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Absolute Return Podcast #24: Here Come the Rate Cuts

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July 29, 2019—T-Mobile And Sprint Win Antitrust Approval For Their Merger. What Did The Parties Do To Obtain The Nod From The DOJ? 

CannTrust CEO Fired And Chairman Resigns As Scandal At The Cannabis Firm Deepens. What Happens Now?

U.S. Economy Grows At 2.1% In Q2, Beating Expectations. Is The Fed Still Going To Cut Rates?

ECB Signals Upcoming Rate Cut And Potential Relaunch Of Monetary Stimulus. Why Is More Stimulus Necessary? 

Regulator Opens Review Into Big Tech Firms’ Market Power. Why Is The Regulator Concerned?

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Transcript

Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.

Julian Klymochko: Welcome investors to Episode 24 of the Absolute Return Podcast. I am your host, Julian Klymochko.

Michael Kesslering: And I am Michael Kesslering.

Julian Klymochko: Today is a lovely Friday, July 26, 2019. It is hot out there. We are stuck inside reporting on a lot of important events that occurred in the market. Everything from regulatory to global macro to fundamental company performance. I mean, we are right in the midst of Q2 reporting season. A lot of companies reported Q2 results this week, which we’ll get into.

    • We will start off with T-Mobile and Sprint. They won antitrust approval for their merger. What did the parties do to obtain the nod from the Department of Justice?
    • CannTrust the beleaguered cannabis firm. They actually fired their CEO and their Chairman resigned as this scandal really deepens. We are going to talk about what happens now.
    • Some economic growth figures. The U.S. economy grew at 2.1% in the second quarter, beating expectations. Is the Fed still going to cut rates next week?
    • The ECB, the European Central Bank, signals upcoming rate cuts and a potential relaunch of monetary stimulus. Why is more stimulus necessary in the Eurozone economy?
    • Finally, a regulator opens review into the big tech firm’s market power. Why is the regulator concerned about these big tech firms?

Julian Klymochko:  A big win for T-Mobile and Sprint shareholders, along with merger arbitrageurs as the Department of Justice announced that it is going to approve their 26 billion dollar merger. T-Mobile, the nation’s number three carrier by subscribers and number four Sprint, have spent weeks negotiating with antitrust enforcers, the Department of Justice and each other over the transfer to Dish Networks. Who as a third player here for the building blocks of a network, effectively a new fourth competitor, of which Dish will be to satisfy regulatory concerns that their more than 26 billion dollar merger would hurt consumers by reducing price competition in the mobile offering market. This approval came after the parties agreed to divest assets to Dish Network in enough effort to create a strong new fourth competitor. What is happening in this merger? T-Mobile number three is acquiring Sprint number four. And without this new player Dish, which just offers satellite TV services, they’re looking to get into the mobile space. Without Dish, the regulator did not want to see only three options for U.S. consumers. The strategic rationale behind the merger of T-Mobile and Sprint, which they have really been working on since pretty much 2013. So nearly six years for them to finally get approval. This deal would deliver 5G network with lower prices, better quality and thousands of jobs while unlocking 43 billion in synergies. Now, I believe that is not at all an annual number. The 43 billion would be the present value of the annualized cost savings in the deal.

Now, this union of T-Mobile and Sprint, which was years in the making, as I said, almost six years. This would create a wireless company, surpassing 90 million U.S. customers. And this is really closing the gap versus Verizon and AT&T, which are both roughly 100 million wireless subscribers. It does not really push them ahead of what T-Mobile CEO John Legere claims Dumb and Dumber referring to AT&T and Verizon. They are still going to be number three, but a much stronger number three player in competing against Horizon and AT&T. Now, the Justice Department and five state attorney generals, they stated they are filing a suit to enforce the settlement conditions that also include selling the Virgin Mobile and Sprint prepaid brands and providing Dish with access to 20000 cell sites and hundreds of retail locations. So that what the DOJ is agreed that T-Mobile and Sprint need to do is really support dish divest these assets to Dish such that Dish is a strong fourth competitor off the bat. They are divesting their prepaid brands to dish and then giving Dish much operating support as it enters the mobile space. In addition to that, Dish has agreed to acquire spectrum in a deal valued at 3.6 billion. And for this prepaid business, they’re actually paying 1.4 billion dollars. That gives them 9.3 million subscribers right off the bat.

The FCC Chairman, Ajit Pai and the FCC, the Federal Communications Commission is another federal regulator in the US. They previously backed the deal a few months ago. They said Friday that the Justice Department settlement, coupled with T-Mobile and Sprint’s earlier commitments to deploy a nationwide 5G network, which is why the FCC initially approved the deal, said it will preserve competition add advance U.S. leadership in rolling out next generation networks, which was really important to the regulators here. And even the president, Donald Trump, wants to see the U.S. become a leader in 5G. And many of the players involved here indicated that this merger was really key to advance 5G in the U.S. Interesting to note that the FCC and the DOJ really haven’t disagreed on a deal in decades, I think since the 1970s. This deal is kind of falling in line where they both agreed to approve it. This deal still faces one small challenge. A group of U.S. state attorney generals. They filed a lawsuit in federal court in New York to block the merger on antitrust grounds. They argue that it will cost customers 4.5 billion dollars annually. I don’t really see this as blocking the deal that could add to some delays. But ultimately, they typically fall in line with the federal regulators. Nonetheless, market participants, shareholders of the two companies, really liking it. Sprint up 7.6% on the news today. T-Mobile up 5.2%, so really positive news in the mobile space for Sprint and T-Mobile. With the DOJ approving their merger, what are your thoughts on this regulatory action?

Michael Kesslering: Yeah. When I saw the news this morning, I also saw a tweet that pointed out that when Legere took over T-Mobile, they were the number four player that had poor infrastructure and retail locations. They could not even sell the iPhone, and now they have surpassed the number three player and also convinced regulators to allow a 3-4 merger. So if you would have asked investors back when he took control of T-Mobile if he was going to be able to do something as drastic as this, I mean, that’s pretty crazy performance. And then he’s also compounded returns for investors in that timeframe as well. I mean, obviously, the DOJ, as you mentioned, they are concerned with the rollout of 5G networks. So that was a big aspect, is that they believe that they can roll this out faster because of the merger. As well with the divestiture of the Boost Mobile and the prepaid business. I believe that Dish Network has been acquiring some spectrum in the auctions over the last couple of years in addition to these subscribers that they already have. Do want to comment a little bit on the strength of this fourth player that that is now being created?

Julian Klymochko: It is interesting to talk about Dish because its founder and CEO Charlie Ergen. He is a quite interesting character, back in his younger days, he was professional card player, and he is well known in deal negotiations for being quite difficult and bluffing. A real savvy negotiator and some interesting history. Dish actually bid on Sprint a while back, way back when Softbank acquired a controlling stake in Sprint. Softbank had a friendly deal to acquire controlling stake in Sprint. I believe this would have been maybe 2011 in that range. Call it seven-eight years ago and Dish came over the top, lobbed in a much higher offer. Forcing Softbank to pay a materially higher price for their Sprint interest. So some interesting dynamics between those firms and for a long time, as you indicated, Dish has been acquiring a lot of spectrum, fuelling market speculation that they are going to get into the mobile business at some point because their satellite TV business is really in long-term decline. Everything is going to streaming, and so they are looking for areas of growth. They focused on the mobile sector and they have long been a rumoured bidder of T-Mobile. But as T-Mobile fortunes have really changed, as you indicated, since John Legere came on as CEO in 2013. He has really just absolutely crushed it. I think his performance as a CEO has been legendary Hall of Fame worthy. He is certainly one of the best CEOs in American business.

Michael Kesslering: And most interesting.

Julian Klymochko: Oh, yeah, quite the character. I encourage everyone to follow him on Twitter. Very entertaining guy, especially on their conference calls and just berating his competitors, making fun of their results. And, you know, he also walks the walk as he talks about them because their results have been nothing but outstanding. As you indicated tremendous results. The stock has compounded a 30% annualized since he became CEO in 2013, which is pretty tremendous performance. And operationally, T-Mobile has just been absolutely kicking ass there, believe their stock hitting a new all-time high today, not just on the positive deal announcement, but also continually exceptional quarterly results, which they just reported yesterday. And so all things going very well at T-Mobile and they’re looking to consolidate Sprint there and Dish becoming a fourth player in the business.

Another thing I wanted to touch on is, is a merger arbitrage, where you look how this deal, what it was structured like when it got announced. As I indicated, there had been rumours over the past six years of these two parties combining. They actually had two false starts where the government indicated, no, we are going to block this deal don’t even bother officially announcing it because it’s not going to get approved. You look over that history now. You look how they officially announced a deal last year, as a merger arbitrage. You are trying to gauge the risk of the deal. The chance of success of the deal actually closing. The risk of the deal falling apart and you look back at it and really, no one could have ever thought. This is how it would go in terms of Dish coming in them creating a new fourth player with all these asset divestments to Dish. It is really interesting from that perspective and basically what arbitrage here would do. Is look at the risk reward basically on the first day, where there is all that liquidity and establish a position on that and basically play those odds that something’s going to happen in your favour. Which certainly was the case here as the parties came to this really interesting creative divestment agreement to bring Dish in as a strong fourth player into the market and ultimately get approval and look forward to closing this deal in the next few months. That was a really interesting dynamic there and we will no further see how these companies do in the future.

Scandal really deepening at cannabis firm CannTrust. What happened was embattled cannabis firm CannTrust. They fired their two most senior officials, including the CEO, Peter Aceto. They fired him with cause after media reports indicated that these top two executives, amongst others, knew of the company’s illegal production of unlicensed cannabis. The company’s Chairman and co-founder, Eric Paul, also stepped down after facing demands from the company to resign. Now they have a special committee investigating this whole scandal. What they are investigating is the breaches at the firm and these high profile departures that stem from the special committee receiving new information. So apparently, members of this special committee did not know previous to the media reporting. This management overhaul comes in the wake of evidence showing that both Aceto, the CEO and Paul, the Chairman, were made aware of the illegal activity at one of CannTrust facilities last year.

So to recap on what happened there, was federal regulators began investigating CannTrust back in June, after a tip from a former employee who turned whistle-blower, he alleged that he helped staged photographs. In CannTrust, Greenhouse in Ontario to hide the fact that plants were growing in unlicensed room. Now, since then, new information has come out confirming this whistle-blower allegation. In addition to numerous other infractions, that CannTrust really tried hiding from the regulator over the past nine months or so while Aceto was CEO. Now media post BNN Bloomberg, they obtained documents this week showing that Aceto told staff to, quote; “continue as planned with unlicensed planting back in November,” which is obviously a big no-no, if the tone of the top is that poor in judgment. Also, The Globe and Mail reported on an email from around the same time that was allegedly forwarded to Chairman Paul and that acknowledged Health Canada had missed cultivation in that unlicensed room.

The email stated that CannTrust, quote, “dodged a bullet when Health Canada missed seeing that hidden room.” But, you know, that bullet seems to have ricocheted and caught them. Internal emails showed that the pair and other CannTrust officials. So the CEO, Chairman all the way down, they’re made aware of the breaches of Health Canada regulations at their growing facility back in November, 7 months before the regular uncovered the illegal practice. So what’s happened since while the price of CannTrust shares, they’re down 60% since this news story broke back on July 8th. And, you know, this is really a company that is on fire, and that’s not in a good way. We have seen precedents in the Canadian market where the marketplace just really loses faith in a publicly traded company. Short sellers pile on and we have to disclose that we are, in fact, short the stock. We have been short the stock for a while. So some disclosure there but as I stated, a company on fire. Let’s look at some precedents. One was Home Capital Group that was another one. They skirted regulations, their stock price really tanked as institutional investors bailed out of the firm’s stock, and they really questioned the future viability of the company. You also saw it with Valeant Pharmaceuticals, a well-known massive blow up. I believe their market cap was north of 100 billion and they were in fact, the number one company on the TSX right before that whole story blew up and a smaller pharmaceutical blow-up was Concordia.

So these have happened in the past. What we have seen is that after these, massive blow-ups where market place participants, shareholders really lose faith in the story, you know, more and more bad news comes out and it seems like they never really recover. None of them went to zero or bankrupt, but their stock really tanked and really just stayed there. They never seemed to recoup their old highs. Actually, a correction, Concordia did go bankrupt. That was one that went kaput, but Valeant and Home Capital executing turnaround efforts. I mean, that is probably the best that you can expect for a CannTrust here. They are not selling any product at the moment. They put all sales on hold. At best, they will likely be forced to destroy a large swath of their inventory in the tens of millions of dollars. At worst, some analysts are speculating that they could face significant regulatory action on both sides of the border in both Canada and the U.S. ultimately face potentially losing their license, which would be a death blow to the company. What are your thoughts on this increasingly hairy situation? I just wanted to note the Buffett quote. There is never just one cockroach in the kitchen. You see one and then you are sure to meet their relatives in the days coming in, which is seems to be what is happening on CannTrust. I mean, the bad news is, keeps getting worse and worse on this file.

Michael Kesslering: Absolutely, and regarding Buffett, I mean, with Home Capital Group, he was the one who came in and effectively saved the company with his loan and basically loaning out his reputation to the company. CannTrust, I don’t believe we’ll be as lucky. I don’t think there’s going to be any white knight that comes in and kind of save the day. But you had mentioned that the stock is down about 60%, which is interesting because there still might be some downside here, as I believe it was analyst from Eight Capital had quoted that about 70% of their inventory balance is on hold currently. There still could be some downside here. Never really know in situations like these but as well, the ironic thing is that it was alleged I believed in the financial post that the CEO was even shown in a promotional video outside one of the illegal growing rooms in early 2019, which just brings this story to almost comedic levels, right?

Julian Klymochko: Yeah, just a total face palm. And I did watch the video and it was confirmed that he did record a publicly promoted video in which he is standing, being interviewed in front of an unlicensed illegal grow room.

Michael Kesslering: Which is very, very ironic and yet the other aspect is they raised two hundred million dollars U.S. dollars in May. And so it’s likely that there will be some shareholder lawsuits as insiders did sell about 30 million dollars’ worth of shares into that offering. So the underwriters of that offering, which includes some of the major Canadian banks, will undoubtedly not be happy about that and may look at legal action.

Julian Klymochko: More than likely. This is undoubtedly securities fraud, in my opinion. As you indicated, CannTrust doing an equity offering, a secondary equity offering of nearly 200 million U.S. dollars just in May. This was underwritten by Bank of America, Citigroup, Jefferies,  Credit Suisse. So clearly, a lot of institutional buyers there at a price probably over double the current share price. The worst part of this, as you mentioned, the Chairman, he was selling the stock in this equity offering while he knew about these illegal growing activities. That is just, you know, many people, I believe, would call that fraud. We will see how that situation plays out. But likely to be a messy legal situation both personally and for the company.

Another thing I wanted to touch on is you have this special committee investigating and potentially looking at all sorts of actions that the company would take. You mentioned in Home Cap, they found, you know, a white knight willing to back the company. On this one, on CannTrust, I have heard rumours of them potentially putting up the company for sale, seeking a white knight buyer. I am really sceptical that any company would step in here for two reasons. I mean number one. Just the unknown potential liability here. It is just far too risky for any acquirer’s board of directors to justify that type of risky deal when you really don’t know what sort of liabilities are attached to this whole scandal involving the illegal growing, not just that, but, you know, the securities issues behind the financing that they did while a knowledge of these illegal activities. And number two, then you look at the entire, you know, what’s going on in the cannabis industry. A lot of companies have done acquisitions of which they’re now paying the price. They are announcing large write offs from these past acquisitions. Everything from write offs, their stocks are down significantly because the acquisitions have not paid off as expected. Then some CEOs are even losing their jobs, the most high profile being Bruce Linton of Canopy Growth who actually got fired. He was really the face of the industry, but got fired for doing too many deals and really not focused in on operational efficiency, which is where investors are really laser focused at this time. So they are really encouraging their companies not to consolidate, not to do acquisitions at this stage of the game. I think that is a number of trends working against CannTrust as they are rumoured to, potentially be seeking a buyer.

Michael Kesslering: Absolutely and even if they do lose their license, that would be, you know, logically that might take them to the process of bankruptcy. So if you were interested in those assets, you would probably just want the normal bankruptcy process to work itself out and then look at the assets.

Julian Klymochko: Right and so wherever ends at here, I think generally investors know potential acquirers, even if they’re looking at this, everyone’s ultimately going to wait to see the results of this Health Canada investigation, which should be robust and lengthy. We probably won’t hear anything about it for a while. But at this point, I mean, no good news out at a CannTrust and it just seems to be getting worse and worse. Now, they had their CEO is out stuck with the interim CEO, so they will be looking for new leadership there, but this one is kind of rudderless at this point.

Going to talk some economic growth figures with the US economy growing at 2.1% annualized in the second quarter. Now this beat economist consensus expectations of 1.8% growth in the quarter. So strong numbers coming out of the U.S. for Q2. These strong economic growth numbers, they come amidst the expectation that the Federal Reserve is going to cut rates next week, which is pretty surprising because typically, as we discussed this in the past, the Fed typically cuts rates in dire situations to prevent recessions when unemployment is rising. But, right now we have record unemployment near 3.6%, economic growth figures coming in above consensus estimates.

Now, the longest stretch of economic growth in U.S. history. So it’s a really interesting dynamic, but it still looks like the Federal Reserve is going to come through with interest rate cuts next week, irrespective of these above consensus GDP growth numbers. Now, it is largely whether they are going to cut by 25 basis points, 0.25% or 50 basis points. Now, the market is pricing in effectively a 100% chance of a cut next week. They are pointing to 83% chance of the 25 basis point cut and a 17% chance of this 50 basis point cut. The effect that the strong economic growth number did have was reducing the market odds of that more aggressive 50 basis point cut coming through next week. Now, looking at all the components of the GDP figure, it reflected increases in consumer spending and government spending, while inventory, investment, exports, business investment and housing investment decrease.

Some quotes here. So one from Bloomberg economists stated that, quote, “The composition of growth toward consumer spending and away from investment will be sufficient to propel GDP modestly above trend.” Interesting tweet, President Donald Trump. Not quite the economist, but I guess he figures one on Twitter. He stated, quote, “Q2, GDP up 2.1%. Not bad considering we have that very heavyweight of the Federal Reserve anchor wrapped around our neck. Almost no inflation, USA is set to zoom.” exclamation mark, not too surprising to see President Trump criticizing the Federal Reserve as he tends to often do. Quote here from Capital Economics, chief U.S. economist. He stated, “This slowdown just about justifies a 25 basis point cut by the Fed next week, but the chances of a bigger 50 basis point reduction just receded further.” Another quote from the chief economist at the Conference Board, he stated, “If the U.S. economy maintains its growth rate above 2%, it can moderate the appetite for further cuts later in the year.” So certainly decreasing the probability of further rates, further rate cuts beyond the one expected next week. What are your thoughts on the US GDP figures and the whole rate cut issue?

Michael Kesslering: So just to touch on a couple of points that you made, you had mentioned the draw down in business inventories that actually accounted for a .85%, subtracted about .85%  from the overall GDP numbers. Without that, you would be, you know, getting in the range of 3% and that is kind of a transitory issue. It is likely to reverse in the next quarter. The other aspect is it is interesting that Trump made those comments, as you could argue; the impact of him with the trade wars has had a way, a larger impact than the Fed as over the last quarter. Exports actually fell 5.2%, while imports grew slightly, which is just expanding the trade deficit that that Trump always complains about with the U.S., which is really just a direct causation of his trade wars. The other aspect is that consumer spending you had mentioned that it was actually up 4.3% in Q2 versus 1.1% in Q1. We are going to be talking a little bit about some of the large tech companies, but that is being seen in the Q2 results from some of these consumer facing tech companies where there is strong consumer demand. And just as a reminder, consumer spending does make up about two thirds of the U.S. economy, so that has a really big impact on GDP numbers.

Julian Klymochko: One thing that I wanted to talk about here is the Fed’s dual mandate. The Federal Reserve’s dual mandate – one is maximum employment. And you look at the figures there and the U.S. unemployment rate really near all-time lows. So, you know, check the box on satisfying that portion of their requirement. It is hard to argue that they are not at full employment. They are not seeing it through the inflation numbers, which they typically would see with full employment. You typically tend to see a higher wage growth than is happening. I mean, the unemployment figure, it kind of proves that there is a lot of people in jobs right now and really no issue with unemployment.

Then the second that really is stable pricing and they talk about stable prices with respect to CPI or a consumer price index – inflation. They generally target 2% inflation has been near there, but not quite. It really makes you wonder, are rate cuts justified here? I mean, the S&P 500, Dow Jones, and NASDAQ, all at or near all-time highs. Markets have been doing excellent, but they are framing this rate cut as, quote, “insurance cut.” They are trying to counteract any economic weakness that is largely coming internationally. We talked about, you know, adequate U.S. GDP growth numbers. It is not quite the north at 3% that Donald Trump wants or the 3.1% that they experienced in Q1.  However, it is a pretty good number 2.1% they cannot complain and they are really going to enact these cuts to counteract two main things. I mean, there is a lot of weakness in Europe. Part of that is, as you know, their economy has been sluggish for a long time. The ECB is going to cut rates, which we are going to get into today. Not just that, but with Boris Johnson now taking leadership in the U.K., it looks like Brexit is going to go ahead. Then number two, on the China front, there is some economic weakness. Their numbers coming in below expectations. The trade war is really weighing on the Chinese economy. Not just that, but other economies back to Europe. We are seeing some weak numbers out of, you know, the really the driver behind the EU economy being Germany. Germany is coming out with some pretty weak economic figures there.

The Federal Reserve really framing this upcoming rate cut, which is going to happen. I think it is likely going to be 25 basis points, but I am sure we will be talking about this next week, really framing this as more of an insurance cut, and so it’s not necessarily another entire cutting cycle. Who knows? It could be one and done. Things could get worse, but they are really pretending to be data driven here and data more. Who knows how much of that has to do with Donald Trump really demanding rate cuts.  But yeah, we’ll report more on this as we see what they choose to do next week.

Sticking the Global Macro but moving across the pond to the Eurozone. Now the ECB president, Mario Draghi, signalled that they are preparing to cut interest rates for the first time since 2016, while also indicating the potential restart of its bond-buying program. Now, the ECB this week opted to keep their interest rate on hold with the main refinancing rate remaining at zero and the deposit rate at negative zero point four percent. So it is already negative, but they’re likely to make it even more negative in the future, hinting at future additional rate cuts. In a move that paved the way for rate cuts in the next coming months. The governing council changed its forward guidance to say that it expects rates to remain, quote, “at their present or lower levels, at least through the first half of this year or 2020”. Sorry for the first half of 2020.

Now, these stimulus measures aim to reinvigorate the struggling Eurozone economy, which, you know, we talk about that U.S. GDP figure of 2.1% I mean, the Eurozone, they are not even really close to that. They are kind of more in the 1% range and inflation is coming in well below 2%. That said, it was expecting to keep its key interest rate at minus zero point four percent or lower for the next foreseeable future. We will kind of see where they are heading either ECB is next Policy meeting is on September 12 in which they will likely enact this rate cut and potential additional monetary stimulus measures. It is now increasingly looking like this September meeting will bring not just one, but rather a package of several monetary stimulus actions. But that is to be seen.

Nonetheless, it really raises the questions about how much more the ECB can accomplish with its current toolkit. I mean, their key interest rate is already below zero. Its negative and their balance sheet as fallen around 40% of Eurozone economic output. Now, this is double the balance sheet of the Federal Reserve, and as we previously discussed, last year the Federal Reserve was actually trying to shrink its balance sheet. Now the ECB looking to grow it, and in my opinion, you know, it could be really pushing on a string here. How much is this action going to actually affect the European economy? People talking about look at negative interest rates are not helping. The banks are really struggling. Just look at the share prices of Deutsche Bank and many of the other European lenders. Some of them are hitting the share prices they have not seen in decades. The financials really struggling there and kind of financials drive lending, which drive many other portions of the economy. Nonetheless, some market action tenure, German government bonds hitting record low yields of nearly minus half a percent.

The Eurozone currency, the euro fell to almost its lowest level in more than two years. Then, you know, the net result globally, we now have nearly 14 trillion in negative yielding debt, much of which is that of the European kind. What are your thoughts on really what is happening in the Eurozone and what the ECB is signalling that they are going to do?

Michael Kesslering: Yeah. So it is looking like they’re going to enact a rate cut of around, likely 10 basis points. That is what’s being priced in by investors. Then you had mention the bond buying program, quantitative easing. For our listeners, they did stop their former QE back in December of 2018, and that was a two point six trillion euro bond-buying program. They had stopped that amid some signs that the region was recovering. Now, if they do enact this again, the really crazy thing about this is that they’ll have to alter some of their…. they are self-imposed rules, but they will have to alter them. That will allow them to own more than 33% of any individual government’s debt. When you talk about the Fed unwinding some of their balance sheet, this creates a real problem for in the future when they are wanting to unwind some of these positions where they hold, upwards of 30% of a country’s debt. I mean, you would think that would take a very long time to get off their balance sheet, if ever.

Julian Klymochko: Not just that, but you look at what is happening in the market. We are seeing record bond prices as shown by their negative yields. You think about it. Well, who crazy enough to buy a negative yielding bond where it guarantees a loss in principle? Well, you think that, the ECB is coming in buying up all the bonds. You look from a supply and demand perspective. They are really increasing demand and everyone else is forced to get really poor prices. What happens when all of that reverses and what is kind of confusing to some market participants is. They are increasing their bond buying, but you many yields are already negative, as we indicated. Everything from Germany to Portugal to France, they all have negative yielding bonds now is getting more negative going to help? Right. So I think that potentially all this market manipulation, it is really just not having the desired effect of increasing inflation and increasing economic growth just because things are so warped. It is really hard to have things function normally when it’s really bizarre when you have all these negative yields that really distorts the capital markets, really distorts the capital allocation process, really distorts the lending process of banks looking to lend to businesses, that ultimately that’s the productivity growth that drives economic growth.  That whole process has really been broken by central bank actions, in my opinion here, so it is really interesting. There is clear evidence that what they have been doing has not been working. They are now just going to keep pursuing that and it is really quite the head scratcher, in my opinion.

Lastly, we just wanted to touch on some regulatory actions from the Department of Justice. What they did this week, they announced a broad investigating into what they call leading online platforms to see if they have been engaging in, quote, “practices that have reduced competition, stifled innovation or otherwise harmed consumers.” The regulator did not name which companies they are investigating, but it is pretty much known that they are looking into Amazon, Facebook and Google parent Alphabet.

Now, the DOJ said in a statement that it would look into, quote, “widespread concerns expressed about search, social media and some retail services online.” So that is really foreshadowing. Look, you know, it is Amazon, Facebook and Google that we are really going to focus on here. Another interesting quote from a different part of the government is actually from U.S. Treasury Secretary Steven Mnuchin had some choice words for Amazon. He stated that “I think if you look at Amazon, although there are certainly benefits to it, they’ve destroyed the retail industry across the United States, So there’s no question they have limited competition.” So interesting quote from U.S. Secretary Steve Mnuchin.

Now, this DOJ move comes after the outgoing European Commission signalled it was also looking to become more aggressive in checking the market power of the largest online platform companies. Another interesting thing that happened from the regulatory side just this week. Now, this DOJ announcement of an investigation came actually one day before the FTC announced a record five billion dollar fine against Facebook. Now, what they are going after Facebook for is mishandling of data and all these privacy breaches of people, their customers. Users of Facebook giant online platform.

Got a statement from Facebook here. They stated that the agreement that they signed will require a fundamental shift in the way we approach our work and it will place additional responsibility on people building our products at every level of the company. It will mark a sharp return toward privacy, on a different scale than anything we have done in the past. I mean, you have to really take these actions by Facebook with a grain of salt. They are just so tremendously profitable, and the reason they are profitable is because, they really don’t give a damn about anyone’s privacy.

They are really harvesting everyone’s data, selling it for top dollar. When you look at the results, their quarterly results, Q2 results, which came out this week, sixteen point nine billion in quarterly revenue, which is as mind blowing up 28% from a year ago. They are enormous, have tremendous market power and still growing like a start-up, growing like crazy. Twenty-eight percent year on year revenue growth. They also posted two point six billion in profit. Now, this reflected a two billion charge as part of its five billion settlement with the FTC. The Federal Trade Commission and Facebook stock up 60 percent year to date. The market is liking what they’re doing. Irrespective of this massive regulatory clamp down, the regulators coming after them, more often with the DOJ announcing this new big investigation, not just, into what we see as Facebook, but also Amazon, Google, and Amazon dominates search, Facebook dominates social media, Amazon dominates retail. Google dominates search. Now, really cracking down on the dominance of these massive online platforms. What are your thoughts on the regulatory action here and just the continued and just, wildly profitable results of these dominant tech companies?

Michael Kesslering: Yeah. First, with regards to Facebook is although they did have this large settlement, it really doesn’t change anything with what they are able to capture for data or their advertising models. In terms of their ongoing profitability, that won’t really change. I just see a lot of lip service coming from Facebook saying that they have been slapped on the wrist and that they have learned their lesson. But there really isn’t too much to change anything moving forward. Another aspect that I found interesting was just the interaction between the DOJ and FTC or lack of interaction is, the DOJ now going after where there’s some debate over what regulatory purview these tech companies come under, whether it be the DOJ or FTC. Then as well, this is a reactionary move really by the U.S., by the DOJ after the European Commission said in April that they were going to lower the bar for companies deemed dominant players and subject them to stricter anti-trust rules, where Trump came in and said that the U.S. should be handling this, not Europe. Then finally, the one last thing I would like to point out is that of those names mentioned from the tech companies, so Facebook, Google, Amazon, and I did hear Apple being mentioned as well, but really just the main three is that Microsoft is noticeably left off this list. And so if you would have asked somebody, five years ago, maybe 10 years ago, if there was going to be antitrust concerns with any of the tech companies, you would have said Microsoft, as some of our listeners will remember, back in the 90s. Microsoft had one of the most famous antitrust cases in history. The fact that they have no concerns in this is quite interesting and quite a shift.

Julian Klymochko: Certainly, and on the Facebook front, as you indicated, probably is lip service and their attitude has always been to move fast and break things. As we previously discussed, this whole Libra cryptocurrency, I mean, that is kind of a face palm moment there. I just really just asking for more regulatory scrutiny and it really just shows how much they care about authorities, which is very little, in my opinion. They are continuing to operate as they like. They are tremendously profitable, tremendously powerful. And they’ve got a question now, is there some regulatory capture here just because these big tech companies spend so much on lobbying the government, and they have such control of their market, they’re so entrenched, you know, is there any stopping them at this point? I guess we will see. But, I don’t think this DOJ investigation will amount to all that much. As you indicated, they previously went after Microsoft 20 years ago. Now you look at Microsoft, trillion-dollar Company as dominant as ever, but clearly facing new competitors by the likes of Amazon, Facebook, Google, Apple. They are all going after each other’s turf, but in terms of other start-ups to compete against them, you know, good luck. They typically just crush their competitors or just copy them. Right.

And that’s it for episode 24 of the Absolute Return Podcast, if you enjoyed it, as always, you can check out more at absolutereturnpodcast.com. We will be back next week with a new episode. So look out for it. Then in the meantime, check out our older episodes. Leave us a review if you would like. We will chat with you next week. Cheers.

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