Episode Transcript
The Finance Ghost: Welcome to episode 225 of the Magic Markets podcast, which is where Moe and I have a little bit of fun each week talking about the markets that we know and love and that we sometimes hate - and sometimes hate us and sometimes love us! Moe, it really is a love-hate relationship and it does vary.
And with the market having rebounded so strongly from everything that's happened with the tariffs, it's a bit of a love relationship again. I bought a few dips and they seem to have worked out because the US market appears to just go up and up forever and ever and ever and ever. I suppose time will tell about that. And that's what we're going to talk about today, is some of the recent interesting macroeconomic stuff - surprise, surprise - that's come out of North America, including some credit rating activity around the US government. Dun, dun dun. That sounds like a South African story. What is going on there?
Mohammed Nalla: I'm laughing, right? Because hopefully we're not the only ones having fun. I hope our listeners are having fun on this as well. And let us know on social media. Hit us up. It's @MagicMarketsPod, @ Finance Ghost - I normally do that blurb at the end of the show…
The Finance Ghost: Just don’t - don't let us know if you're not having fun. If you're not having fun, that's fine. Just do that quietly.
Mohammed Nalla: Absolutely let us know if you're not having fun! Let us know!
The Finance Ghost: Don't make our lives harder than they are already.
Mohammed Nalla: Ghost, we're not just shooting the breeze, right? I think we've been covering a lot of macro recently just because there's a lot happening in the macro space. I mean, one week it's tariffs, the next week it's not tariffs. Then it's a US credit rating downgrade. Yes, not exclusive to South Africa. I don't think the US is currently at risk of being junk or sub-investment grade, but a credit ratings downgrade, people get worried when they see this.
And I remember looking over the course of the weekend because the news broke last week after markets had closed late on Friday. And so lots of chatter on social media saying, oh, this is going to be terrible for US markets come open of futures on Sunday night. Remember, futures can actually trade outside of normal market operating hours. And I was sitting there looking at this saying, well, no, not if history is anything really to go by because we've had credit ratings downgrades for the US before and the market largely shrugs that off.
So we want to unpack why that is the case. I mean, if you look at the market's reaction, pretty muted thus far, we haven't seen much of a negative reaction. I think, Ghost, you've touched on a very important point and that is US markets seem to be going up, up, up in a straight line. We had a little bit of a wobbly. I'm glad you actually bought some stocks on the dip. Those will have done really well. But we're now reaching levels where the bulls actually have to decide whether they can sustain that move just on a technical basis or the bears really need to take the bull by the horns and actually force the market lower. And you're waiting for that to resolve.
Now, against that backdrop, having a credit rating downgrade is obviously not a good thing to have. And that's why it's remarkable that the market hasn't reacted very sharply to that, because it's probably looking for reasons to resolve whether we go higher or whether we go lower. And one interesting data point that actually picked up is that recent retail investor activity has picked up. They've been buying the dip, if you want to call it that. Institutions seem to be pulling back a little bit. And again, we need to see how that resolves because usually the institutions tend to be ahead of the curve. But given just how markets have been so volatile recently, you could argue that institutions are a bit on the back foot.
I'm cautious. My long-only portfolio has significantly lower volatility than the US S&P 500. I actually was looking at it this morning to say, how have I done over the last six months, the last 12 months, and on a relative basis when the S&P was down very sharply, I wasn't. But similarly, when it's rallied very sharply off those lows, I haven't actually enjoyed a lot of that upside. It kind of just behaves in a very low volatility manner. Again, that's by design. I'm very happy with that. It helps me sleep easy at night. But let's see how this resolves.
Let me jump into the US credit rating because that's where you started this off. We had Moody's downgrade the US from AAA to AA1 on Friday. Now, they are the last of the big three ratings agencies to actually move the US down from that highest tier that you usually get. Now, why is this important is that, remember, the US risk-free rate is effectively the de facto global risk-free rate. And this last, let's call it nail in the coffin - like I say, they're just playing catch up with S&P. They're playing catch up with Fitch. And the market largely expected this because we've been speaking for the longest time around some of the fiscal pressures that the US is facing.
If you ask me, I think some of the market's reaction to the downside, marginal as it may be, is not really related to the actual announcement of the US ratings downgrade, but it's rather related to the fact that concurrent with this, we actually had the US - remember, you've got Trump with his big budget bill coming through, he's trying to get that through Congress, they haven't come to an agreement yet. And that bill is set to actually add $3.3 trillion to the US deficit over the foreseeable future. Now that's a big number and that certainly gets people's risk flags up. They're saying, how sustainable is this US deficit?
Trump came in saying, hey, we're actually going to look at trimming the deficit, but his budget actually does the complete opposite of that. And I think that is some of the reason why you're seeing this bifurcation in terms of the equity market’s - let's call it - resilience.
But then if you look at the bond market and a lot of people will tell you watch the bond market because at the end of the day, the bond market is the bully. That's the cost of funding for the US Government. The bond market hasn't reacted favourably to the ratings announcement. It's not reacting favourably to the fiscal metrics. You've actually seen the US 10-year yield, the US 30-year yield, those have been trending higher. And that is a cause for concern simply because the US has a lot of refinancing risk, they've got a lot of debt that's coming due this year. They're going to have to refinance that. And, as they refinance it with a 30-year yield close to around 5%, that's going to actually bake in some of those fiscal deficits as the interest costs remain quite large.
Now, last point, and then I'll pause here. The US can do this for a very long time because they enjoy that exorbitant privilege of being the world's reserve currency. I'm not going to get sidetracked if we want to discuss that. Ghost, you can actually jump in, you can ask me some questions. But that is the only reason why the US keeps on effectively writing the cheques. The question is how long can that actually continue? And the fact of the matter is, I think it was Keynes that actually said the market can remain irrational longer than you can remain solvent.
The Finance Ghost: Yes, absolutely, which is why I'm happy to have all of my positions as just outright positions rather than on leverage where you can very easily just get closed out. I think that's one of the points I wanted to make actually is that you were talking about how retail has kind of dived back into the market and institutions are being more cautious. This is where I'm actually so grateful for my time horizon of investing. I'm only 37, so for the benefit of listeners who don't know that. So many, many years to go until I would even think of retiring. And honestly, I can't even imagine what I would do with my time if I did retire. But be that as it may, I’ve still got decades. And that means that when the markets have a wobbly and I look at this and I say, wow, these are great companies, I really want to own these forever, I'm pretty happy to just buy that dip and go along for the ride because if they dip more, I'll just buy more. And if they come back, then great. I'm not looking to sell. Now I would say the thing I've regretted most in the markets over the past few years is the times that I've sold. Obviously that's easy to say because we've been in a time of fiscal - just loose monetary policies, right, and equity's going up and everything else. I might feel very differently if the market had come down or gone very sideways the past few years, but I do try and take that into account when I look at these positions and I decide what to do.
And it was quite interesting - I've got some notes that I'm keen for us to touch on later from this JPMorgan Investor Day - but some of the comments that Jamie Dimon made were around how complacent central banks are at the moment - that's the exact word he used - at a time of budget deficits. And then he went on to use the word complacency again in the context of the markets and how things have just bounced back despite what's going on out there.
So that seems to be the thing that's bothering him at the moment is people are just shrugging off what's happening, the tariffs and what's happening now with the credit rating of the US. I think you should expand on that point around the reserve currency. But you know, is that what you're seeing as well? It's just complacency? Would you agree with our hero Jamie Dimon there? Look, he's a hard man to disagree with. So, I'm almost giving you no choice here.
Mohammed Nalla: I'm not going to disagree with Jamie Dimon on a couple of points. First and foremost, I think we have to actually just couch this because we've gone through an era where we've had fiscal largesse. You've had fiscal deficits, lots of expansionary fiscal policy, certainly in the wake of the COVID pandemic. At the same time, you've had monetary largesse, you've had easy and cheap money. The fact that rates trended slightly higher from those COVID lows, it's still at multi-decade lows, so again, you're waiting for a resolution around that because on the one hand you've got fiscal hawks calling for fiscal consolidation - whether they can actually get that across the line is questionable, it's a lot more difficult, politically speaking. And then you've actually got the central banks and they've been the responsible party to a large degree.
I'm going to get shot for saying this right, but central banks have been relatively more responsible. I say relatively because money's arguably still cheap. You could argue that when inflation was running quite hot, central bank should have done a lot more in terms of actually pushing rates a lot higher. The US economy has run so hot for so long and that creates some of those distortions. Now if you looked at the Fed's recent commentary, Jerome Powell is effectively saying: we don't know. He's looking at the same data that you and I are looking at. And he says in this era of economic uncertainty, you don't know where fiscal policy is going to go. Arguably with a $3 trillion addition to the fiscal deficit, that's fiscal expansion, that creates inflation on top of the tariff risk to inflation. And so Jay Powell is actually saying, I shouldn't be cutting rates where we are right now, so he might push back a little bit against Jamie Dimon saying, we're not complacent, we're just waiting for some of these risks to resolve because we don't know whether those risks are to the upside or the downside.
And right now, if you ask me, I think the Fed's assessment is that the risks are to the upside on inflation. The only time where the Fed would need to capitulate and actually cut rates very aggressively is if those tariff headwinds then filter directly into slower economic growth. And the fact of the matter is that the US economy has been running hot. If the fiscal taps remain open, that's going to keep that game going for a little bit longer. And the problem with that is that it arguably then plays through into the Fed actually keeping rates a little bit higher rather than capitulating and cutting those interest rates.
So that's the dynamic there where I kind of agree with Jamie Dimon. There's a lot of complacency. But I would argue the central bankers, they're not really the pressure point here. The pressure point’s coming from the fiscal side of the equation. That's where there's a lot of work to do that needs to be done if the US is in fact concerned around the fiscal situation.
Now, I say big “if” because going back to the point around the US dollar, it's the global reserve currency. A couple of key stats here. You know, people don't realise this, but if you look at any debt outside of the US, predominantly that is denominated in US dollars. And so there's this chronic US dollar shortage that exists globally. And you see this in times of crises, the US dollar, for example, during the pandemic, had to go - the US regulators actually go and extend swap lines to make sure that there wasn't a dollar liquidity crunch. Because if you have that, the financial architecture starts to unravel. And that tells you that that global dollar shortage is something that is structural. It's probably not going to change for a very long period of time unless the world starts to reorientate around the US dollar.
Now, I've always said talks about the demise of the US dollar are certainly premature. We're still pricing - almost every single commodity in the world is priced in US dollars. Everyone references the US dollar as the cross-rate for their currencies - if you're going from for example South African rand into Thai baht, you're going to go rand to the dollar and then dollar to the Thai baht, you're not going to go directly to the Thai baht. And so those kinds of structural, let's call it safeguards are what keep the US dollar in demand globally. And that is a structural thing that doesn't change over time.
If we just match up one last data point and then I'll pause there, Ghost, if we match up what effective dollar supply is and this looks at real physical dollars and just overall financial dollars in the system, that's roughly around $25 to $30 trillion. But if you then imply what global demand for dollars is and this would be debt, it would be just use in trade, it would be foreign currency reserves off sovereigns like South Africa and just overall transactional demand that comes through between $40 to $50 trillion. And so that $10 to $20 trillion gap, that's the chronic global dollar shortage that allows the US to keep writing the cheques and to enjoy that exorbitant privilege.
Does it break? Well, time will tell. Rome wasn't built in a day, but also wasn't unravelled in a day. But I think this is like a 30-year mega trend that if you're concerned you're going to pay attention to that. And again, the crypto and bitcoin maximalists are saying this is exactly why you shouldn't be holding dollars. You should be using crypto for example, as your store of value. You know me, I like gold. Gold's come off a little bit. But at the end of the day, there's a very strong point here to say that fiat currencies are risky over a very long multi-generational timeframe.
The Finance Ghost: Absolutely Moe. It's super interesting stuff. Look, it's a little bit outside of my wheelhouse - I'm the first to admit it - on all the macroeconomic stuff and the currencies and I'm super glad that we have you to just keep us appraised of all this stuff. I’ll tell you what is in my wheelhouse is digging into company updates and transcripts and looking for goodies in there. So shall we move on to some of the stuff that I gleaned from the JP Morgan investor day or is there anything else you want to land around the beloved dollar?
Mohammed Nalla: No, let's definitely get into JPMorgan. I mean it's the investor day. I know you love Jamie Dimon, right? But what I maybe want you to do, Ghost, is look at the prevailing narrative, but also where you can poke holes in it. Because for me, it's sometimes what people are not saying rather than what people are saying. We know Jamie Dimon is the elder statesman. We know Donald Trump supposedly does listen to Jamie Dimon. What did that transcript say to us, Ghost? Or more importantly, what didn't it say?
The Finance Ghost: I'm going to surprise you now because I've got to tell you that I think some really interesting stuff actually came from the CFO Jeremy Barnum. Which is not to say that Jamie Dimon didn't have some interesting stuff to say around complacency, etc. etc. - and I don't think we should dig too much into the JPMorgan story because some of our premium subscribers will probably want us to do that the next time we do JPMorgan, a company that we did actually cover recently, it is a core long position in our portfolios. In the world of US banking, JPMorgan is pretty much the one that you want.
So I'm actually going to focus on Jeremy Barnum. He's the CFO. Kudos to him for largely excusing himself from the Q&A because he had his daughter's college graduation shortly thereafter. He has his priorities straight, although you do wonder how they managed to plan an investor day on the same day as his daughter's college graduation.
But be that as it may, he had an incredible line and I just have to share this: he said, you cannot outgrow us. Isn't that just the most US-based comment you've ever heard in your life? Right? The US self-belief and borderline arrogance is just amazing. It's why they've built the things they've built. There's no one in Europe who is going to say that - the European business culture just cannot comprehend a comment like “you cannot outgrow us”. And then he goes on to reference 84 million US customers, $4 trillion in AUM. Over 90% of Fortune 500 companies do business with JP Morgan. Now, he's probably right, but just what a remarkable thing to say. Isn't that great?
Mohammed Nalla: The Chinese may have a thing or two to say about that. I know their banks have bigger asset bases than JPMorgan.
The Finance Ghost: No, fair enough. And there are many companies that have gotten it wrong on think that they'll never be disrupted, but it does show you how strong they really are.
Another great comment from him that I thoroughly enjoyed was talking about and I quote, “the folly of looking for constant operating leverage and ever-expanding margins” - so basically what they are saying is we need to keep investing in order to keep making money. And we make more revenue than we spend on an incremental basis. But don't think that we're just going to expand margins forever and ever and ever. That's not real life. And something I've always enjoyed with the JPMorgan management team is just how - not just how blunt they are, but just how sensible they actually are. They just say it how it is and they're right, how can you possibly have operating leverage forever? It means you're under-investing in your business, you look good for a few years and then everything just falls over. This is why I like to invest in management teams who are there for the long haul.
Something that I really did enjoy as well was their comments on AI. And Barnum talks there about how he's been and I quote “vibe coding” with the help of AI. So just a little throwaway comment there about how clearly he has too much spare time because he can try and learn about coding using AI. But then he goes on to talk about how 200,000 of their global employees have access to their generative AI platform for just general tasks and efficiency gains, etc. So nice to see AI in practice, I guess.
Another interesting comment that came out of all of his prepared notes was around how they forecast the unemployment rate and the related impact on credit losses. Now obviously this is an ever-developing story. What will the unemployment rate look like? Obviously tariffs have an impact here. All the macro stuff you've talked about, but I think this was the point that I wanted to land was less about the specific percentage they're looking at, at the moment, and more about how difficult it is and how the numbers happen first and then the reality. And what I mean by that is they talk about how the outlook changes instantly, but the actual deterioration in the unemployment rate takes five quarters. I enjoyed that a lot. So basically, they're having to look ahead and say, well, we think this is where unemployment might get to, hence our credit provisions need to be X. But in reality, it doesn't happen like that overnight. You don't suddenly jump by 50bps in unemployment, for example. It happens over several quarters and then it's showing that they were either right or they were on. This actually shows you some of the variability in this banking space.
Mohammed Nalla: Indeed. And I want to jump in there because it's part of the reason why we love covering the banks. Certainly a bank like JPMorgan, like you say, we've covered it quite recently in Magic Markets Premium again, and that's because sometimes it's what they're telling you, sometimes it's what are they doing with their provisions. That's giving you a very good read-through from probably one of the apex players in the industry in terms of what is the economy likely to do now. They're not going to get it right 100% of the time.
But if you're out there looking for leading indicators, if you're going to use that - and how I generally use it is I would take that through into: how am I allocating across sectors? Am I allocating more defensively? Am I allocating more cyclically? You know, playing for that.
I get a lot of that read from the company transcripts and the bottoms-up analysis that we're doing in Magic Markets Premium. Because it's not just the banks. Remember the banks cut across multiple segments, multiple industries. That's why the banks are very useful. But you also get that from a number of other companies. What are they doing with capex, what are they actually seeing?
And you're going to have to actually read, you know, transcripts across different sectors and then at the same time transcripts across different quarters as well because remember these things take a very long time to play out. There are lots of moving parts, very valuable and again, it's why I'm so interested in what you picked up out of that investor day. Because sometimes I pay a lot of attention to the earnings calls. You get some of this coming out of there. But pay attention to the investor days as well because sometimes, like I say, it's what they're saying, sometimes it's what they're not saying. That's a very useful data point, Ghost.
The Finance Ghost: Absolutely. So a couple more nuggets before we bring the show to a close. The NII guidance, that is their net interest income. This is your core banking lending activities - guidance is a little bit all over the place and they point out that it's really hard to know right now what's going to happen with interest rate cuts and what happens to the curve. No one is quite sure what's going to happen this year with NII, but here's the interesting thing: their guidance is $90 billion at the moment (roughly) and they expect expenses to be around $95 billion. So it's just a good reminder that the bank is profitable because of non-interest revenue or NIR. It's a slightly cheeky conclusion to draw because some of those expenses are obviously supporting NIR, not just NII, but I think it shows you and it's a point we raised when we covered JPMorgan in our premium research, that this is where the variability of returns actually comes from in this banking environment is that NIR is particularly difficult to forecast. And that's pretty much where their margin sits at the end of the day, that's the profit that they make.
And despite all the economic noise, they are still comfortable at a 17% through-the-cycle target for return on equity. Now, I can tell you, most South African banks cannot even do 17% in rand, let alone in dollars. So that is a big part of why I remain very happy with my long JPMorgan position. And just to finish off, I think Jeremy Barnum gave such a little masterclass on capital allocation towards the end of his prepared comments. He talked about their willingness to deploy capital below 17%. And he kind of pre-empts a question. He explains that, you're going to ask me why we don't just take money from our low earning operations and put it into our high earning operations, and he makes it very clear that the constraint for their high return on capital businesses is not capital availability. Obviously the amount of capital available for that business is theoretically infinite. JPMorgan's balance sheet is much bigger than those businesses need.
And that's the point - their growth constraints are something different. It's a level of demand in the market or whatever the case may be. So businesses with a high return on capital can grow as fast as they want basically, as fast as the market will let them, because the capital is always available to them. Then JPMorgan looks at it and says, right, well our high margin stuff is pretty much capped out here, now what do we do? Now they look at their lower margin businesses and now what do they have to decide? Do we put more capital into those or do we go and do share buybacks?
And that's where they then go and do the analysis to say, okay, well maybe something makes a return on equity of only 16%, that's below our group average. But because of where their share price is trading at the moment, it's still a better investment than the effective ROE that they get from buying their own shares in the market. So share buybacks remain less appealing for them than deploying capital into their lower return on equity businesses. And they finish off this beautiful little masterclass by explaining that return on equity should be thought of as an output, not an input. In other words, their internal hurdle rate is not 17%.
Possibly just some finance geeking out here, but I've got to say I quite enjoyed that from Jeremy Barnum. And then he went off to his daughter's college graduation. Mic drop. Goodbye. Thank you. See you for my next bonus. Beautiful. What a life.
Mohammed Nalla: Yeah, when you look at that JPMorgan management team, really solid, really strong, you'd probably struggle to find an executive team as well seasoned at what they do than JPMorgan. The interesting play-through for me, Ghost, is that we can just start joining all of these dots together, because what was on that investor call you can then filter through in that JPMorgan doesn't know what's happening on the yield curve. But we've just covered Simon Property Group, for example, that's a retail REIT in the US, the biggest one there, and we discussed the interplay from the yield curve into what that means for that specific business.
So the value of this Magic Markets ecosystem is being able to look at JPMorgan, what's happening under the hood there, what's happening in the investor calls. It's then drawing the dots between that and what we're seeing in different sectors. It's when we looked at Berkshire Hathaway, for example, we had some very interesting capital allocation nuggets coming out of Berkshire Hathaway. And so as a listener to the show, you're really getting to tap into very valuable knowledge streams that exist out there. You've got to look beyond your wheelhouse to some of the best, brightest minds out there in the industry.
And that's not necessarily us - that's the CEOs of JPMorgan, that's the CEOs of Berkshire Hathaway - draw the lines between what all of these companies are telling you, and it becomes a real treasure trove in terms of how you navigate your own investment journey.
Ghost, unfortunately that's where we've got to leave it this week. Let us know what you thought of the show. Hit us up on social media. It's @magicmarketspod, @financeghost and @mohammednalla, all on X or go and find us on LinkedIn. Pop us a note on there.
Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
