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First Bear Spotted

Chris Hill, The Motley Fool

In this episode of MarketFoolery, host Chris Hill and Director of Small-Cap Research Bill Mann discuss why recent comments from FedEx CEO Fred Smith are worthy of every investor's attention. Elsewhere, the Russell 2000 index officially entered bear market territory, and start-up fintech company Robinhood got a call from its friendly neighborhood regulator. Finally, Bill shares a key piece of noninvesting advice he received on this day 19 years ago.

A full transcript follows the video.

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This video was recorded on Dec. 19, 2018.

Chris Hill: It's Wednesday, December 19th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today, it's Bill Mann!

Bill Mann: Hey, Chris!

Hill: Good to see you, man!

Mann: Glad to be here! How are you? 

Hill: I'm doing better than some of the businesses we're going to be talking about today. 

Mann: All of the businesses we're going to be talking about?

Hill: I don't know about all. Let's start with FedEx (NYSE: FDX), which is having its worst day in 10 years.

Mann: You're doing better than them.

Hill: I'm doing better than them.

Mann: You've had many worse days than today over the last 10 years. 

Hill: Yeah. Second quarter profits for FedEx came in higher than expected. I think it's fair to say that nobody cares about that. 

Mann: No!

Hill: Because Fred Smith, the CEO, came out on the call, cut guidance for 2019, and did not mince words.

Mann: Brought the Molotov cocktails with him. How is this not a golden age of FedEx?

Hill: Well, for a good stretch of time... look, this is a bad day to be a shareholder holder of FedEx. But in general, if you've been a shareholder of FedEx for the last 10 years, you're doing well.

Mann: Yeah, you're doing great, but the stock is down 25% this year before today's drop. I believe that's right. Maybe including today's drop.

Hill: You talk, I'll do the math.

Mann: We could get a math guy on this. Fred Smith came out and he did not take too many prisoners. He basically has said that globally, there have been a bunch of bad political choices that have hurt FedEx all around the globe. He talked about the weakened Chinese economy due to the tariffs. He talked about the immigration crisis in Germany. I'm having a hard time figuring out how that ties in, but he went there. A bad tax decision, Brexit. And he said this is all causing a lot of macro-economic slowdown. Then, he came out and said that they expected their earnings were going to be much lower next year, between $15.50-$16.60 a share down from about $18. Record shipments, profits rose, margins were down a little bit. But they're worried that bad times are coming.

Hill: With today's drop, the stock is down about 34% year to date.

Mann: That's amazing!

Hill: We talked about this few weeks ago when Toll Brothers had their quarter. Part of the statement from Toll Brothers was essentially blaming the media. 

Mann: [laughs] Did they blame Brexit? 

Hill: Well, no, they blamed the media for publicizing that there's a housing slowdown. It's like, hey, that's not this. This is Fred Smith laying a good chunk of the blame at political leaders in the United States and outside of the United States. 

Mann: Yeah. He took himself off of a lot of Christmas card lists. I mean, he did. And I can't say that he's wrong. I mean, obviously, you're talking about a company that is truly the canary in the coal mine for how people are feeling right now. Those things are all making people feel worse, making them think maybe they need to batten down the hatches a little bit. 

One of the things that FedEx is doing also is, they announced a buyout of their employees. They think they're going to save around $250 million per year during this. Again, they've hired a tremendous number of new employees this year. They're battening down the hatches.

Hill: We've seen other large manufacturers -- I'm thinking primarily of General Motors -- earlier this year offering a voluntary buyout, and when not enough people stepped forward, they announced the layoffs. It seems reasonable to expect that it's not off the table that FedEx would have layoffs in maybe the first half of 2019.

Mann: Yeah. Layoffs are possible. Keep in mind that FedEx's employee base is a little more seasonal than, say, GM's would be. I'm sure layoffs will be a much later down the road decision for them, depending on how the buyouts go, because just through attrition and seasonal adjustments, they'll be able to change their mix quite a bit.

Hill: FedEx is one of those businesses that I think of -- look, no single company is a "bellwether" of the economy at large. But I would put FedEx on the list of bellwether contributors, if you will.

Mann: [laughs] Bellwether-esque.

Hill: Yeah. And I'm curious, one, if you agree with that, and two, are there other companies that you look at and you think, "As much as any other single company, this is a good indication of the broader economy?"

Mann: That's a great question! FedEx is probably the top of the list. I would say Amazon because they simply have such a broad base of things that they're selling. Of course, their growth rates have been such that they're taking away from a lot of other competitive sources. Also, companies like Macerich, the Class A mall operators. People have said malls are in huge trouble. The malls that are really in trouble are the Class B and C ones. The Class A ones have done quite well. But those, if they start showing weakness, that's probably a pretty good sign that the economy is struggling.

Hill: FedEx is down, but it is not a small-cap. The Russell 2000 index, essentially the small-cap index, officially became our first bear of the year. Here in the United States, officially in bear market territory.

Mann: Yeah. Since August, it's dropped 20%. So, by definition, that means that small-caps in the U.S. are in a bear market. The Russell 2000 is a basket of 2,000 companies, as the name might suggest, with a median market cap of about $964 million. A lot of people think that small-caps are a little bit more sensitive to the U.S. economy, so fluctuations in the economy would make them more sensitive. I happen to kind of think that that's garbage. [laughs] I mean, over the last five years, the S&P 500 -- I won't make you do this math, I actually looked it up -- has gained 16.5% per year. The Russell has gained only 5%. I think a lot of that has to do with the FAANG stocks. I also think it has to do with indexing. I think that, probably, the Russell is a little bit more levered to people who are making actual bets on a company-by-company basis. So, where are you going to go when you're nervous? You're going to pull away from that first. 

Hill: The Russel 2000 down 20%, does that get interesting to you at all as an investor?

Mann: Well, yeah. When you think about what a market of 2,000 companies being down 20% means, that means some are down 5% and some are down 50%. Some of those that are down 40% and 50% also happen to be companies that have done very, very well over the last few years. I mean, really, really good companies like Align, for example, is down around 40% since the peak in August. These are great companies. If you believe that they will continue to be great companies, the time that you would like to buy them is when they are under a little bit of pressure. So, yes, I am very, very interested in some of the opportunities that this type of disruption, and the gradual and inevitable rise of the market, gives us.

Hill: This is a nuts-and-bolts question. Does the Russell 2000 rotate those stocks on a quarterly basis?

Mann: The Russell Corporation is very CIA-like in how they do things. You're perfectly welcome to pay them for their data. But, yes, in actuality, they do reconstitute, I think it's every six months. I might be wrong about that. It'll get reconstituted again sometime soon.

Hill: I'm not paying you for your appearance here, so I'm certainly not going to pay the Russell Corporation for the answer to that question.

Mann: [laughs] Yes. I gave it my best shot, and it's worth what you paid for it. But yes, they do reconstitute.

Hill: Over the last two to three years, we've gotten a lot of questions about Robinhood, particularly from younger investors. Robinhood is an app that appeals to younger investors. It's usually some version of the same question, which is: "Hey, what do you guys think of Robinhood?" Robinhood is a start-up fintech company. It made some headlines recently because they announced they were offering -- I think I may have heard this on the radio when I was driving around last week. And I remember hearing it and thinking, "Wait, is that true? Is that real?" They announced last week that they were going to start offering Checking & Savings accounts with zero fees and a 3% interest rate. And I thought, "Wait a minute!"

Mann: That's hard.

Hill: "If that's true, I might want to move my checking account to them, if they're going to give me 3%." And then, immediately, I thought, "Wait a minute, is that sustainable?" So, where does it go from there?

Mann: Not only is it not sustainable, but it turns out that Robinhood's not a bank, so they can't offer either checking or savings accounts, or what they offered, which was "Checking & Savings" accounts, ostensibly one account that was checking and savings. Matt Levine, who's a fantastic columnist for Bloomberg, described that as "the magic ampersand," because it meant it was perhaps neither a checking account nor a savings account, it was this new thing. But the SIPC, which is the Securities Investors Protection Corporation, came out and said, "No, you cannot do that. You're not a bank. Everything about what you're doing is a little bit weird, and perhaps illegal, so we would suggest that you make another choice. And, by the way, 3% and zero fees in this rate environment, that seems pretty tough."

This is really a story of what happens when a financial technology company runs fast and break things. It turns out, one of the things that you can't break is your regulator. [laughs] So, they came out, and they gave what I would describe as a half-hearted "We're sorry, we didn't quite get this right." But in actuality, they got swatted pretty hard by the regulators. 

I love this story, because I wonder if it was almost the New Coke story, if they knew in advance that they couldn't do this, but they just wanted to get a lot more attention for things that they can do, or for whatever they're going to be releasing next; or, if they really, truly didn't know. I don't know which is more likely. The conspiracy theorist in me likes to think that they knew exactly what they were doing, and that they couldn't do this.

Hill: I don't know. We've certainly seen -- one example that comes to mind is Urban Outfitters

Mann: Also not a bank. [laughs] 

Hill: Also not a bank. Every couple of years, Urban Outfitters will have some article of clothing that sparks outrage. That, to me, is different. In those situations, I'm more willing to believe, "OK, we're going to get backlash for this, but we're going to get a lot of attention for it."

Mann: That's true.

Hill: It's one thing to get the attention of the public. It's another thing to get the attention of regulators.

Mann: [laughs] That's right. It's like the Starbucks Christmas cup controversy vs. actually making your regulators think that you're bozos. That may not be something that's long-term sustainable. You don't want to ring the dinner bell at your regulators, ever.

Hill: Every once in a while, I will swing by the desk of our chief legal counsel here at The Motley Fool, Lawrence Greenberg, when something like this is happening.

Mann: Great guy!

Hill: And I'll just say to him, "I don't know what kind of day you're having, but look on the bright side, at least you're not a lawyer for [insert name.]" In this case, it's like, "Hey, at least you're not the head lawyer at Robinhood, because they're having a hell of a week."

Mann: [laughs] That's right. They're having some excitement, which lawyers will generally tell you is not the kind of thing that they like to have.

Hill: Before we wrap up, we're less than a week before Christmas. But today, special day in your family. 

Mann: It is a special day in my family. I wanted to actually give a shout out to you. My daughter, Hannah, is 19 today. 

Hill: Happy birthday, Hannah!

Mann: Happy birthday, Hannah! If listeners out there want to come wish her a happy birthday, come to my Twitter feed at @TMFOtter, and tell her hi and happy birthday. I would love that, and she would love it. 

But, Chris Hill has a very important role in my very early fatherhood, a conversation that happened 19 years ago today. It turned out to be the night that Hannah was born. Your daughter was born July of '99. Chris came up to me, and you said, "I'm going to tell you something that no one else will tell you. No one else. The first two weeks of being a parent is hell. You're going to feel bad, and you're going to wonder why you're feeling bad, because nobody's telling you. And I am the one who's here to say, you're not crazy." I've told this story, I've said this to people more times than I can count. It was a really, really valuable conversation, because it was spot-on. [laughs] Happy birthday to Hannah! The remaining 18 years and 50 weeks have been pretty good.

Hill: I suppose that could have been worse. I could have said, "You're in for the worst Christmas of your life."

Mann: [laughs] "Bet you didn't think your millennium New Years was going to be spent like this."

Hill: Thanks for being here!

Mann: Thanks for having me, Chris!

Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Bill Mann has no position in any of the stocks mentioned. Chris Hill owns shares of AMZN and SBUX. The Motley Fool owns shares of and recommends ALGN, AMZN, FedEx, SBUX, and TWTR. The Motley Fool has a disclosure policy.