Ep.74: ECB Bazooka & Tesla's Lesson In Financial Engineering

Okay, hello and welcome to episode 74 of the Market Maker podcast, and I'm joined— who is in the office today— Piers Curran, fresh back from holiday as well. How's it going, Piers?

Well, I prefer to still be on holiday, to be honest, but I did manage to actually get out of— well, anybody listening who lives in London, yeah, I chose a perfect time to get out of London when it hit 40 degrees No air conditioning nightmare. Yeah, I was on the Cornish coast.

Oh, I just—

asking in the much more pleasant 22 degrees. So, wow.

Do you know what? It's actually on my— the skylight on the back of my house, it's actually melted part of the skylight. It's the same. Yeah, which is hugely annoying. But hey, once, once in a lifetime, record-breaking. When I say once in a lifetime, That's probably not correct.

The new norm.

The new norm, yeah. But look, it's been an incredibly busy week, um, whilst you've been away and also whilst you've been back the last couple of days. So let me just run through some of the highlights and then I'll go into what it is we're gonna do a bit of a deep dive on. First off was, of course, Russia. They've resumed pumping gas to Europe through the Nord Stream 1 pipeline following a 10-day maintenance break. This was a huge issue in markets last week. There's a lot of apprehension about what are Russia going to do, and obviously Putin loving that situation, I'm sure, with his hand literally on the, the turnkey of the pipeline on the Nord Stream 1, uh, and everyone in Europe kind of on their back and knees trying to calculate what the risks were. But the point is, is that they've restarted, albeit it's still at a fairly low volume rate, but it's about where it was before. A key piece of equipment, this is what the Russians, the way they've played it, is still being serviced. I think it's a turbine over in Canada. It's now believed to be back on its way to Russia, but Putin has said, "If that thing ain't returned, then we're going to reduce the supply further." And so it's almost like a relief, I think, that Europe's had, and that has been reflected in a lot of different asset prices, particularly in the energy space. But this is far from concluded, I would say. So yeah, definitely something to keep your eye on closely.

What's the— so the Nord Stream 1 is back on, but it's running at a capacity of 30%. That's what I read.

Yeah, 30-40% I've read. So around, yeah, around those margins. So which is it? Which is okay. But I did read another stat which was talking about Germany And I think when it comes to Germany's capacity levels, as we start to head in towards the back end of summer, they're still hugely depleted from where they need to be as a government target.

Yeah.

So yeah, it's certainly still not a done deal as yet.

Yeah. And I guess the point about this is it might be fine whilst we've got record temperatures, and so heating is not a requirement. But the further this goes on into the end of the year, the more of a monster issue this becomes and can really kind of fracture— I guess most importantly, maybe could really fracture the unity of the West and their response to this crisis. Because if Germany— if German households can't heat their house come Christmas, then yeah, that's going to be the biggest influence on Germany's decision-making and stance on how to move forwards. And that'll probably be at loggerheads with a much more hawkish, um, US-style response who are sitting pretty the other side of the Atlantic.

Yep. And also probably the hawkish stance even more so from the US as they head into the midterms and start sharpening the rhetoric on the foreign affairs front as well. So yeah, very good point. The data this morning as well, we've just had the flash PMIs. So if anyone not familiar with this, the Purchaser Manager Index is essentially talking to purchase managers, conducting a survey and asking them how do they feel, what's their situation with their prices they're paying, their inventories, their employment, and generally getting a bit of a temperature check about what they feel about the future. And that data has just come out and the German flash PMI PMIs for manufacturing has fallen below 50, 49.2 versus 50.6. And that is meaningful because 50 is the kind of threshold for growth or contraction within that particular economic reading. The French number as well doesn't make for particularly pleasant reading either. And of course, this comes— we'll talk about the ECB a lot more in a moment. But it comes with the euro surviving the parity breach. But it's not looking like that will last for too long. And in fact, actually following that data I just mentioned, the euro is on the back foot and has broke through the double bottom which we saw in yesterday's ECB meeting. So the euro under some pressure this morning and Bund futures, German fixed income rallying on the back of this. Other things then. So this week, UK, plenty going on in the UK. UK inflation hit a new 40-year high. It hit 9.4%. And when it did, the pound went raging down, not up, which is slightly contradictory to economic theory. And the rationale behind that is, look, inflation is going up in the UK. It's a sure thing. And actually, the Bank of England themselves have communicated it's likely to go up towards 11%. So the fact we're at 9.4% and you pick up the newspaper and you think, oh my God, record-breaking headlines, 9.4%, it's going to get a lot worse. And if you're feeling severely depressed, as actually UK consumers have been labeled in the latest GfK consumer confidence reading overnight, then I'm afraid there's going to be some tough months ahead and it's going to get worse before it gets better. The soaring food, fuel prices, rising interest rates is all putting confidence down to a near 50-year low in the UK at the moment. And this all comes with the Bank of England governor, whilst we're all there in a cost of living crisis, he's having his champagne supper at the Mansion House speech, which he does on an annual basis with all the movers and shakers in the city. And he put on the table, we're going to go 50 perhaps. Um, which we'll talk about a bit more. Probably not that surprising in the context of what else is going on at this point in time.

We'll see. Can I just say, on the— we kind of talked about this last week, but that whole thing around the consumer confidence data being so severely negative, and yet, like, the UK released their retail sales figures this morning. If you take out fuel So retail sales ex-fuel, and actually it was up 0.4%, which was much better than what was expected. We were expecting a contraction of 0.2%, minus 0.2%. So it is still this weird case that whilst people are saying they're worried, they don't seem to be changing their behavior yet. But I'll qualify that, sorry, that is the June retail sales figures. I mean, it's almost the end of July now, so it's pretty old data.

Yeah, yeah, I think that's a good point because things are getting, you know, worse by the month at this point in time. The other thing as well is kind of compounding a little bit of uncertainty, probably, um, lesser so for consumer who's not hit so directly and immediately as just filling up their car at the pump, but that is the political uncertainty And it's looking like a two-horse race this morning, at least. We've got a little bit of time left to run, but Rishi Sunak and Liz Truss are locking horns over who's going to be the next Prime Minister. Predictions— I was looking at a couple of asset managers and they're a bit nervous because of the fact that a new YouGov poll of Conservative members— and the reason why this is important is because they're not going to do a poll for the pop, you know, the general national population, because it has to be the Conservative members who choose this person. We all don't get a say in this process. It's a, it's a Conservative Party thing that they need to sort out. And that YouGov poll said that basically Truss has 62% compared to 38% in a lead over Rishi Sunak. So quite a large proportion. And asset managers this morning that I was listening to were saying, look, Rishi Sunak is the market— market-friendly, it's the continuity kind of, uh, candidate. Whereas with Liz Truss, it's the idea about, uh, the ramping up of borrowing because of her view of what she would do with the immediacy of tax, and then also the pressure she might then to start put on the Bank of England and also relations with the EU as well. And we all know that given she's been the chief kind of architect behind the talks on the Northern Ireland negotiations. So yeah, is Truss—

is Truss the kind of— is Truss the Trump to kind of Rishi's Biden kind of thing? Like, Truss being anti-Europe, being, right, let's cut tax let's spend more money. Whereas Rishi's obviously much more— what appears to be a bit more sensible and a bit more reserved and a bit more pragmatic about the fact that we've got too much debt anyway. And spending more anyway, isn't that going to just lead to more inflation, which is actually our biggest problem?

Yeah, I don't know if Rishi's playing this right. I agree with everything you're saying. And I was watching some of the televised debates they were having, and Rishi was saying what is technically true. He's saying, look, if we do this tax move, you're going to make things basically worse for people. Yeah, but that makes economic sense if you understand the economics of the process. And I don't think he's played that hand quite well, even if that is his stance of his policy.

But what's— but it is the Conservative Party members that are voting. Right. Now, what would you say? What is their average?

The grassroots, the grassroots are pro-Brexit. They want Truss. That's it. So Rishi's got his work cut out now to pull this back, I think. Yeah. But yeah, the point being is that there could be these asset managers predicting a marginal downside risk to sterling should she get picked. But we're talking about a 2% margin, which with all the other things that are going on is relatively, I'd say, tame. But that would be opposed to a more supportive type move you could expect under Rishi. Um, so we've got a little bit of time to run yet until they get to the point of when we'll find out about this. Um, the other things that have been going on are one of the biggest ever tech IPOs on the London market. I think we talked about this perhaps on an old podcast episode. But it's been put on hold exactly because of this political crisis we're having at the moment. And the whole kind of basis of this is that Boris Johnson personally lobbied SoftBank billionaire Masason. You might have heard of Masason because he was the chap that really backed WeWork to the eyeballs and back again. If you've seen that documentary, um, quite a character is our Masason. Yeah, it's pretty crazy. But yeah, so Johnson was trying to woo Masason to secure a partial listing for the chip designer Arm on the London Stock Exchange. Would've been a big win for the Johnson government. But SoftBank may pursue a more straightforward, just straight up US listing, which was actually Sun's original favorite place to do so. Just quickly, Piers, why is this such a big thing? Like, why are governments so keen to get this within their own domestic market?

I think this is a disaster for the UK. I honestly— this is just— the UK has become the, like, the the old granddad of the stock market world. Go back over the decades and find listing in London was certainly considered as one of the premier locations to take your company public. Now it's just like a graveyard. I'd say that— and one way to kind of measure what I've just said is if you look at the FTSE 100, I mean, it's just packed. It's so old school. It's so dull. It's so boring. It's just packed full of miners and banks and energy firms. There's just no tech. And unfortunately, the last 20 years has been about tech. So if you look at the FTSE 100, it's trading at 7,288 right now, this second. Okay? Go back 20 years, If you take the high, the end of the 1990s, it was trading at 6,900. So basically in 20 years it's gone up, uh, 400 points. What happened? Like 5% less. Okay, it's gone up 5% in 20 years. Then you go and check out the something like, I, I don't know, the S&P 500 chart. And over those 20 years, um, it's gone from— well, let me just actually give you the accurate maths here. It's gone from— in the end of the '90s, it was trading at, let's just call it, 1,500. It's now trading at 4,000. So I don't know what the maths is there, like, I'm just going to roughly say 200%. It's not quite that, but— so the S&P is up 200%. The FTSE's up 5. That right there tells you the whole story, that companies aren't interested in listing in London anymore. The investment climate, um, it just doesn't look attractive. And this— and Arm is like the UK's kind of poster child of the tech industry, and they've been trying to get up— you know, Arm have been trying to IPO for a while, and the UK government have been massively lobbying for Arm to do it in London, and it's like their big marquee, you know, it's like their big kind of signing of Messi, for example, right? It's that type of thing. It's a statement to say, look, the UK tech industry is here, we are thriving, Arm is now locked in, come and join us kind of message, just to try and turn around this, this very long-term kind of negative trend that we've got going on. And yeah, if I'll now go and list in the US, I mean, it's just— it's pathetic. So I'm so annoyed.

Oh, I want to see Piers Cowan at PMQs, um, just giving it, giving it to the, uh, the government on the back of their—

sign me up.

All right, well then, the other final things for the wrap before we, we delve into the, the ECB, Tesla, Netflix earnings, and so on. Super Mario. Is, uh, Snap. And the reason why I mentioned Snap is because it front runs Google and Meta, who we're going to get the, the mega-cap tech giants report next week, Tuesday through Thursday next week. So stay tuned, they're coming, and no doubt will be the focus of our podcast next week. But Snap fell nearly 30% in aftermarket trade last night. I remember last quarter They fell almost 30%. They're down about 80% on the year now. And getting snapped, literally, they are getting broken. And they flagged worries about advertising and the wider economic slowdown. And this kind of puts me back to a Barclays note that I saw, and they were talking about the fact that, you know, it's bad now for advertisers, it's basically going to get worse for digital advertising platforms. So Meta, your Snaps, YouTube, these sorts of things. And they were talking about a step down in spend and basically the whole internet ecosystem going through the period of adjustment we're having right now. And then the ascendancy of new challengers, i.e., TikTok and Apple, into that advertising space. And these are giant names by audience size. Obviously, that's eating into compounding these issues for the likes of your more traditional ones. I think we've got Twitter coming out today as well with earnings, and that'll be a similar one. Actually, Elon's been very quiet since we last spoke. Actually, he's been very quiet. Actually, one of the things we'll talk about, he jumped back on actually the conference call for Tesla, which we'll get to, but I thought he'd already given that up. So yeah, there we go. There's— but the final then thing for the week, Joe Biden. Yeah, you know, my poor granddad's got COVID, and so he's, he's only got mild symptoms. I mean, the show goes on, really. I saw he gave a speech, um, he blamed the oil industry for his cancer, he said, um, earlier this week. The White House then needed to come out and clarify he does not have cancer. It was to do with some skin treatment he was having or something of that nature prior to him taking his position in the White House. But yeah, it's— he's having a tough time. And unfortunately for Joe, we wish him well from Team Amplify, but he's got a real tough couple of months ahead.

I mean, Well, a couple of— yeah, but that aside, he's still got— he's got 2 years, 2 and a half years, the end of his first term, right?

Yeah, he has indeed.

I mean, I'm, I'm genuinely worried about that.

Yeah, but let's, um, let's get into it then. Before we start talking about the ECB and Super Mario. If you do listen to the podcast episodes every week, first off, thank you very much. And secondly, may I please ask you for a rating if you're listening on the likes of Spotify or indeed Apple? Drop us a review. It really helps promote the podcast to a wider audience. But let's talk about the ECB. They hiked 50. So this was not a massive surprise. The general guidance from the central bank had been a little bit more like perhaps the 25 now or 50 later, but they've kind of gone a little bit early. And they also approved a new tool, and that's called the TPI, the Transmission Protection Instrument. I actually did a LinkedIn post on this yesterday because I thought this is getting a little bit silly now. Yeah, because when you talk about the ECB, you've got the TPI, the OMT, the PEPP, the APP, the TLTO, the CSPP. I mean, I can keep going if you want. But these are all the tools. So when you think—

This is the best one. This is easily the best one in my view, the Transmission Protection Instrument. When I read that, what springs to mind, Transmission Protection Instrument, what springs to mind is some kind of medieval chastity belt to prevent sexually transmitted disease or something.

Isn't it not quite as exciting as that? But yeah, so let's break this down. So they hiked rates. First of all, it's the first hike that they've done in 11 years. We'll remember at the time, everyone hates him. I loved him. My man Trichet made a bit of a blooper, but I just loved his flair, his style. But yeah, he was the last guy. So he did that back 11 years ago. Just makes me feel like I'm aging a bit.

July 2011. Yeah.

So this was the biggest move that they've done since 2000, in fact. So 3 points I want to talk to you about with the ECB and kind of deconstruct a bit of color around it. First off, this idea— and we talked about this a little bit with the Bank of Canada— front loading. So yesterday they exited from negative interest rates allowing the governing council to make a transition to a meeting-by-meeting approach, is what they said. So what's this front-loading? Why is that important? What's the strategy there?

So yeah, as I talked about last week, but basically it's just trying to get ahead of this inflation situation, which has run away with itself and is currently out of control. And so it's about just accepting the fact that central banks have been late to get on it in terms of controlling inflation. They should have started hiking earlier. And there's no point now. I mean, you could say, well, better late than never, right? But actually, no, because if you're going to start late and just do small hikes, you're just always going to be behind. So this is about Rather than just better late than never, it's on top of that, it's saying, well, let's make up for the fact we're late by going bigger early. And then that kind of catches us up. And then, okay, we can see and we might be able to hike at 0.25% increments or 50, depending on the situation as we go through each meeting. So yeah, it's just making up for the fact they're late to the party.

Okay. And then point 2 is, is this Transmission Protection Instrument, the TPI? So first off, what is it? Let me explain and then I'll get your take on it. And we can draw perhaps parallels to something that they did in the past, which was a very meaningful catalyst for what ended up being the biggest bull run perhaps in stock market history. And kind of links us into your fanboy moment. But before we get to that, the TPI aimed at basically limiting the divergence in borrowing costs between the bloc's strongest and the weakest countries. And so the easiest way for me to kind of explain that is think of Germany and then think of Italy. Now, when I'm talking about, obviously, not size of economic activity, because I'm not talking about Malta or Slovakia or Slovenia, Talking about the general investor, foreign investor appetite to buy these countries' debt. And obviously something like Italy is very potent right now because of the political uncertainty. And so the cost of that debt is getting more expensive comparative to say what we classify as benchmark, which is Germany. Now, all 19 eurozone countries will automatically be eligible for this instrument as long as they have not fallen foul of the EU's fiscal rules and are meeting the conditions attached to the EU's Recovery Fund. So the ECB will also consider if a country's trajectory of public debt is sustainable and if it has sound and sustainable macroeconomic policies. So let me translate that into English. If it was Liz Truss, the— basically, ECB would say you're not eligible. And I don't want that to be too politically divisive, but the point being is that you can have these radical populist agendas and talk about deep tax cuts, lots of spending, increase your borrowing, but that automatically sees you fall foul then of the conditions of being fiscally prudent that me as a central bank would want to effectively lend you money because I'm not going to get it back. And so there's a kind of negotiation that probably has to go on to some degree. And this has happened for Italy before, right? Not that long ago. When Super Mario first came on the scene, uh, we were right in the midst of this. And that was one of the things that Mario, to his credit, fixed, because he's a sure head on his shoulders, uh, in that respect. So yeah, thoughts on, on the TPI in general, or the mechanics of how this works? And does it— will it ever need to be used, or is that the purpose?

That's an interesting final point you've made there. I mean, yeah, this is this is like the ECB whipping out the bazooka for a second time. Okay, the first time being the OMT, which we'll talk about in a minute. But this bazooka is basically— it has the potential for unlimited purchases of assets. And whilst they've said on the one hand, you know, this would be government bonds, it can also be private sector assets, and they haven't been specific. So you immediately think, okay, corporate bonds, but who knows, right, where that might go. I mean, the Japanese Central Bank were buying stocks not so long ago. So this is an unlimited asset purchase program, and the idea is that— well, I guess, yeah, we might as well just talk about it. The OMT program was like its predecessor, and what's interesting about this is the timing, because do you know what happened on the— so in 4 days' time we've got the 10-year anniversary of something. You know what?

Oh, the famous speech.

Yes. Oh, on the 26th of July 2012.

Is that right?

10 years ago.

It's a good spot, that.

Mario Draghi delivered his very, very, very famous one Whatever It Takes speech. Google it. It's one of the most iconic speeches, well, of our age, I would say. I would literally go as far as saying that. Anyway, what he set in motion was this idea, which was the bazooka. So this is— and this is where they rolled out their OMT program, which is— it's just called something different letters, but basically the same thing. We will buy unlimited amounts of assets. And what they mean by that is they mean we will prevent any eurozone country from defaulting. Now, the way a eurozone country would be forced into default would be if their cost of borrowing rose to an unaffordable level. And so we talk about this being their bond yields, okay? So government bond yields is a measure of the cost of borrowing. And if we're worried about a country let's say, political instability that we've got right now with Italy. And if we're worried that also that means— if we're also worried that they've got a huge amount of debt. So Italy have got the highest amount of debt levels in Europe, so 150% of GDP, okay? Their government debt is 150% of GDP. They've got a deficit at -7.2%. So things are looking— and because of COVID obviously, government— the government books are looking pretty dodgy, right? Because they've had to borrow a load and spend a load to get us out of this nightmare COVID situation. So here we go now with political instability, and investors start to get worried. Well, hang on a minute, what's going on here? And actually, is this sustainable? And Italian bond yields are on the rise, okay? And they're up. And what's really important, they were testing the 2018 high, and we broke it briefly. We kind of spiked very briefly up to 4%. It's dropped back a little bit, but we're sat right on the 2018 high. Let's just call it 3.4%, okay, 3.5%. Now, that's fine at that level. That's, that's affordable, okay. The problems come if it, if it really gets away from itself, when markets— it's kind of a vicious spiral, basically. If traders and economists and analysts believe that this whole Italian thing is not sustainable, then they'll start selling Italian bonds to get out, right, to remove their risk exposure. But selling bonds means you drive the price down, and the way a bond works is as prices drop, yields go up. So as investors exit stage left to get rid of their Italian risk, it actually makes the risk even higher. By driving up bond yields. And the concern is if bond yields go above, let's say, 5%, then we're likely into territory— well, actually, hang on, that perhaps isn't affordable for Italy in the longer term. So this is where the ECB come in. So they come in and go, well, you know what, if you lot are all selling and stampeding out the door, we're going to come in and we're going to start buying and we're going to drive the price back up and the yield back down, making it affordable again for Italy to borrow. This is the principle. It's the bazooka. You can sell as many as you want. We've got more money. We're going to buy it and we're going to hoover it up. Okay? Now, this OMT program delivered by Super Mario, in principle, that's the situation. They actually did a bit of buying right at the start, but to all intents and purposes, the program never got used. They said, we will buy unlimited amounts. And how many did they buy? Virtually none. Why? Because the threat of buying unlimited amounts actually changed the course of the markets because investors said, well, we can't fight an unlimited kind of player. So you know what? We're going to stop selling Italian bonds. And you know what we're going to do? We're going to start buying them because the ECB are going to ride into town and this market is going to go through the roof. So actually the market did the job for them. Now this is only possible if you pull the bazooka out and say, right, I'm going to shoot. And if it's believed that you will shoot, then you don't need to shoot because the enemy runs away.

Well, to coin a famous phrase from Bruce Lee, the art of fighting without fighting.

Yes, right now Here's— let's step it on, though, because Mario Draghi is Super Mario. So when he whips out the bazooka, I believe it.

You run for the hills. Yeah, that's right.

The problem is that we're 10 years on and the ECB are having to whip it out again. And Mario's not at the desk anymore. Lagarde is. And she's just not quite— and this is my personal opinion— she's just not quite as believable. And the concern is you need to whip it out again so soon. And so I'd say the risk of it delivering in the same way it did 10 years ago, I don't think it will deliver in the same way. And anyway, just— sorry, finally, you talk about the eligibility thing. So who's eligible for this transmission protection instrument? And the problem is, well, the ECB on the one hand has said, look, it's unlimited, but then they've kind of hospital passed the decision to basically the European Commission or the IMF, because they're saying, look, we will spend as much as we want, and it's unlimited, but the decision as to whether we do so actually now rides— sorry, resides with the European Commission, who have to basically decide, are they eligible? So, you know, are they, you know, it's subject to the kind of excessive deficit procedure, are they in the excessive imbalance procedure? And most— I don't know, the other one is, is— so the country's public debt must be sustainable and its fiscal policies sound. How do you Who makes the decision as to whether their fiscal policies are sound and their debt is sustainable? I mean, and when the Italian government's just imploded, then is it sustainable? Are their fiscal policies sound when there's no government?

Right.

I definitely don't think the European Commission can say with a straight face, Italy's fiscal policies are sound. When they have no government and they're in disarray. So surely that means they don't qualify.

Yeah, the worrying thing here— yeah, the worrying thing here, I think— I've got a third point, please, we will come back to, but just given what you're saying is the fact that we have had Super Mario tender his resignation. So we're now going to head towards, uh, the polls, elections in Italy on the 25th of September. Mario is going to be there as a caretaker prime minister, but the odds are currently of a right-wing government taking power. Brothers of Italy, along with the far-right League and the Forza Italia, the center-right. So you're talking about a right, quite significantly right-leaning, and they typically then, proposals tend to be based around national domestic politics. So this is talking about, as everything you just said, appeasing the populace in this sense, so spending money and things like that. This is only going to get worse, right?

Yeah. And they're talking about installing the, uh, the leader of the FDI, who's someone called— as this lady called Ms. Meloni. And apparently she's odds on to be—

yep—

prime minister. She's like— and in some corners of the press is being described as a neo-fascist. And basically— they're not my words, um, and She's only got 3 years of experience in government, and that's when she was a youth minister in 2011. So really inexperienced, very far right, very anti-Europe. And so yeah, I mean, further risks the whole point around— if Italy did need this chastity belt thing, then maybe they don't qualify.

Yeah, but maybe then the ECB strategy is to get ahead of this, front run it by putting the bazooka there, right? To know that now we've got 2 months left of extreme political disturbance coming out of Italy. So let's be pretty vague on details, but let's put it out there in investors' minds because we need to get ahead of the problem.

So, and then he's— in the ECB's defense, and I don't know, I often defend the ECB, but they have been quite proactive here. Remember, they had their emergency meeting whenever that was back in June, one week after their kind of policy-setting meeting. And so they saw this coming, and they've— at least they're ahead of the game on this. So that's credit to them. It's just back to my worry Is anybody going to believe that they're going to fire this bazooka?

Yeah, one thing I would say, just to restore a bit of calm, Italy is no stranger to political crises. I think the, the next government, when they come in, would be the 70th— 7-0— 70th government since the Second World War.

Oh, what?

I was trying to find a comparison. I was trying to find like how many football managers Italy have had since the Second World War, but it's probably like half of that figure.

That's got to be the most in Europe, hasn't it? Oh, it has to be comfortably the most. Yeah, that's an average of one a year, a change of government every year.

It's crazy.

Yeah.

But yeah, that's for a bit of context.

Yeah.

All right. Well, look, let's move it on to the— let's talk a little bit about single stocks and it's earnings season. And the two that I've chosen for us to discuss are Tesla and Netflix, two of the kind of more popular names amongst our community, I know. So starting with Tesla, they withstood disruptions to production in China and high costs of scaling up their their new kind of super plants in the likes of Texas and Germany. They reported a 57% jump in, quote, adjusted earnings per share in the last quarter. Their revenues came in at $16.9 billion. That was actually up 42% from a year before. It was still a little bit short though of analysts' expectations of $17.1 billion. What I want to talk to you I want to talk a little bit about though is Tesla and this idea of financial engineering. I know you're a man of numbers, so I want to get your feeling on this. From my side, the first thing I want to put out there with Tesla is that it was at the beginning of this month, they came out and made a statement. In my mind, this is the art of managing your stock price. And they came out knowing of the COVID zero tolerance impact on their production, which still predominantly comes from the Far East, and the scaling up of these new plants. So they basically front-run the move by saying their deliveries are going to be down quite a lot. And they're going to be down quite a lot because of this COVID disruption and shutdowns in China and the supply shortage that's happening. They said they were going to deliver 254,000 vehicles in the second quarter against an expectation value of 350,000. This was 3 weeks ahead of the earnings report coming out. Lo and behold, they come out and actually they can kind of manage to a certain extent then some of the downside numbers on production. Because I was looking at the investor slide pack and for what I classify as kind of a growth stock, some of these bar charts aren't looking too favorable at the moment because they've kind of peaked and they're coming down in a number of them.

The hockey stick's been flipped over.

Yeah. So yeah, initial thoughts on your take on Tesla. And there's a few other interesting observations about Bitcoin that we can talk about.

Yeah. Yeah, I mean, Tesla are the masters of kind of financial engineering, to be honest. And, you know, they've been kind of hiding the fact that they've been a loss-making business for years through these tax credits system that they kind of make a lot of money out of being an EV producer.

You know, from a—

they get a lot of tax credits that they can sell to enable other companies to offset their carbon footprint. And this has been one kind of way of them engineering their books so that it looks positive and profitable when actually, if you strip it all out and look, have you made any money from making and selling cars? And the answer's often been no. And this has been one of the big issues with Tesla. Can they scale up production and can they do it in a profitable way? So there's that kind of tax credit thing, but then Other little stuff like this in this, in this report, you know, stuff with their EBITDA. But basically EBITDA, adjusted, adjusted EBITDA, is basically— it's the company's profit once you've taken out certain factors that you could argue are one-offs in terms of costs. So they're not ongoing costs, so therefore you know, we shouldn't— you know, let's just assume these costs didn't happen. What would our profit be? Because these costs aren't going to happen in the future. So to have a better gauge on future profit, we should kind of strip loads of stuff out. So it's a very adjusted EBITDA. You've always got to be very careful about because it's engineered to look as favorable as possible. Like, one example in this report is that they've the adjusted EBITDA took out stock-based compensation schemes. So this is where staff are receiving whatever options, stock options, as part of their remuneration packages. And I mean, two things about that. Well, number one, is that, is that a one-off? No. And number two, actually a lot of it is just instead of kind of conventional salaried remuneration, you're giving them stock options instead. So actually Yeah, really, that's a very, very tenuous thing to take out, um, and really shouldn't have been taken out. So that has massage— massaged their EBITDA number higher when really it shouldn't have been.

Yeah, and another very famous EBITDA manipulation was WeWork again, right? WeWork was a company which were expanding at a meteoric pace They were spending money like nobody's business. Then when they tried to IPO and they had to outlay their details of how they're calculating their adjusted EBITDA, I mean, the things that they were trying to say were unrelated to day-to-day operations. Their total sales marketing spend, things like that. WeWork appears to be telling potential bond investors, remember at the time, that 97% of its operating expense is non-recurring. And when you looked at their numbers in the true light of day, they were shocking. And that was when WeWork got absolutely like— their valuation, I think, went from something crazy like $40 billion down to $6 billion. Yeah.

And rightly so.

Yeah. But yeah, the other thing then with Tesla that I thought was super interesting is that As of the end of Q2, they said that they converted approximately 75% of their Bitcoin purchases into fiat currency. Conversions in Q2 added $936 million of cash to the balance sheet. So let me finish on the point here, then we'll talk a little bit about it. But Musk said they sold the Bitcoin to maximize its cash position because of uncertainty related to COVID shutdowns. This guy's brilliant. This guy just cracks me up. He's like, right, how do I get out of my Tesla options? Okay, let's have this fake Twitter bid or spin out $8.5 billion, done. Okay, so how do we prop up then this Tesla thing whilst I'm going about my— Okay, yeah, let's sell down these Bitcoins so that we can prop up the balance sheet. So much for my diamond hands. So yeah. Anyway, that aside. So couple of other things. While Tesla was desperately trying to gather cash, and this ties in what you said, so there's $1.3 billion here that they've managed to just create. And this has come from the combination of those Bitcoin sales and these regulatory credits, which you mentioned. So while they were gathering this cash, they're not investing in growth. In Q2, their R&D spending was down $200 million. To give that context, that's 23%. Then people look at Musk and he's got idea after idea and he's chasing all these different revenue streams. The R&D spend is down 23%. Now remarkably then, this means that without the sale of Bitcoin, Tesla's free cash flow of $621 million would've been negative. And if that was negative, would've been the first negative run for free cash flow since Q1 of 2019. So he had no choice. He had to dump the Bitcoins in order to just prop it up.

Yeah. I mean, look, this is again, really bad. I mean, so free cash flow, just to just to make sure everyone's aware. So that's operating cash flow minus capital expenditures. So I guess to put another way, that the cash that a company is able to generate after spending the money required to maintain or expand the company, right? So it's like your cash profit once you take into account all all expenses are operating. So yeah, if you're cash flow negative, then obviously that's not sustainable. And so this is where normally we talk about startups and companies in their early life of growth and their cash flow negative. And that's why they always need to do a Series A round and then another Series B round of funding and a Series C and whatever the number, right? They always need to raise capital because they don't have any cash, free cash flow yet, because they're not generating revenue, or maybe they're not making a profit on the revenue that's being generated yet. It's all going into growth, right? So yeah, the fact that Tesla are still in this situation of, you know, at night, you know, a negative free cash flow quarter, then that's definitely concerning. Um, and 75% of the Bitcoin holding has been sold to to put a little Band-Aid on that, but what are they going to sell next quarter to cover that up? Is my concern. And what was— I mean, to be fair to Elon, it was a great Bitcoin trade until a few months ago. And now that trade— I was trying to find out what was their average purchase price. And I don't know, on a very quick quick kind of Google search, so it might not be accurate, but I've got here a stat that says their average purchase price was $34,200 per Bitcoin. Now, if they were selling through Q2, well, they could have broken even maybe. I mean, at the start of Q2, what was it, $46,000, and it ended Q2 at $19,000. So maybe they got out without losing money. I don't know. If they sold at the end of Q2, then they definitely lost money on that trade, but it's hard to know. But yeah, Tesla, I don't know. Again, a kind of financial engineered earnings report to kind of COVID up the cracks.

Yeah, I must also say that Tesla actually trading back up to $815. They rallied 10% yesterday. So, you know, as much as we talk them down, I definitely am a You know, in terms of— because people will always criticize our kind of talking down of it as a stock. I think, you know, just to be clear, from my point of view, Tesla is not a long-term winner in, in, in that sense. So whether it goes up 10% yesterday or 10% again today—

and some of that's technical, by the way, that big move yesterday, because the breakout broke back above— there was a really important double bottom February and March this year, basically around about $760. Okay, really important double bottom. Then that, once we broke lower, that then has been resistance through the summer. So that broke, and I think a lot of that, a lot of that 10% pop is definitely a bit of technicals. You got, you know, you've had a lot of people shorting Tesla, um, and it might have been these, some of these trend following strategies just got kind of taken out, which gave a bit of temporary kind of buy-side volume perhaps that kind of made that rally bigger than it otherwise would have been.

Yeah, okay, well, let's, let's, let's move over and talk Netflix, our final topic. And the reason why is because Netflix came out and they only lost 970,000 subscribers in the Q2. That's a pretty good figure.

Great, well done guys. Awesome.

Yeah, the, the point being is that that was actually a significantly smaller loss than what the street was expecting. What had been communicated from the firm was that this could be as bad as 2 million subscribers being lost over Q2. And obviously in the context, all of this coming as people tighten their belts and you know You know, the COVID thing is over in sense of the appetite for that product over that period in recent years. So if the bad times were coming, but they've managed to tactfully go around managing that to a certain extent. Their shares actually popped initially 10%, but they only actually finished up about 3.5% yesterday in the end. A couple of, couple of interesting points though coming out of their call that they had, which was on the content side. They talked about a move to, to batching from binging, and what they're talking about here is essentially prolonging the lifespan of its biggest shows. Um, I have always wondered why that strategy of, of deploying the entire series in one go, why that was a thing. Yeah, um, it seemed like we went from traditional TV when I was a kid and you literally had to wait a week for an episode, and then we just— Netflix came, it's gone full board. There you go, there's the full series.

Yeah, it was one of their hooks, a strategic, strategic move.

Yeah, I think you could have, could have juiced that a little bit more to then eventually get to that delivery, but they've kind of gone back and It makes sense. I don't think it's a massive surprise. It comes as I saw one stat saying that the number of people who cancel Netflix has jumped to 87% since a year ago. But that probably makes sense because on a comparative sense, given where we were a year ago with COVID there's probably a lot of people taking it, keeping it, whereas now they take it, cancel it, and so forth. So they've got an issue here in the sense that they need to keep people engaged. Their numbers were propped up by the surprising success. I think it was Series 4, Stranger Things. I don't know what it clocked, over a billion hours of watch time, something insane from a numbers perspective. Um, but two other areas I thought were quite interesting. We talked a little bit earlier about Snap, an upcoming of Meta, um, Google, others with advertising. The streamer said it aimed to unveil its lower-cost ad-supported tier in early 2023. And this comes on the heels of Netflix tapping Microsoft to be its partner in an ad-supported offering. So Microsoft also sniffing around as well in this space.

Yeah, I mean, we've been talking about Netflix. I mean, that— why is it taking them so long to kind of just change things up and, and just kind of I think the strategy at the top level was just— they've been so obsessed with spending huge, fast, disgusting amounts of money on content. Um, it's all been content, content, content. That'll win the day. And, you know, I think it's— we were talking, we were literally talking about this 12 months ago on the podcast, I think. And why aren't Netflix having some kind of ad revenue stream? Or why aren't they having some kind of process where, you know, you can in-purchase, you know, in-show purchases of merch and all this kind of stuff. But yeah, it seems inevitable, I guess, now that they're finally getting around to it. They're literally announcing this probably into the worst moment for an advertiser that we've seen, well, I guess since COVID start of 2020. But outside of COVID this is probably going to be the worst advertising recession, really, for more than a decade. So that's why they're saying, look, it's not going to come till 2023, because, yeah, they need to get— they need to have the macro climate switch back to a more favorable scenario before they kind of start to launch this thing.

So again, is this a kind of soft-touch financial engineering when you start talking about these in your conference calls? 100% in a period of heightened and kind of negative macro headwinds. You start talking about stuff that doesn't really even exist beyond the conversation at this point.

Yep. And you, you've got to start talking about it because you've got to cover up the bad stuff. You can't just have an earnings call where it's just, look guys, we lost a million users. Um, yeah, I mean, it was Zuckerberg's earning call. He made the, the error earlier in the year. Look, we're losing TikTok. Loser users and TikTokers smashing it. Yeah, and he was honest.

He was honest.

Yeah, he was honest. And you see what happens. So I mean, that's how not to do it, you know. It's cover-up, it's cover-up, cover-up, cover-up. This is an absolute classic case of that. And actually, the CEO and the co-founder, Reed Hastings, he said it's tough losing a million and calling it success. We're talking about losing a million instead of 2 million. Our excitement is tempered by the less bad results, is what he said. But yeah, I mean, bear in mind, like, they're losing— they're losing users, right? You only have to go back 6 months. In January of 2022, analysts were predicting Using basically Netflix's own guidance, analysts were predicting that they would add 20 million users this year. They would add— wow, that's just 6 months ago. And what's happened? Well, they lost users in Q1, they've lost a million users in Q2, and they're forecasting now that they'll add back 1 million users in Q3. So net-net, they'll be about break-even for 9 months when they were supposed to be adding 20 million users. The big risk for Netflix is the next earnings call, because at least the last one they said, look guys, we're probably going to lose 2 million users in Q2, and they only lost 1 million. Now they're saying we're going to add 1 million users in Q3. So if it's another negative quarter, then that's, that's going to hurt.

Yeah, I was trying to just quickly find, because I did see a number a few weeks ago, but Netflix is one of the— one of, if not the best performing stock of the last 10 years or something like that. It's up something crazy like 6,000% or something. So maybe, maybe the board got a little bit complacent over the years.

Um, you say that, but it is also— it does have the It's infamously the worst performing stock in the whole of the S&P 500 for the first 6 months of 2022. The worst. It's 500th on the table. So whilst, yeah, fine, the long-term growth looks amazing, yeah, what's happened recently has just been— it's the Netflix— it's the great Netflix recession, isn't it?

Maybe there should be a Netflix original about Netflix.

Yeah, I'd subscribe.

Well, look, the other thing that I think was really important, and I think it's a good thing to talk about, um, because perhaps not something that's on the radar of, uh, I guess a more of a retail investor level, is the consideration of currency headwinds. It's something that CFOs like to talk about a lot. We actually listen to these corporates talk. Um, and it's a common theme you'd like to get through the rest of this earnings season. To give you an idea, Netflix warned of the strengthening US dollar, the impact on its international revenue, and international revenue makes up 60% of its top line.

Yeah, that's crazy. So that, that basically, I mean And this is a theme of the earnings season, and it was a theme of the last earnings season. Basically, any US company, any US company that's operating on an international footprint where, yes, okay, like Netflix, look, their biggest market is the US and Canada, right? But their biggest single market, but as you say, 60% is actually internationally generated. So that means that the exchange rate between the dollar and all of these other international currencies then plays a really important role in the dollar revenue, the total dollar revenue of the business. So let's say, because the dollar index has just gone through the roof this year— I mean, I'm looking at the dollar index, which is the dollar's value against the basket of currencies. And at the start of the year, it was trading at 96. It's now trading at 107. I mean, it's been a huge— one of the biggest dollar appreciating moves ever, right, in such a short space of time. But if the dollar's appreciating, that means international currencies are getting less valuable. So let's say you're— you've got Netflix subscribers in Europe who are paying in euros. or you're— so you're receiving their money in euros and then all the pricing is in euros, right, for that customer base. But then Netflix need to convert the euros back into dollars, their domestic currency. But if the euro's devalued, then the amount of US dollars they're receiving per eurozone customer goes down. So if the dollar's value goes up 10% versus the euro, they're literally losing 10% of revenue in dollar terms, all because of an exchange rate move. Um, so this has been a massive headwind for these big kind of giant multinational US companies. This dollar strength is a real killer.

So as like an investment bank, how do they come into this to offer some type of hedging vehicle to offset this type of currency movement? Because surely this is a a major source of revenue for a bank because there's so many big multinationals out there?

Yeah, absolutely. Massive, massive source of revenue for banks is, you know, FX swaps and FX derivatives that are baskets of derivatives to hedge off, you know, these multinational companies hedge off their global exchange rate exposure. Now, how effectively Netflix have gone about that. You basically need a really good CFO who knows what they're doing, who then gets ahead of all of this risk. And so I don't know, in Q1 maybe the dollar strength really caught people by surprise, that the speed of it. So maybe they hadn't hedged off perfectly Q1. Q2 they really should have done, but did they? I mean, I don't know. Um, I would say they're never really fully hedging either. So they're definitely going to— even with a hedging strategy in place, that there's definitely still going to be some negative damage done to them.

So as a CFO, you're kind of like a Christine Lagarde where you're trying to say like Netflix warned of the strengthening US dollar's impact. They didn't say the size of the impact, they warned of the impact. So now I'm giving myself the benefit of the doubt to the analysts who set the benchmark then for the expectation in the marketplace. So I'm kind of putting the bar down in order for me then to give myself some wiggle room to hedge this off as best I can.

Yeah, exactly. And look, the other things to say about Netflix, I mean, you know, longer term, I mean, obviously having a shocker, right? It's been a disaster on of a year so far, but kind of what comes next. And obviously there's this whole kind of subscribe, this sort of streaming subscriptions thing, let's say, it's still pretty new relatively. And this is kind of the first, I would call it, and others are calling it the kind of streaming recession. It's the first one. So it's hard to know, I guess we're finding out for the first time whether consumers will unsubscribe from what is on the face of it a super low-cost item. So the thought had been that these streaming services would actually weather a recession pretty well because the cost, like Netflix, the cost is— their most popular plan anyway is $15.49 per month. So when you put it like that, it's like, okay, it's not that expensive. But when you're also subscribing to 4 other streaming services. It's like, which one do I ditch? And Netflix right now is the most expensive at $15.49. The, uh, HBO is at $15. Disney+ is actually $8 per month, so definitely carrying a competitive edge there on pricing. Um, and you know, I'd say from a geographical point of view, the US is there, and the US and Canada. So they lost 1 million users overall, but actually they lost 2 2 million in the US and Canada. So you're definitely seeing those US— and here was a crazy stat I found. The number of streaming subscriptions in the US is more than the size of the population. There's 380 million streaming subscriptions and the population's only 330. Million. So that's just saying, well, obviously households have multiple streaming subscriptions. Even a household of 4 on average has more than 4 streaming subscriptions. Then you think, well, hang on, how many streaming subscriptions are there? I mean, how many have you got?

Yeah, I got Disney, got Netflix, Prime. Yeah, but then Spotify, like when you talk, when you put it all, package them all up.

Yeah, well, there you go. So you're a household of 4, so you've got, you've got 4.

Yeah, yeah. So my 4-week-old is there binge-watching Stranger Things.

Give it 6 months. But so certainly in the US and Canada, it's the biggest market, it's the most mature, and you're seeing this churn now, and you're seeing people kind of switch off. And it's the likes of And this is in the quarter where Stranger Things landed, which was massive, right? So they still lost 2 million people in Q2 in the US and Canada, even though Stranger Things landed on the doormat.

I bet they're— I bet they are putting the biggest squeeze on the director of Squid Game for the return series.

There's no Squid Game this year. You know what's coming next, second half of the year? New series of The Crown. And there's a couple of movies. There's the sequel to Knives Out.

Oh yeah.

And then there's the sequel to Enola Holmes. So sticking to the Stranger Things actress, uh, what's her name now? I can't remember her name. Eleven in Stranger Things. She's, she's Enola Holmes. Okay. Anyway, so they're the big, they're the big content kind of things that are dropping in the second half of the year. Um, but final point, Netflix, even though it's doom and gloom and nightmare, they are— they are— there's a real positive thing about Netflix and then maybe a longer-term negative. The positive thing is they're way ahead of rivals in terms of subscribers. They've got 221 million subscribers, Disney 138 million. Um, and actually Netflix are profitable, which most of these streaming services are not. So actually at the end of the year, talking about free cash flow, at the end of this year, despite a disaster, they should end the year with $1 billion of free cash flow, which you can't say about any of the other streaming services. But Netflix are always having to land these monster new content, whereas the likes of Disney, you know, they've got Star Wars, right? They've got a massive franchise engine. Okay, and so does like HBO, they've got— or Warner Brothers, they've got Harry Potter. You know, Netflix lacks that monster franchise engine that can keep churning it out. Um, so maybe that's a risk longer term.

Yeah, and from an earnings perspective, it really does step up another gear next week. And to give you a bit of, uh, foresight on that, Microsoft, Alphabet, they report on Tuesday next week. Meta on Wednesday, Apple, Amazon on Thursday, and then the oil majors Exxon Chevron on Friday. It's the biggest earnings week next week. It's gonna be big, so stay tuned.

Down the hatches.

Cool, thank you very much, Piers. I'll let you go. I'll see you in the office shortly. And yeah, see everyone next week.

Have a good weekend.

Take care.