Let’s Talk About Talking About Inflation. Plus, Expedia Stock.

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From an investor perspective, the problem is that inflation distorts price signals. You don't really know what the truth is and you make misjudgments. So the chances of getting things wrong are higher and therefore the risk of losses is greater. Greater than will be the case in the world of price stability.

Hello and welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Stephen King, not the Pet Sematary one, the HSBC economist who has a new book on the history of inflation. He says don't count out high inflation. It could remain alive and scary for a long time. A little like Pet Sematary, but for consumer prices. We'll talk about that. We'll also talk with B of A analyst Justin Post about the outlook for summer vacation spending and why he says it's time to buy Expedia stock. Listening in is our audio producer Meta. Hi, Meta.

Hi, Jack.

You have graciously agreed to return to the podcast that you started, the Barron Streetwise Podcast. Thank you. Great to see you again. Should we talk about vacations first or inflation? Vacations, right?

Vacation.

Go ahead and give people your top 3 vacation tips for summer 2023.

Okay.

I probably should have asked you to prepare something, but I forgot. Go ahead.

Sunscreen.

Yes, check.

Clean towels.

I mean, are there people out there bringing dirty towels on vacation? Go ahead.

No idea.

I'm counting it. Go ahead.

And drinks with little umbrellas.

No, I can't count that. No, I'm sorry. Number 3.

Surf and turf.

I mean, That's that. Are you talking about the meal? That's a dinner recommendation. Are you saying that people should surf, and then if you surf, you should return to the turf? Don't stay on the surf. That's not gonna work out.

It's a metaphor, Jack.

All right, good. There you have it. I have my mind on vacations, uh, not because I have, uh, made my summer plans yet, but because I've been reading my Wall Street stock research, and I came across this note from BofA analyst Justin Post, and he makes a bullish recommendation on Expedia. I wonder if you could just give me kind of the tale of the tape with these online travel businesses. You mentioned Expedia and Booking and Airbnb. How do these compare? Who's thriving? Who's lagging behind? Or how do things stand?

Sure. I think if you look at a high level, Booking has really gained share since the start of the pandemic. They've been more aggressive with their marketing spend and have had some real interesting stuff with product merchandising on their website. And you see that their room night share has increased and Expedia has lost share. That it's really— those are the two major companies in the online space. And so Booking has really capitalized on the travel rebound since the pandemic. And has gained some share. Expedia is almost back to pre-pandemic levels but hasn't had the relative night growth that, that Booking's had.

What do you think Booking's has done right or well to gain that share?

I think they've done really well with, with marketing spend, but, but also merchandising. If you become a loyalty customer, which I think they call Genius customers, they've been able to offer discounts for certain customers in certain situations and been really smart about how they're making their offers on the websites. And so better marketing tactics and also merchandising. To be fair, Expedia has been more selective on who they're marketing to and has seen real margin improvement since pre-pandemic. So they've kind of pursued different strategies. Booking's been more geared towards market share and Expedia has tried to reduce their dependence on marketing channels and be a little bit more selective on the customer they're trying to go after.

What does it look like in terms of the share that are traditional hotel rooms and, you know, hotel rooms they're selling on these sites versus homeowners who are selling, you know, spaces for vacation rentals?

Sure. So there are two markets, but they are converging. The hotel industry is much larger than the alternative accommodation industry. Vrbo is a competitor that Expedia owns that competes in alternative accommodations. That's their brand. Booking is doing most of their alternative accommodations on the Booking website. They really don't have a separate brand. And then of course, there's Airbnb. That's the leader in the alternative accommodation industry. If you add them all up, I think people would tell you alternative accommodations might be teens of total room nights. There's no official numbers out there, but it is growing faster. And so more and more people in our consumer surveys are willing to stay in alternative accommodations. So it's a faster growing channel., but it is still small relative to hotels. And I think Airbnb is not— I think I know they're the leader in the space. They have about 50% share and then Booking and Expedia are kind of the second and third players.

To my knowledge, you don't cover the hotel companies, but have you given any thought to how much of the lodging universe that these vacation rentals by owners or alternative accommodations could make up at some point?

Yeah, since the pandemic, we do consumer surveys and we've seen the percentage of people who say they're willing or want to stay in an alternative accommodation go up a lot. And I think early in the pandemic it was just health reasons. People wanted to be out of hotels with a lot of people and be in their own accommodations where you didn't have a lot of interaction with others. But we've seen that over time go from mid-teens. And in our last survey, 35% of people said they were looking or willing to stay in alternative accommodations. So I think as the industry has grown, you know, much like we've seen with e-commerce and online travel, people are getting more familiar with the concept and more interested in traveling and staying in alternative accommodation. There are a lot of different reasons people point out on why cost for an entire family is certainly one. Convenience. And, and then, you know, Airbnb has done a great job, uh, kind of segmenting the different types of accommodations. You know, you can search now for a home with a great pool, for example. And so they've done a really good job segmenting the market and making it easier for people to find the right home. So a lot of different reasons, you know, much like e-commerce and travel, but the adoption rate of alternative accommodations is definitely growing.

I have seen people posting things on Twitter where they say, well, look, here's the cost of my rental and here's— there's this extra fee and here's a cleaning fee. And when you put it all together, it's a good deal more than the original price. But there are also fees on hotel rooms. You know, there might be people out there complaining about cleaning fees and extra fees, but it's not been something that has slowed the growth in this industry. Is that right?

Yeah, it's not brand new to the industry. Airbnb recently, they have had complaints. They recently put fee transparency on their website. So as a user, you can look at the price both pre-fees or all in. You can toggle between the two. So it is something that they're trying to address and they're also trying to make sure that the hosts have reasonable fees and encouraging them to do so.

Okay. So Expedia sounds like the recent laggard in this group, and yet this is your favorite stock. You're bullish on Expedia. Is that because of the value? What is it that you see in Expedia? Do you expect that them to catch up to the others? What do you like?

I think there's 3 things. Certainly their room night growth has not been as strong as their competitors, and that's a big overhang. But I do think they're trying to improve their audience base and really get more app users and more loyalty customers that down the road will have higher repeat rates. So I think that could be a little misunderstood in the stock, and we hope that the customer base is improving. Second, AirDNA data suggests that Expedia's brand, Vrbo, in alternative accommodations is performing quite well. And so we think the progress and the value of that brand is underappreciated in the stock price. And finally, if you look at the free cash flow valuation, it's much lower than their competitors. So I think that the value of that cash flow is underappreciated in the stock. There's no debt due until '25 for Expedia. So as long as they're hitting their numbers, we think they can apply a significant amount of cash to buy back stock, and we'll see if they do that. But you can really start shrinking the share count over time with the cash flows the company generates, and I think that can create value for shareholders.

In general, the summer vacation season, how do you think it shapes up? Is it going to be a good year for vacation spending?

Yeah, certainly inflation and other factors are affecting consumer spend, but we think this is the second year of the post-pandemic travel rebound. So we think people will, you know, while they're being squeezed, maybe will spend more on travel and leisure this year again. So another strong year and a growth year versus last year. And so overall, I think summer will be good. If you think about the booking seasonality, this year is a little bit more front-end loaded. So you had more bookings in January and February than you'll see in the second quarter versus last year. So I think investors will see a bit of a slowdown in booking, but overall the summer vacation activity will be very strong, and, uh, that's something to look forward to for the whole sector.

Thank you, Justin. The ticker symbol for Expedia is EXPE. It was recently a $94 stock, and it's down from over $190 about a year ago, so it's lost half of its value. Justin has a price target for Expedia of $150 per share. That implies upside of more than 50% from recent levels. We'll see. He says that the VRBO business alone is worth $16 billion, and he points out that's more than Expedia's market value as a whole. Now, We Need to Talk About Inflation is the title of a new book on inflation, which we will be talking about right after this quick break.

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. The latest U.S. inflation rate is 5%. That's for the year through March, and it's way down. It's the lowest 12-month inflation rate we've seen since May of 2021. That's good, but It's 2.5 times as high as where the Fed says it would like to see inflation. That's bad. And it matters because the Fed, of course, has been aggressively raising interest rates to fight inflation. And that's pretty good if you're collecting higher interest on your money market account. But it's quite bad if you're worried that these higher interest rates are going to trigger a recession, or if they're going to cause the value of your stocks and bonds to head lower, or if they're going to cause layoffs. That sort of thing. So we're all watching to see what's next for inflation so we can make some guesses about interest rates, so we can get a feel for the near-term future of the economy. And there's a new book out on the subject of inflation, and it talks about a lot of history to give us an idea of what might happen next. And I reached out to speak with the book's author, Stephen D. King. Okay, so we have this latest reading on inflation here in the US. It's 5%. It's too high, but it's also weighed down. So doesn't that mean that this is all done? Aren't we going right back to 2% inflation, everything under control? Isn't this all an episode that we're just about to put behind us? Something tells me maybe there's more to it than that.

Yes, there's more to it than that, because the 2%, which is sort of plucked out of thin air by central banks and governments, is all very well, but you need to understand what creates inflation in the first place. And sometimes inflation can be low and sometimes it can be high. But the idea that a central bank has a kind of time machine that takes it to the future and can always determine today what the future inflation rate is going to be, that I think is, is not really true. And the only reason why people tend to think it is because A, central bankers have those targets, so the easiest thing to do is to say the central bank is determined to hit its target. And B, because economists generally say, well, if that's the target, I might as well forecast it, because why should I forecast anything else? So the forecasts tend to converge around the target. But as we've seen over the last, you know, 2 or 3 years, the outcomes have been very different from both the target and indeed the forecast that people have made. And, you know, the big debate at the moment is how much of that is temporary or transitory, if I dare use that word that Jay Powell abolished a couple of years back. But, and also how much of it is something which is becoming a more embedded problem in terms of higher inflation for any given level of economic activity than we've been used to in quite some time.

I asked Stephen what history can tell us about inflation now. He mentioned a pair of oil shocks in the 1970s that are associated with very high inflation, but he says that prices started climbing well before those shocks.

But particularly actually in the US, the problem with that argument is that inflation was accelerating rapidly from the late 1960s, and arguably you could say that the oil shock was just the icing on an already inflationary cake. So it's one very good example of where inflation surprises on the upside, and it's not just caused by, you know, things like higher oil prices. And then if you go back in, in history, where there are lots of extreme examples— I mean, I go back to Roman times, the Roman emperors effectively debased the coinage. They effectively took out more and more of the silver from silver coins. So effectively, they were creating money to pay their troops. And all that really happened, of course, was that the value of these supposedly silver coins just collapsed because they're making more and more of them with less and less silver in each of them. So this is a classic example of, yeah, effectively too much money chasing too few goods. And the common theme here, I suppose, is that in each of these cases you've got some kind of monetary event, some kind of monetary expansion, which inevitably leads to higher inflation than you were expecting. So the sort of equivalent today is that back in 2020 when COVID really kicked in, you had this huge fiscal stimulus, which was, I think, the right thing to do because that was aimed at effectively building a financial bridge between a pre-COVID world and the post-COVID world. But at the same time, central bankers around the world looked at the collapse in activity and said, oh my God, this could be the Great Depression all over again. We've gotta print lots of money to prevent a Great Depression. But as it turned out, there were no multiple bank failures, there was no mass unemployment, there were no mass bankruptcies. There was no collapse in stock markets of the kind we saw in the 1930s. So a lot of the sort of debt deflation problems that existed back then did not appear in 2020 and beyond. So I would suggest that the common historical theme here is that if you're taking risks with monetary policy, however defined, whether it's, you know, making more and more coins with less and less silver, or whether it's effectively, you know, cutting interest rates to rock bottom and doing QE and that sort of stuff, you may find that there are inflationary consequences that you hadn't initially anticipated. And I think that's some of what we can see.

So what would a bad outcome on inflation from here look like for us?

It's the sense of inflation being sticky, that effectively the economy slows down, interest rates have gone up to a significant degree, and yet we find ourselves in 6 months, a year, or 2 years' time with inflation not returning to the sort of 2% number that is the sort of magic number that central banks want to achieve. How might that happen? Well, one way you could look at it is through labour markets and how tight they may be. You know, if we find that labour markets are still tight and wages are rising in response to the price increases we've already seen, and under those circumstances you've got the beginnings of some kind of wage-price spiral, I suppose. It doesn't have to spiral like the 1970s, but it can still be a situation where prices feed off wages and wages feed off prices, so the whole thing begins to get a sort of head of steam. Another issue, I suppose, actually associated with the recent banking traumas, which is that, you know, in the past, in history, we've had situations whereby a central bank has been forced to step in to deal with a financial upheaval And by doing so, it's allowed inflation to become more clearly established. So if you think about examples like Long-Term Capital Management and the Russian debt default in 1998, or the stock market crash in October 1987, in each of those cases, the Federal Reserve and other central banks sort of reversed course because they had to deal with the financial event. But, you know, within the space of a year or 18 months, they were back to dealing with inflation because inflation was proving to be more difficult than they had anticipated. The problem today, of course, is that compared with both of those periods, inflation is significantly higher. So the trade-off between the financial stability story and the price stability story, that's perhaps more difficult to manage now than was true back in the late 1980s and certainly the 1990s.

And before I ask you about how do we tell which kind of outcome this is going to be, just for people who I mean, there are many investors alive today who have not lived through a period of serious inflation. And, you know, maybe they're saying, okay, prices rise a little faster, how bad could it be? What is the problem with inflation? Why should we fear inflation?

So there are both political and financial reasons for fearing it. The first political reason is that it is an incredibly arbitrary and hence unfair way of redistributing income and wealth. What typically happens during a period of inflation is that some people are better able than others to protect themselves from rising prices. So if you're in an oligopolistic industry, you've got pricing power, you can probably pass on your cost increases in the form of higher prices. If you're in a very powerful union, you can probably get a decent wage increase to compensate for the higher prices. But if you're, say, self-employed, or if you're a worker who's not a member of a union, under those circumstances you may find that your negotiating position is very, very weak. So you create winners and losers. You also create winners and losers in terms of debtors and creditors. Typically, inflation is the debtor's friend. It effectively erodes the real value of your nominal debt. So for example, if you've taken out a loan of $100, but your wage is rising at 10% each year or something like that, then the ability to deal with that loan gets better and better over time. But at the same time, if you're a saver, cash saver in particular, not a particularly sophisticated saver, there is a risk that your cash savings are eroded over time. So that's the sort of first political problem. As far as finance is concerned, there's a general sort of view, I think, that you're better off in real assets rather than nominal assets during periods of inflation. So you're better off in equities, you're better off in, say, real estate than you would be in government bonds or cash. Now, that is sort of roughly true, but it's not entirely true. So the first problem is that all assets tend to do poorly during periods of inflation. It may be that real assets relatively do better than nominal assets, but they all tend to do relatively poorly. But the second problem is volatility, that if you look at the 1970s, if you bought equities at the beginning of the decade and stuck with them through the decade as a whole, you'd have done better with those than investing in government bonds. But if you looked at the performance of equities year by year, the volatility is so great that you could easily get your timing wrong buy the equity market at the wrong moment rather than the right moment and discover that over an 8 or 9-year period you've actually made significant losses. So from an investor perspective, the problem is that in effect inflation distorts price signals. You don't really know what the truth is, and so you're making educated guesses at all points in time. Your measuring rod is sort of changing length all the time, which is what effectively inflation is, and you make misjudgments. So the chances of getting things wrong are higher And therefore the risk of losses is greater than will be the case in the world of price stability.

Stephen talked about how to tell whether inflation is likely to prove sticky. In the book, he discusses 4 factors. Number 1, central banks had up until recently been, as he puts it, absolutely determined to deal with the polar opposite of inflation. They focused on trying to beat deflation or disinflation and avoid this Japanese-style languishing of the economy. The second factor: central banks had taken credit for a long stretch of low and stable inflation. They called it the Great Moderation. But Stephen says it likely had a lot to do with the incorporation of Chinese and Indian workers into the global labor market over the past 20 or 30 years, helping to keep a lid on prices. Now that's unwinding. Talk of hyper-globalization has given way to terms like reshoring or nearshoring. Companies are trying to deal with supply chain weaknesses, even if that means that costs have to come up a little bit. Number 3, price stability. Stephen says it's not just a consequence of what central banks do. He says it's almost like a pact between central banks and the public. They believe that central banks are going to get it right when they forecast inflation, they behave accordingly. If central banks get it wrong for a sustained period of time, the public loses faith in what they say, and that can affect future prices. The final factor is monetary expansion. There was a lot of new money created during the pandemic that has left people with excess savings and a high ability to spend. I asked Stephen about what ordinary investors should make of this. I have one last question for you. Let's take the example of Joe and Sally Saver. They're 50 years old. They've amassed $1 million in savings and they plan to work for another 15 years. And they're hearing this about inflation. They're gonna look in the book to see what the signs are that they should be thinking about. But then they're wondering what they should do about it. They're wondering, will they be okay? You know, they've got a regular standard mix of, you know, 60/40 mix of stocks and bonds. Is there anything that Joe and Sally should be doing differently in their lives to protect themselves from what might happen with inflation?

Well, the good news is they're going to work another 15 years. They've got some protection anyway, because in theory, many people's wages should rise to a certain degree in line with the inflation. So they've got protection from that perspective.

And they've got $1 million. Let's not make light of, you know, they've had— yeah, yeah, yeah.

I've got that. As far as the actual savings are concerned, well, you just need to make sure you haven't got too much in the way of cash. You know, cash is your big friend when you've got deflation because effectively cash rises in value as prices and wages fall. But when you've got inflation, cash is the one thing you really want to avoid being in. It's just a toxic place to be in an inflationary world. Now, of course, there's no guarantee the world will be inflationary, but if I think the risks have gone up, then that would suggest that one should look very carefully at how much cash you've got in that portfolio.

Thank you, Stephen and Justin, and thank all of you for listening. If you have a question you'd like to hear on the podcast, just tape it on your phone, use the voice memo app, and send it to jack.hough@barons.com. Meta Lutzov is our producer. Meta, how do you feel after your first day back on the podcast? Let me guess, you've never felt more alive. I've never felt more alive. I knew it. 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. See you next week.

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