for as we enter the fall, kids hopefully go back to school, and presumably there is more availability for people to reenter the jobs market if they decided to stay on the sidelines due to unemployment benefits or simply because of childcare responsibilities?
Christopher: Yep, that’s a great point. We think there’s a lot of things going on there, so let me break it down maybe with three quick points. The first is, the jobs and the people and the mismatch between where the jobs are and where the people are is an important feature. We’re seeing, in a lot of big cities, for example, that the jobs are plentiful but there’s just not that many people that want to take them at certain rates, so there needs to be more done around that issue, number one. Number two is, I think we would expect as a result of that piece, a long period where the job market recovers. Historically, we’ve seen very fast recoveries in the job market — couple years, three, four, five years — but this one may take longer because of that mismatch, and some of the things that you described earlier: the kind of wait on the sidelines, wait ‘til delta passes, et cetera, so that’s likely to keep job growth slow, but we think it will be persistent, a combination, and here’s the third point, of higher wages in a lot of areas, and I think the reduction in the unemployment benefits will start to put people back into work mode, add to the fact that the delta variant seems to be spiking and retreating relatively quickly, you see that in some of the U.K. data, and it may be that we get to the end of the year with maybe a slow-creep improvement in the jobs data. That should be good, because overall it gets us to a more confident viewpoint that we will see the economy transition back to what it usually does, which is benefit from consumer spending and job growth, and a lot less from this fiscal stimulus, because you know what, it’s rolling off this year, and we’ve got to make up some ground.
Host: Yeah, Christopher, let me ask this: Between now and year-end, what’s your trajectory for the stock market? Do we see a 10% pullback correction that many would say is healthy, even during normal times? Do you anticipate we see a correction or not?
Christopher: You know, I think delta could be a cause of that, so could the Fed overreacting. I think that was one of our major concerns. You know, right now, we think the stock market’s got a lot of good news priced into it. I’ll be a little bit of a cliché here, you can’t rule out the possibility of a 10% correction. They happen fairly frequently. You should expect at least 1 1/2 to two every year. We’ve been short on those corrections over the last several years, mostly because policy has been dominating the effects in the markets. Our expectation though here is that investors are going to shift their focus away from just looking at the broad market and more clearly on more narrow sectors associated with economic growth. That job story pans out, and the stimulus is starting to come off, then we’re going to see more consumer-led, we’re going to see more growth-oriented, economically sensitive areas of the market do a little bit better, relatively speaking.
Host: Now we do have some earnings reports after the close. I’m just curious, in terms of the stay-at-home plague, Christopher, are there sectors of this economy, as we do head into a school year, as the delta variant spreads, all of these factors to consider, are there sectors of this economy that you anticipate will outperform?
Christopher: Yeah, I think the economically sensitive ones, so put it this way, our expectations are for the economy to continue slowly improving — that we’re going to see higher inflation at least for a period of time. Transitory for us means all the way into 2022, but we’re going to see higher interest rates as a result of that. That’s pretty good for financials, generally speaking, so we’d be more favorable there. As we mention, that the earlier, the idea that we see the industrial and material sectors, more goods being produced, return to more normal consumption in this economy fueled by business investment that’s been stunted because of COVID, that’s going to rebound, we think, later this year and into next year, so we’ll expect the materials and industrial sectors to pick up from that. And I think finally the technology sector continues to show that it is a bulwark, really, against anyone’s doubts that growth can’t happen in any environment. They continue to deliver. We expect to continue to see tech deployment in almost every sector of the economy, and that’s still pretty good for technology shares.
Host: Mm-hm. Okay, so lemme ask you this. We are seeing that more and more companies are requiring vaccinations, the federal government for some groups even requiring vaccinations as well, Facebook though with some new news that it’s going to delay its return to office until January of next year, we see other companies requiring vaccinations and delaying return to work with delta: Is that good or bad for the economy and thus the stock market (the vaccination mandates, or lack thereof, and a delay in the return to office)?
Christopher: Well, I think what we’ve learned so far is that companies can make really good profits with people working at home, but I think there’s other issues that are related to vaccination, there’s other issues related to communing when you get everyone back in the workplace, that are also important benefits that are intangible, and they’re hard to judge. On the pure metrics of whether or not companies can be profitable with people working at home, well, we already know that that can happen. I think it’s the other benefits, when people are communing, the other types of happenstance interactions when people are in the same place, that is one of the important benefits I think of bringing people back to the same location. I think as far as good or bad, I don’t think I’m in a good place to answer that, but I would say that when investors are thinking about the durability of a company’s strategy, they’re often going to look at corporate culture, and it’s very hard to have a corporate culture when everybody’s in disparate locations. You very often need to have interactions where people can commune and talk and discuss what’s going on.
Host: I did see too that Dr. Scott Gottlieb saying that offices that mandate employees be vaccinated don’t need more COVID precautions, so certainly, if we do see more vaccinations, perhaps less masks, more collaboration, more productivity, right, this is all the future of work, impact on the economy, thus the stock market that we’re thinking about big picture, we do see some of these earnings come in, and I think that we’ve got the Airbnb ones ready. I know my producer’s going to jump in my ear and tell me whether or not we can get to those as we see these results come down the line. Christopher, I do want you to stick around as we digest some of these results. For a company like Airbnb, I mean just big picture, is that a company that you think will benefit in the year ahead?
Christopher: So we think that companies that are in the leisure sector, so put Airbnb just broadly in that sector, can do well on two fronts. The first is the recovery. Remember, they were hit the hardest, and they’re likely to recover the most in a lot of areas, but we think it’ll be bumpy. But here’s the other piece of the puzzle. Why we have confidence that the economy will continue to grow is because if you look at the United States by, say, metropolitan areas, 90% of the GDP of this country is in the metropolitan areas. It also happens to be that that’s the areas where the highest vaccine rates, there’s a highest adoption of vaccine, masking, etc. It’s not perfect, but we have confidence that the GDP story, and hence the recovery, and hence back to your leisure story, actually plays out relatively well through the balance of this year and into next year, so yes is your answer.
Host: We got the Airbnb results. Those shares are down. We got the Disney results. Those shares are up. It would really seem like, even though Disney can be dubbed the stay-at-home stock because of its streaming service, it would really seem like a full economic reopen is what this company needs to sustain its stock price going forward, knowing that parks and resorts are such a big part of its overall business.
Christopher: Well I think broadly speaking, the reopening trade in many of these stocks that are sensitive to it is largely built in. Not all the way — there’s still more to go, particularly as you’re talking about the improvement in job growth, talking about the improvement in, say, release of spending. A lot of people have been concerned about COVID and the effects of it, and what they’ve done is they’ve decided to save a lot more, so there’s a lot of money of savings on the sidelines. Some estimates put it between 3/4 and almost $1 trillion of excess savings. Some of that can go right back into the economy, so not that it’s going to happen all at once, but there is a pool there is what I would suggest that you can continue to see people travel, continue to pick up on leisure activities over the course of the next several months, certainly as either a combination of vaccinations rise or COVID / the delta variant abates and becomes less of a concern.
Host: Mm-hm. Now it is interesting here, Disney with a strong pop after hours, not quite at a record high, up about 4.5%, looks like just about 16 bucks shy of an all-time high. Airbnb, you know, this is kind of a tricky one, because obviously we’ve benefited from more travel, but you could still argue, if Facebook, for instance, is delaying as it is, we learned this afternoon its return to work until 2022, that could be business for Airbnb. Christopher, in that particular sector, how is Airbnb positioned? Do you think that this is a company that can weather the continued weight of the coronavirus?
Christopher: So broadly speaking, if you’re talking about a lot of the vacation, vacation rentals and other kind of business models like Airbnb, they’re asset-light — they tend to do relatively well, and they don’t need a lot of revenue changes to generate a reasonably good earnings margin. So at least as they kind of cover their cross space. I think specifics on Airbnb I’m going to leave to the side, but I think when we talk about an industry like that one, they’re relatively well-positioned, particularly as we talk about travel picking up, the desire for, I think, older travelers to have unique or differentiated experiences, there’s ways that shops like Airbnb can offer those things, so the opportunity set I think still remains relatively good for demographic and savings-based reasons. I think the real challenges in the near term are related to COVID, to vaccinations, and you know, remember, many of these places are far away. You’ve got to get on a plane to travel, so there’s a whole interrelationship between not just what happens at, say, Airbnb or other companies like that, but all the other necessary steps in the travel chain.
Host: We know food delivery has been hot, hot, hot during the pandemic. I think the big question is, will it remain that way heading into the new year? What is your take on this, and perhaps this space more broadly?
Christopher: Well you know, I think convenient-based strategies are going to remain really warm, if not hot, at least over the next several quarters, if not well into ’22 and ’23. One thing COVID taught us is that people will pay for convenience. But what it also taught us is that the cost of service in many of the business models still needs improvement, still needs refining. The last thing it taught us is that investors are willing to pay for the growth here, and so where you get short-term periods where the stocks may be ahead of the growth expectations, and maybe more modest growth expectations need to be built in, that can be part of ultimately how investors react to the news, but I think as I mentioned at the outset, the expectation is that the convenience paying approach with consumers having a lot of savings on the sideline we think is likely to continue well into the next several years, so I view this more as an industry secular trend that looks pretty constructive.
Host: Pretty constructive, I think probably people would agree with you there, even though again, we do see investors punishing shares, after hours, that stock now down about 4%, well off of its all-time high of 256 bucks a share, currently at $181 a share on the after hours, down about $7 from where it closed on the day. Does have competition though, right, I mean ghost kitchens, that’s something that it needs to look out for, perhaps something that it could capitalize on. Is there a moat around these businesses that you think can transcend beyond just the next few years?
Christopher: Well I think the challenge for many of these asset-light and technology-driven businesses is that the Amazon model, which is what many of them shoot for, is very challenging and takes a long time and a lot of capital to get to, so Amazon’s built an entire ecosystem, as an example, Tencent’s done it and a few others, and once you have that ecosystem, that’s ultimately where you start to turn a lot more in terms of cashflow and profitability, but you’ve got to get to that, you’ve got to diversify your offerings and you’ve got to continue to manage your existing customer base and your cost of service, so those are all the complicated interactions that need to happen in this space, so when you talk about a moat, unlike say an energy company or a materials company with patents, they’re not always in the same space. They’re much more about, how can they build the ecosystem, deliver a high-quality service and retain customers so that the lifetime value of them is ultimately what you can capitalize on as a shareholder?
Host: You know, one of the things that I think’s important, and you know, you could put DoorDash in this category broadly speaking, you could put Airbnb perhaps in this category broadly speaking, but one trend that we did see today is big technology led the way, even as interest rates or bond yields rose. That would seem to be a positive for the market. Christopher, I’d love to get your take before we wrap this particular segment, just the fact that we’ve seen tech fall in the wake of higher rates, but today, we saw both rise. Does that indicate where we could be headed from here in this market?
Christopher: You know, I think on the one hand, a lot of wacky things happen in the summer. There’s not always as much liquidity as you want, and I think investors are looking to try to position ahead of the third quarter, so I don’t know that it’s an indicator if it’s only one data point. I think more broadly though, the trends are constructive, at least for the economy going through the balance of this year and next year, and I think the tech story actually could improve a bit as the year opens, as the year goes on, because you might see some reopening of trade and some opportunities in Europe, and potentially, if things with China simmer down, we get into a little bit better place there, so right now, tech’s got some good expectations built into it. I think the acceleration we’d look at from, say, Europe or kind of a more multinational revenue stream, is an important piece of that puzzle. So while interest rates are rising, that’s the other part of the story, I don’t think they’re rising enough to matter. We have to say, for example, get to 1.75 or maybe even closer to 2% on the 10-year before some of those tech stocks will start to take notice, and it really would take probably closer to 2 1/2 to 3% for you to really start to hurt P/E multiple, so we’re a ways away.
Host: All right, Christopher, we’re going to leave it there. Thanks so much for sticking around this past half hour, and that’s Christopher J. Wolfe, Chief Investment Officer at First Republic Private Wealth Management.
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