An Election Dispute Could Rattle Stocks. Plus, The Future of Movies

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Tenet, in certain respects, is a perfect movie to open with because it's a traditional kind of blockbuster spectacle. And I think when people hear about that and see that, they're going to want to go back.

Welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard, that's Richard Gelfond. He's the CEO of IMAX, the company known for massive movie screens and whiz-bang sound. Rich is excited about a big-budget popcorn movie called Tenet, which has good reviews and opens in the U.S. on September 3rd in movie theaters. Remember those? In a moment, we'll hear more from Rich about the outlook for the movie business, including IMAX. We'll also say a few words about another costly spectacle, the U.S. presidential election, and how a muddled result could affect the stock market. Listening in as always is our audio producer Meta. Hi, Meta.

Hi, Jack.

The Republican and Democratic conventions have just wrapped up on television, and the presidential debates don't start until September 29th. Meta, That leaves about a 1-month lull in the campaign action. Are you sad about that?

I'll find a way to get by. Put on a brave face.

You must have taped the conventions so that you can rewatch them if you really have to, right?

Yeah, of course.

Okay. Let's say a few quick words about the stock market. This podcast launched in March, close to the pandemic low point for the U.S. stock market, and I told listeners then that stocks look like a good deal for the long term and to stick with them, but to diversify because near-term returns are uncertain. In the weeks that followed, I explained that I had become a Benjamin Button investor, that I had a cautious asset allocation more appropriate for an investor older than me, and that I used the downturn to increase my allocation to stocks and start acting my age. Since then, I have I've regularly told listeners to stick with stocks, but I guess this is Benjamin Button: The Sequel, because this past week I trimmed my stock allocation again. It's not that I think stocks were a bad deal. I mean, they're expensive. The S&P 500 trades at 21 times last year's record earnings, and that's about 40% more expensive than the historical average. And earnings are in a deep slump at the moment. They might not return to last year's level for maybe 2 years. That tells me nothing about stock returns over the next year, however. Those are totally unpredictable. But it does suggest that average returns over the next decade could be lower than investors are used to because starting prices are high. Of course, interest rates are so low that even if we assume stock returns will be half as generous as usual, they'll still surely beat bonds. That's even more likely now that this past Thursday, Federal Reserve Chairman Jerome Powell announced a change to the way the Fed targets inflation.

By reducing our scope to support the economy by cutting interest rates, the lower bound increases downward risks to employment and inflation. To counter these risks, we are prepared to use our full range of tools to support the economy.

Hang in there, there's only 38 minutes left in this clip. You know what, I'll just sum it up. The Fed made a change to how much inflation it's willing to look the other way on, and the upshot is that however long you thought interest rates would stay this low, they're now likely to stay this low for longer. That boosts the case for stocks. U.S. stocks were already on a tear, but the market shot a few percent higher during the week or so between when investors learned Chairman Powell would likely deliver that news and when he actually did. And as has been happening all along, shares of big tech companies like Apple, Amazon, Facebook, and Tesla led the way. The S&P 500 as a whole was recently up 56% from its March low point. But I trimmed my stock allocation because of something ickier than stretched valuations. It was politics. Now, I don't belong to a political party and I'm never going to join. Partisan talking points make me itch and wheeze. In politics, everyone tries to push emotional buttons and no one talks about taking an evidence-based approach to efficiently allocating resources for maximum societal benefit at moderate taxpayer cost. When you see all of that on a bumper sticker, let me know. We're going to hear a lot of talk in the weeks ahead about what the stock market will do if one party or the other wins. And that's nonsense. You might have even seen a chart showing historical returns under Democratic and Republican presidents sorted by periods when their party did or didn't control the House and Senate. Those charts are nonsense too, because they don't predict what the stock market will do this time around. There's a serious sample size problem. Donald Trump is our 45th president, and 45 presidents just aren't a big enough sample to draw stock market conclusions from. Especially considering that if you want to use good stock market data, you have to reduce that list by more than half. You might be left with 20 presidents. If I flipped a penny 20 times and it came up heads 8 times, we wouldn't conclude that the chances of it coming up heads are 40%. We'd say the chances are 50/50 and that the sample size was too small. Quick side note: the chances of a penny coming up heads are not 50/50. The starting position of the coin matters. So does whether the penny is caught or allowed to land on a smooth surface and spin. The metal is unevenly distributed, with the head side heavier than the tail side. There was a Stanford paper on that subject years ago. Anyhow, I see no reliable link between political parties and stock returns. To believe presidents predict returns, you'd have to feel more or less the same about Barack Obama and Donald Trump, because Both presided over rip-roaring gains. Or you can look at some other factor that was the same across both administrations, like ultra-low interest rates. I try to leave elections out of stock decisions. Parties change over time. Politicians aren't the same as parties. Some are more or less effective in getting their way once elected. Other external conditions like interest rates change, and so do starting valuations. Also, markets are forward-looking, so some of what's going to happen after the election might already be predicted by investors and reflected in stock prices. So I didn't take down my stock exposure because of who might win. I took it down because of what might happen if we can't agree on who won. I've seen one contested presidential election in my life, maybe one and a half. In 2000, George W. Bush defeated Al Gore, but the election took place on November 7th and it wasn't decided until 6 weeks later, December 13th. It came down to a narrow difference in the state of Florida. There was a recount. I learned the word "chad," which refers to fragments created when a hole is punched in paper, like with a voting machine and a paper ballot. There were arguments over dimpled chads, which were just indented but not torn, pregnant chads, which were very dimpled. There were swinging chads, which were attached to the ballot at two corners, and hanging chads, which were attached at only one corner. In the end, the Supreme Court halted the recount and Gore conceded. Looking back, there was no breakdown in societal order. Citizens didn't abandon institutions and look to the military command for signs of what would happen next, as sometimes happens in fragile democracies. The most dramatic moment might have been the so-called Brooks Brothers Riot, when angry demonstrators gathered seemingly spontaneously at a Miami-Dade election office and demanded an end to the recount. What was unusual about this screaming mob is that it was so neatly dressed. A lot of khaki pants and button-down shirts. Everyone looked kind of like me in 2000. It turns out the rioters were party workers and the demonstration wasn't so spontaneous. In hindsight, the aftermath of the 2000 election seems tame, but the stock market didn't like it. The S&P 500 fell 5% between Election Day and the concession. The decline was concentrated in the first days following the election. Now, we can't count 2016 as a contested election. The electoral count was clear. But there was a 3 million vote difference in the popular vote, which doesn't mean anything for the outcome except that President Trump has said that he would have won the popular vote if you deduct the people who voted illegally. I haven't seen evidence for that claim, but that type of argument could become relevant for stocks this year. The pandemic means there will be far more mail-in votes this year than in 2016. The president has said that mail-in voting opens the door to widespread fraud. I haven't seen proof of that either, but I think we can agree that mail-in voting opens the door to delay. To complicate matters, Democrats say that the new head of the Post Office plans to deliberately slow the mail, which he denies. I'll leave it to others to debate these matters. What concerns me here is that the chances of a disputed outcome seem high. Or at least too high to ignore. In a July interview, Chris Wallace of Fox News asked the president whether he would accept the election results.

The president said, "I have to see." I think mail-in voting is, is going to rig the election. I really do.

Are you suggesting that you might not accept the results of the election?

I have to see. Look, Hillary Clinton asked me the same thing.

No, I asked you the same thing in the debate.

I took that comment to mean he'll only accept the results if he thinks they're fair. What worries me is the thought that politics could turn any delay into a dispute over fairness. And I can imagine the dispute being over something much more difficult to prove or disprove than pregnant chads. Let's just say I'm worried that things could get more chaotic than the Brooks Brothers riot. That's a possibility, but it's not my prediction. There's a reasonable chance that the president will win reelection, and a reasonable chance that Joe Biden will win too decisively for the matter to be called into question. But just in case, I've taken my exposure down until the election passes. I never bail out of stocks altogether. Benjamin Graham, known as the father of value investing, advised using bumpers—never going below 25% in your stock allocation or above 75%. I do that, but I use a higher range: 35% to 85%. Since March, let's just say that I favored the top half of my range for stock exposure— but now, just for a little while, I'm favoring the bottom half. And for the sake of stability, I hope I'm worried for nothing and that I foolishly miss out on a bit of the upside.

You want to crash a plane? Well, how big a plane?

Meta, have you heard about a movie called Tenet? That part is a little dramatic. And do you plan to see it?

I have heard about it, yes. And yes, I would like to see it. In the theater? I mean, I'd love to see it in the theater because I really miss going to the movies, but I don't think I'm gonna go for this one.

You're not ready yet? No. So it's a big movie with a budget of more than $200 million, and it has a big-name writer and director, Christopher Nolan. Best known for a string of Batman movies called the Dark Knight Trilogy. Hollywood is talking about this movie like it's the beginning of a comeback for movie theaters. It's already been released in more than 70 countries, and it's getting a wide US release this coming week. On RottenTomatoes.com, the movie gets an 85% fresh rating. That's good. Hey, Matter, you know how some movies look deep inside the human condition and the force us to rethink relationships.

Yeah, I think that's actually Nolan a little bit.

Oh, I was gonna say I don't watch those kind of movies. I like the ones that have superheroes, zombies, or CIA agents, but this one has a CIA agent, so it seems perfect for me.

You really can have it all.

But like you, I'm not going to the theater just yet. I'm not what you call a first mover when it comes to matters of safety. I'm a wait-and-seer. I'm pretty sure that I'll go back to the movies by early October because there's a movie coming out then called Wonder Woman 1984, and if there are two things I love, they're Wonder Woman and 1984.

Nothing good is born from lies, and greatness is not what you think.

I might have to go to the theater for that one, even if it means I have to find a hazmat suit roomy enough to fit a tub of popcorn inside. Maybe a Junior Mints utility belt. Anyhow, I had an opportunity recently to get an update on the state of the big screen business from a guy with some of the biggest screens. Hi Rich, can you hear me? It's Jack Howe from Barons. Hi Jack, how you doing? Hey, good. I didn't know— I signed up for audio here, I didn't know we're doing video too, so Well, we're not.

I hope we're not because I'm wearing a t-shirt.

I love it.

What is that, Avatar? Yeah, it is. I've been wearing it all day. I would have, you know, put on the official outfit of business executives.

No, I love it. It's a real cinematic experience. Rich Gelfond is the CEO of IMAX, which moviegoers know if they've ever paid a little extra to watch a movie on a giant screen with intense sound. IMAX technology extends to the cameras and equipment used to make movies and the design of theaters. The company makes money by licensing its technology and designs. Theater owners can pay an upfront fee and an ongoing royalty, or they can partner with IMAX and have IMAX put up part of the capital to redesign a theater and then share future box office proceeds. There are recurring maintenance fees too. Studios give IMAX a cut of their box office revenue to use its format for shooting films or to convert films. IMAX also makes its own documentaries and some local language films outside the U.S. I asked Rich to describe what makes seeing an IMAX movie special.

When you're in an IMAX theater, you feel like you're experiencing the film, and one of the sayings I like a lot is Your eye can shop the image. So in a regular movie, the director sort of tells you where to look through the way it's projected. But in IMAX, there's so much information there that your eye could look at the situation and you could really figure out how to view it yourself.

Few places were hit harder by the shutdown than movie theaters, but it's important to note that IMAX makes 3/4 of its revenue outside the U.S. China's a big market contributing about 1/3 of revenues. Rich says theater shutdowns didn't hit markets at the same times. When China shut down, the rest of the world was open. When the US and China were closed, Japan and Korea were open. Revenue never went to zero and IMAX raised cash by, for example, selling documentaries to the streaming service Hulu. IMAX is expected to burn cash this year but return to positive free cash flow next year. And Rich says his financial position is strong.

We have a long period where we can be patient and we can invest in what the industry's gonna look like afterwards. For us, it's not survival. It's about using our resources to figure out how to make it better when the world opens up.

Okay, so what about the world opening up? Will the movie business be changed forever? Can theaters survive? Rich says it's important to keep a global perspective. He mentioned some recent movies in Korea and China that have been well attended, especially if we keep crowd restrictions in mind. Those are easing. In China, Rich says they recently went from filling 1/3 of the seats to allowing 50% capacity. In the US, Rich says he sees potential for the pandemic to change how and when people visit theaters. He says last year was a record one for IMAX, even though only 10% of its capacity was filled.

And the reason for that is people like to go on Friday and Saturday nights, so they're very crowded then and less crowded during the week. But we're hoping because of the response to COVID by people, by working from home, that people will naturally spread themselves out.

Rich says he's hopeful that safety protocols like wearing masks will make theatergoers feel safe. He says international results bode well for the U.S. I guess we'll find out, but when? Maybe as soon as right now. Here's Rich.

Tenet, in certain respects, is a perfect movie to open with because it's a traditional kind of blockbuster spectacle, so it takes place in in a lot of locations. It has fantastic special effects. It has great sound, great music. And I think when people hear about that and see that, they're going to want to go back. Another, you know, point of reference would be, you know, as you know, sometimes to excess, people went back to restaurants and bars, especially millennials in a lot of numbers. We think theaters will be a lot safer than those kind of places, and a lot of the movies we're releasing are geared to millennials. So I'm encouraged.

But what about the China risk? Relations between the governments of the U.S. and China are rocky. One of the key U.S. presidential campaign issues is which candidate is willing to take a tougher stand on China when it comes to matters of trade and intellectual property protection. There's all kinds of potential for a backlash, but Rich says he's relatively well protected from that. Although the movie business might bring to mind Hollywood, IMAX is headquartered in Ontario, Canada. Rich points out that its China business is traded separately in Hong Kong, and although it's majority owned by the Canadian parent, The CEO and most of the management are Chinese. The company works with Chinese studios and directors to make Chinese movies, and many of the theaters serve as anchors for China's malls.

I never say never, but I think the chances of retaliating against a company that is, you know, so close to being a Chinese company and the way it operates and the way it's structured and where trades are remote.

We've heard on this podcast from Bob Iger at Disney and Bob Bakish at ViacomCBS, which owns Paramount. Metta, is that too much of a double name drop?

Oh no, you should name drop way more in general.

We've heard from them about whether and how the pandemic might change the relationship between studios and theaters. With theaters closed, they've had to decide whether to delay movies that are already in production or distribute them through other venues. For example, Disney will premiere a live-action remake of Mulan on September 4th on its Disney+ streaming service.

"She's both beautiful and strong." "Your job is to bring honor to the family." Live-action means with real people.

Cool people in Hollywood use that term to mean a movie isn't a cartoon. Also, cool people in Hollywood never say cartoon. Anyhow, for those who already subscribe to Disney+, Mulan will cost an extra $29.99. It's a total outrage and my daughter and I can't wait. But the Mulan plan isn't a new business model for Disney. It's making the best of an awkward situation. More worrisome for the theater business is a July announcement from Universal and AMC that they would shorten the theatrical window, the amount of time between when a movie hits theaters and when it goes to streaming, to 17 days from 75 days. Could that be a sign of the beginning of the end for theaters? Rich says no, because for big movies streaming can't provide enough of a financial payoff to justify the budgets.

IMAX is in the blockbuster business. And I don't think there'll be significant changes to the windows for blockbusters because the model really doesn't work. So if you expect to make a billion dollars, let's say, with a blockbuster, there's no way you can model that out on PVOD and streaming where you make that kind of money.

Now, outside of blockbusters, for movies with smaller budgets, Rich says the pandemic could lead to more of them going straight to streaming. Or to changes in the theatrical window, even though he doesn't think many studios will follow the AMC/Universal 17-day plan. He also points out that director Martin Scorsese recently signed a deal with Apple to make a movie called Killers of the Flower Moon starring Leonardo DiCaprio and Robert De Niro. It'll debut in theaters and then go to the Apple TV+ streaming service. Rich says Scorsese signed the deal with Apple in part because of Apple's commitment to theaters.

You know, I have very little doubt that, especially as the windows shorten, that a lot of the streaming services premiere their movies theatrically and play them there for a while. And I think that'll replace some of the content that theaters are losing, the smaller movies, because they're going to theaters sooner.

All told, Rich remains hopeful about the movie business not just for me and getting a chance to see Wonder Woman this fall in my popcorn suit, but for many years beyond.

I think it's a time and a place where people are saying, you know, streaming in the living room is gonna replace movies. But, you know, over the last 100 years, there's been radio, TV, DVD, VHS, lots of delivery systems, but people crave a cultural experience. They want to go to the movies. I mean, people have kitchens, but they go to restaurants. General opinion is too quick to announce a trend as happening forever when you're in the moment. And I think movies have been here 100 years, and they're going to be here for a long time in the year after.

Meta, to use a movie term, is that a wrap? I think it is. Let's skip the listener question this week, because next Friday we'll be airing a question special. And as always, please keep the questions coming. Just tape on your phone, use the voice memo app, and send an email to jack.hough@barons.com. Thank you for listening. Metalootsoft is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, please write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @JackHough, H-O-U-G-H. See you next week.

At CLA, we're in your corner and on it. We coach tax strategies and Little League first base. We help you adopt AI data tools and we adopt Rescue's name Buddy. We walked your factory floor and jogged the local 5K, though sometimes we walk that too. Wherever you're coming from, we're right there with you. Wherever you're going, we'll get you there. CLA, CPAs, consultants, and advisors. Learn more at claconnect.com/withyou.