How Low Will Mortgage Rates Go? Plus, e.l.f. Beauty

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I could see a scenario over the next 6 to 12 months where I think mortgage rates could easily be 100 basis points lower than they are today. Why? Well, because I think the Fed's going to cut a little more aggressively than the market's pricing in. But I also think that mortgage spreads will compress from here as well.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Andrew Cizerowski. He's the Strategic Income Portfolio Manager at Morgan Stanley Investment Management. And in a moment, he'll explain what's next for mortgage rates and why, for investors, mortgage-backed securities look attractive. We'll also look at the wild ride recently in shares of e.l.f. Beauty, and we'll hear from that company's CEO and a top Wall Street cosmetics analyst. Listening in is our audio producer Alexis Moore. Hi Alexis.

Hey Jack.

I'm going to do my best here. I'm going to put on a brave face. I do have a mild burn on the tip of my tongue. I got, uh, I got too aggressive recently with some corn on the cob. What happens is you, you pull it out of boiling water and a corn on the cob will hold its heat for a long time. But you know, corn's delicious. So there's always a, it's always a difficult standoff where you gotta wait long enough to not burn yourself, but you don't want to wait too long because you can't wait to get into that corn. And I didn't wait long enough, but I'm going to push through. Please don't call me a hero. Now I want to talk about e.l.f. Beauty. You are familiar with this company's products, correct?

Yes.

Elf Eyes, Lips, and Face, right? It's a little e, little l, little f, right? Very Gen Z, but then a capital B on Beauty. It's the name, if I'm being honest, it's like being as much of a pain in the neck with, uh, you know, somebody having to write that name as possible, but we'll give them a pass for that. If you look at the chart of this stock, this thing has been public since 2016, and this is a stock chart that would scare off a meme coin trader. This thing has been wildly volatile, but depending on when you bought it, you might also have made great money. Over the past 5 years, the stock has returned 492%. That compares with 106% for the S&P 500. Growth has mostly been rapturous over the years. There have been a couple of exceptions. The stock debuted in 2016. The IPO price was $17 a share. It closed the first day of trading over $26, and then over the next 2 years, The stock price got cut in half. There was a rare sales decline for the company. The company's CEO at the time, Terang Amin, responded by closing the company's own stores and focusing on its sales through national retail partners as well as through its website. He also improved marketing. I wanna focus on the period that started with the stock's high price over $200 a share last summer and ran through a steep decline into the 60s, followed by a rebound to about $120 recently. Just this month, there was a 9% decline when the company reported quarterly financial results, followed by a 10% gain when Morgan Stanley upgraded the stock. The recent volatility comes down to this: Elf is a company that makes most of its goods in China and sells most of its goods in the U.S. And now we have higher tariffs and some tariff uncertainty, and Elf has had to respond by raising prices. It did so by a dollar. That's a dollar on pretty much everything across the store. Ever hear of something called the lipstick index? It's a well-known economic phenomenon that I'm pretty sure is total baloney. It was put out there by a cosmetics tycoon a couple of decades ago. It holds that women are supposed to buy more lipstick during economic downturns. The theory is it's an affordable luxury. It makes them feel better. I haven't seen any evidence that that really happens. But on the subject of liponomics, here's a very real economic phenomenon. It's called price elasticity of demand. It's the degree to which a customer will pull back buying a certain good if the price goes up. For some goods or some customers, the elasticity is high and others not so much. And that to me is an interesting case study that's playing out right now in e.l.f. Beauty shares. If a $7 lipstick goes up by a dollar, that's a big percentage increase, but at the same time, it still looks good relative to that $50 lipstick. So just what does the elasticity of demand look like for e.l.f.? I don't think investors are quite sure, and I think that explains the stock's recent volatility. Everyone's waiting to see. And that's as much as I can tell you. Let's hear more about the company from Terang.

e.l.f. Beauty's been around for 21 years. We got our start selling cosmetics over the internet for $1. Everyone thought the founders were crazy. This was 2004, pre-iPhone. You couldn't sell cosmetics over the internet, and you certainly couldn't make money at a dollar. But that spirit of disruption has been with us ever since. We've since migrated to other channels. Our main customers in the US would be Target, Walmart, Ulta Beauty, wherever you'd buy mass cosmetics. We are still strong online with a great business at Amazon, our elfcosmetics.com business. The number one brand amongst Gen Z, but we're most known for is still making the best of beauty accessible to every eye, lip, and face.

How do you figure out what your next hit product is going to be? I mean, one way I would imagine is you look for something out there that people like that's $100 or $150. You figure out a way to make something similar that's $15 or $20. I would imagine that that's a good route. Is that, is that something you do? What, what is your R&D or in-house development process look like?

I'd say two things. First of all, we're big believers in having our team reflect our community. So our workforce is 74% women, 76% Gen Z and millennial, 44% diverse. They absolutely are the community we serve and probably the richest source of insights in terms of what's hot, what's trending. They obviously look at the data. We have an incredible innovation capability. But the other great thing about us is we're known for our community engagement. We know our community, where they live, what they like. And a lot of times, our community tell us exactly what they want. My CMO sometimes terrorizes me by dragging me on TikTok Live. It's under our theory of zero distance between the C-suite and our community.

I was just going to ask how your social media game is personally, but go ahead.

So my social media game is probably woefully inadequate, but luckily e.l.f. Beauty is quite strong. So my CMO will drag me on TikTok Live. There was a time I went on last year. And she's like, all right, you got the big boss now. Tell him what you want. I'll look at the chat field and it'll light up. And it's like, oh, there's this prestige brand. It's got these bronzing drops. We love them, but they're $38. I can't afford $38. Help us out, El. And I'll say, okay, yeah, yeah, okay, you guys want bronzing drops. And then there'll be like another 2 dozen chats like, no, no, boss man, we want them now. Like I said, I'll leave that TikTok pretty traumatized. I'll call my head of innovation. I'll say, please, We have a 3-year product pipeline. Please tell me we have bronzing drops somewhere in that product pipeline. And she says, yes, we do. I'm like, all right, great. When are they coming out? It's like 18 months. I'm like, no, no, you don't understand. I cannot go on another one of those TikTok Lives and have our community yell at me. So we introduced them within 6 months and at a fraction of the price. I think ours came out at $9 versus the $39 prestige item. And we do that over and over again. Importantly, our ability to react to that quickly, be able to have that innovation capability, be able to deliver that prestige quality at a fraction of the price.

I won't ask whether folks in the office have started calling you boss man, like your, uh, like your fans on social media, but tell me about where you are in the company's growth. In other words, for investors, what's your ambition for the company 5 years down the road, 10 years down the road? I see these headlines about pushing into new stores or expanding your relationships with stores? How much room is there to go? Are some of the retail partners, do they get at all nervous about other competing products that sell at much higher prices?

You know, one of the great things, I've been CEO of e.l.f. Beauty for 11 and a half years. Every time I get a new candidate, I tell them, oh my God, you are joining us at the exact right time because we're just getting started. And I fundamentally believe that. If you take a look at our net sales, they're about $1.3 billion. We feel in the coming years we can more than double that, get past $3 billion. We see white space in color cosmetics, skincare, and international. In color cosmetics, we're now, as I said, the number 1 unit share brand in the US, number 2 dollar share, with clear line of sight to market leadership. But if you look at Target, which was our first national retail customer, we're their number 1 brand with over 21% of their entire category. And the only difference between Target and everyone else is Target had a 5-year head start on everyone else. And we're seeing the same trajectory with every one of our customers where we are the most productive brand a retailer will carry, the highest dollar per linear foot sales. We're very proactive in changing out our assortment to make sure we keep that high productivity, taking insights from our digital channels. And then we have two of the fastest growing skincare brands in e.l.f. Skin and Notorium, both distinct and complementary, but both very fast growth. And then we're in the very early days of our international expansion. International is only 20% of our business today. For many of our global peers, it's over 70%. And the great news, because of that strength that we have in social, we see pent-up demand for e.l.f. well before we get into a country. In the last year, every retailer we've launched into, we've launched into the number 1 to number 3 position. We had a launch last year with Douglas Italy. Douglas is more of a prestige shop. And we asked Douglas, we don't even have any Italian consumers, how much should we modify this brand for for the Italians? They said, no, not much. Italians like hot American brands. The only argument we had with them is we have the number 1 SKU in color cosmetics in the US, our Power Grip Primer. They told us Italians don't use primers. And we're like, you know, we're a test and learn, we're a digitally native brand. Why don't we put it in and if it doesn't work, we'll sub it out with something else. Sure enough, not only is e.l.f. the number 1 brand in dew gloss, but Power Grip Primer is the number 1 item in their entire store.

I'm learning so much here. Italians do use primer even though they thought they didn't. I'm going to Google primer after this. No, it's good. I'm going to go down a whole internet rabbit hole on that one. For more on e.l.f. Beauty, I reached out to Olivia Tong. She's a beauty, personal care, and household products analyst at Raymond James, and she's bullish on e.l.f.

Beauty is a fantastic category insofar as it typically does grow volume and price. On a regular basis and there's no shortage of real estate on your face. People are always interested in looking for more opportunities to make themselves feel better and look better. From that perspective, it's really interesting, number one. Number two, their average price point is $650. Mass average is $10-ish. Prestige, sky's the limit. So it is democratizing accessibility for these products, Also, really importantly, they advertise pretty extensively. They spend about 25% of sales on average year in, year out on advertising, which you don't typically see with value-tier, value-oriented brands.

Is it the case that— I know this is a company with some tariff exposure and maybe they need to raise prices. Was that an issue? Is there anything that you see with this brand that leads you to think that there's a demand issue, that customers are pulling back or going elsewhere, or do you see a company that's still growing in a healthy way? It's just that maybe investors' expectations got too high or that sort of thing.

It's sort of all of the above, right? Expectations had started to increase. They were seeing a lot more folks. There was a lot more fast money that was getting into this stock as well. And the tariff discussion had started. They make, now it's close to 75% of their product in China in Trump 1.0. It was 99% of their product. It was also 90% US or 90+ percent US, and now it's 80% US. So your tariff exposure has come in and your exposure—

You mean in terms of the sales?

Exactly.

So they make it overwhelmingly in China, they sell it overwhelmingly in the US. Have I got that right?

Correct. And now it's still the case, but it's now 80/20 in terms of US versus international. And it's 75% of their product is produced in China. They are looking to diversify more of that, but it's still, generally speaking, will continue to be China skewed at a 30% incremental rate. Still kind of makes generally sense to not move production too much. I mean, you wanna do some sourcing diversification just because everybody's moving some sourcing diversification, but I don't think that you necessarily necessarily need to move at the kind of like cheetah-like pace that everybody was thinking they would have to when we were going up and up and up to $145 incremental.

So the stock, when you look at it now, at, at given the latest that you've seen from earnings, first of all, did you like the most recent quarterly report?

The most recent quarterly report was a solid report. You saw a nice top line performance. You saw better than expected margins. The next quarter has some funny timing and transitory things that are impacting them. But on a full-year basis, we honestly didn't do much to our second half estimates on the expectation that this will continue to compound.

And what's the case you make on the stock? When you look at the stock's price, it's now lower stock price, and you look at the growth trajectory of the company, what kind of stock is this? Is this growth at a reasonable price? Is this— these people must be crazy for leaving this stock at this price because there's a lot more to come going forward? Or how would you characterize the value that you see in the stock right now?

Yeah, I think you have a couple of things to think about with respect to this stock now. Now, we thought that the reaction post earnings was overdone. Now that said, it had fallen way too much and it's come back for the most part since earnings. From here, we think there are a couple of things to think about. Number one is how they think about the fall, the innovation cycle from here. The first thing that they had planned to do didn't quite hit the mark, so they pulled forward the fall launch, which did hit the mark. There is more coming. There's more innovation. Number 2 is around the international expansion. So continuing to expand there, that's number 2. Number 3 is around the categories. And most of the categories where they have the highest share are not necessarily the biggest categories. So as you think about continuing to expand into other categories, getting into some more of the traditional categories where the legacy players have big shares, there's some opportunity there. From a channel perspective, I mean, there's no other brand that's both in Dollar General and Sephora. So channel continues to be an opportunity too.

Thank you, Olivia. Wall Street expects e.l.f. to return to earnings growth rates in the mid-20s starting next year. And the stock goes for about 28 times next year's earnings forecast. It's an ambitious price, but for a company with plenty of room to grow, we'll see what happens next. Let's take a quick break. And when we come back, we'll talk about what's next for mortgage rates and the outlook for mortgage-backed securities.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.

Welcome back. I want to talk a little bit about mortgage-backed securities. Do not roll your eyes and make snoring noises. This is an exciting topic and I'm going to give you a few reasons. Number 1, mortgage rates are higher than they were a few years ago, and that's a bummer for people who are shopping for a house. But if you're an investor eyeing mortgage-backed securities, it's an opportunity for yield. Number 2, as Andrew at Morgan Stanley is going to explain to us in a moment, spreads for these securities are unusually high right now. That's an opportunity. And number 3, although mortgage rates remain higher than we're used to in recent years, this past week they actually hit their lowest point in 2025. There's reason to believe they're headed even lower from here. So if you're a home shopper, maybe there's better news coming. But what does that mean if you're a mortgage-backed securities investor? That's what I wanted to figure out. So I reached out to Andrew Cizerowski. He's the Strategic Income Portfolio Manager at Morgan Stanley Investment Management.

Affordability in the housing market is very low right now, partly because home prices rose so much coming out of the pandemic and partly because on the financing side, mortgage rates are so high. And why are they so high? Well, they're so high for a number of reasons. One is that you have base Treasury yields that are just much higher. But the other component is this spread which agency MBS investors get. So the spread over treasuries is actually quite elevated right now relative to where we've been over the last 15 years. And it's elevated because there's a couple of negative technicals. The Fed's been shrinking their balance sheet on the mortgage side, so that's been kind of weighing on the market. Back in 2023, you had Silicon Valley Bank and First Republic Bank, and banks are large investors in this market, but they essentially because of kind of poor interest rate management, you had essentially banks kind of leave this market because they weren't hedging their portfolio appropriately. And so that caused one of the biggest buyers— so your two biggest buyers before were the Fed and banks, and both of them essentially left the market for a while, which has kind of kept spreads elevated. And, you know, we think that right now you can get 140 to 150 basis points over treasuries in something that's essentially Depending on if you're investing in Ginnie Mae, which is explicitly backed by the US government, or Fannie and Freddie bonds, which have been in government conservatorship since 2008, those are implicitly backed by the US government. So you're getting essentially this very attractive spread that we feel today because of these negative technicals and ultimately volatility in the bond market's been high. But again, we think it's a very attractive time to go into the market because of these, especially when you look around at the alternatives, you look at how tight investment-grade corporate spreads are. You look at how, you know, you could get more spread in an AA agency MBS than a BBB investment-grade corporate, and that's not something you can historically say.

You heard Andrew mention spreads. If you buy something like a corporate bond, it typically yields more than a Treasury. The difference is called the spread, and it reflects the extra risk of buying that corporate bond. Just how wide the spread is depends on a variety of factors, including how risky the company is. But also, average spreads can grow wider or narrower over time. Sometimes investors are in a mood to take on risk and sometimes not so much. They might expect better days ahead for corporate borrowers in general or worse days. And the same is true in mortgage-backed securities. What Andrew was saying is that spreads now for mortgage-backed securities are unusually wide. That has to do with technical reasons, a couple of big sellers. And not to increased risk. One of the key risks for mortgage-backed securities is refinancing. If mortgage rates fall, then borrowers can generally refinance anytime they like. So if you have exposure to these mortgages as an investor, you're never quite sure how long they're going to last. In general, Andrew says that if you had something like a broad ETF of treasuries and another one of mortgage-backed securities, you would expect both of them to do well as interest rates decline. But the traditional treasuries would probably do better. As those rates fall, it increases the refinancing risk for mortgages. That could limit your upside. Andrew also told me that he thinks opportunities are better for active managers in mortgage-backed securities. Indexes tend to hold too many old mortgages with very low interest rates. Also, Andrew says this is a very large asset class, but some of the public's view of it is still tainted by memories of the global financial crisis. Hearing about mortgages gone bad, Andrew says that was related to risky types of mortgages that have pretty much been done away with. It was non-government mortgages that were the problem back then. Agency mortgage-backed securities, he said, ultimately went up during 2008 in the financial crisis. For investors out there who have actively managed broad bond funds, Andrew says you might already have exposure to mortgage-backed securities, although depending on your circumstances, you might want a little more. When I spoke with Andrew, the 30-year fixed mortgage rate in the US was about 6.7%. Andrew says that mortgage rates are likely to continue falling, and to understand why, you have to look at the Federal Reserve and the employment market and consumer prices. Okay, let's get to what is next for mortgage rates.

Yeah, obviously, you know, predicting the kind of future rate policy is difficult. We do believe that when you focus on the macro side of things, we think the labor market is slowing, will continue to slow. Ultimately, the Fed has a dual mandate, and that's full employment and stable prices, which they define as 2% inflation. Now, we know that inflation has, as tariffs have kind of reemerged, has reaccelerated. We think that's something that's going to be a temporary one-time jump in prices that's not going to be good for the consumer. So the Fed will be missing on the inflation side of the mandate. On the other side of the equation is the labor market, which we think the Fed's going to focus more on. And they've had the luxury over the last couple months of sitting on hold. We, we think that's gonna get tougher and tougher. We obviously just had this very weak payroll report that came out on the first of the month, and we think that you're gonna see more of the FOMC members break rank and want to get a little more aggressive on the cutting side. What does that mean for mortgage rates? I, I think it's gonna be a positive for mortgage rates. We think that interest rates in general, treasury yields and mortgage spreads are gonna be coming down over the course of the next year. As the Fed looks to get from a restrictive state to a stimulus state with monetary policy. I don't think we're ever going back to where we were in 2021, which is that kind of 2.5%. So I think people have to get that out of their mind. That was the anomaly. The mortgage rates today aren't the anomaly. The mortgage rates we had in 2021 when QE was going on and essentially the Fed was kind of clamping down mortgage spreads by buying mortgage-backed securities on top of keeping interest rates low, that's the anomaly. But I could see a scenario over the next 6, 12 months where I think mortgage rates could easily be 100 basis points lower than they are today. Why? Well, 'cause I think the Fed's going to cut a little more aggressively than the market's pricing in, but also think that mortgage spreads will compress from here as well. The other benefit you'll have as the Fed cuts rates, we think the yield curve's going to steepen, but a steeper yield curve's actually a good environment for agency MBS because you get, as interest rates come down on the front end, you know, you have levered buyers out there, you have mortgage REITs, you have hedge funds, you also have banks, which will no longer wanna be just rolling T-bills or other kind of short-term cash instruments. They're gonna be looking to move out the curve a little, and that's gonna help kind of compress mortgage spreads over time as banks come back into the market.

I heard you say 100 basis points, meaning 1 percentage point, meaning if we're at 6.7% today, maybe sometime in the next year, you'll see a 5.7% mortgage rate. And that's better than you think because those 3% and lower mortgage rates were an anomaly. So 5.7% is pretty good if you see it. Is that the idea?

Exactly. And it just, again, it still makes housing a little less affordable than it was back in '21, '22. But you have to keep in mind that we're not going to go back to that environment. If you're a new home buyer, one of the things you're benefiting from right now is that home prices in certain regions are actually starting to fall, or home builders are having a tough time selling some of their inventory. So what they've been doing is actually offering mortgage buydowns. So we see in the mortgage-backed security market, even though mortgage rates today are 6.7%, some of the mortgage bonds being created today have coupons of 4%, 4.5%, even 3.5%, because mortgage, you know, if you're a home builder, you're actually buying down these rates, could be 200 basis points or 250 basis points to essentially make the underlying mortgage payment a little more affordable for that homebuyer. And the other thing you're doing is you're not taking the 10% hit on the price. So then the rest of the homes in your development have to take a 10% hit because everyone sees that you're actually kind of quietly taking a different version of a 10% hit by buying down that mortgage, which might cost 5 or 10 percentage points in housing terms. And so it's a kind of sneaky way that home— the housing market's not really as strong as it seems in some areas because of these mortgage buydowns.

Out of curiosity, you don't have to answer this, but I'm wondering, I'm picturing in my head, was there ever a moment in the past where you went to get a mortgage for yourself, you know, and you talked to a mortgage broker who didn't know about your superpowers, and the mortgage broker is talking to you and saying, well, let me explain to you, you have this and you have this, and you're thinking to yourself, hey, listen, pal, did that moment ever happen?

That moment has occurred a number of times, actually, over the course of of my homeownership journey. I can tell you that as a mortgage-backed investor, there's also mortgage brokers, some who are much more aggressive than others who are trying to churn these borrowers and aggressively contact you. And my first mortgage was through, I won't even mention it, but basically it was someone who had this very aggressive policy. So as a mortgage investor, I don't want to invest in this super aggressive bank that's always trying to kind of churn these borrowers over. Caused me for life to avoid this one who will remain nameless just so I don't get in trouble with my firm or their firm.

Thank you, Andrew and Olivia and Terang. And thank you all for listening. If you have a question you'd like played and answered on the podcast, you can send it in. It could be in a future episode. Just use the voice memo app on your phone, send it to jack.hough@barons.com. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcast, Spotify, or wherever you listen to podcasts. If you listen on Apple, write us a review. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.