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Our industry-leading analysts discuss what’s emerging—from risks and opportunities to growth themes like AI and energy transition.</p> </div> </div> <div class="cta-container "> </div> </div> </div> </div> </div></div> </div> </div> </div> </div> </div> <div class="aem-wrap--separator"> <div class="separator separator--transparent separator--top-padding-none separator--bottom-padding-none"> <div class="separator__line separator__line--transparent separator__line--thin"></div> </div></div> <div class="aem-wrap--text"> <div class="text" data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"> <p style="text-align: center;">For a full inventory of the <b>Global Research Unlocked<sup>TM</sup></b> podcast series access your favorite podcast provider.</p> </div></div> <div class="aem-wrap--separator"> <div class="separator separator--transparent separator--top-padding-small separator--bottom-padding-none"> <div 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class="background-container__content container-fluid background-container--white"> <div class="aem-wrap--layout-container"> <div id="layout_94824" class="layout-container "> <div class="layout-container__content container container--mobile layout-container__col-layout--fullwidth"> <div class="row"> <div class="col col-xs-12"> <div class="aem-wrap--page-anchor"> <a id="podcast-tile" class="page-anchor" href="#podcast-tile">Section</a> </div> <div class="aem-wrap--podcast-tile-container"> <div class="podcast-tile-container " data-action="podcast-tile-container-component"> <div class="container"> <div class="tiles row page-tiles"> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/active-storm-seasons/Shanker_headshot_resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: october 10, 2024</div> <h4 class="tile__headline header--h4 header--blue "> Rising insurance prices becoming as dependable as active storm seasons </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>Insurance costs should continue to rise in high-risk areas as state-backed policies to the private sector are likely to cost consumers more.</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b><br/> <b>Josh Shanker</b>, Senior U.S. Insurance Analyst</p> <p> </p> </div> <div class="tile__media "> <script src="//cdnapisec.kaltura.com/p/4699762/embedPlaykitJs/uiconf_id/51133253/langs/en,es"></script> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_2tymekg4" infiniteCarousel="false" isAudio="true" isAuthorMode="false" 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transcriptText='[{"id":"1_2tymekg4","transcript":"%3Cp%3EHelene%20and%20Insurance%20Impact%20Podcast%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%3A%20Hello%20and%20welcome%20to%20Global%20Research%20Unlocked%2C%20where%20we%20discuss%20what%27s%20rising%20from%20growth%20industries%20to%20rising%20risks%20and%20opportunities%20in%20global%20markets.%20I%27m%20T.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%20at%20BofA%20Global%20Research%2C%20and%20we%27re%20recording%20this%20episode%20on%20Thursday%2C%20October%2010%2C%202024.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3EWell%2C%20on%20the%20other%20side%20of%20things%2C%20suddenly%20the%20cost%20of%20insurance%20has%20been%20going%20up%20in%20a%20way%20unanticipated%2C%20and%20clearly%20it%27s%20affecting%20the%20valuation%20of%20homes%2C%20especially%20in%20areas%20that%20we%27re%20seeing%20more%20in%20California%20to%20begin%20with%2C%20where%20some%20homes%20can%27t%20find%20insurance%20and%20that%27s%20hurting%20the%20price.%20But%20the%20cost%20of%20living%20has%20been%20rising%20a%20lot%20in%20states%20like%20Texas%20and%20Florida%20as%20well%20because%20of%20the%20cost%20of%20insurance%2C%20and%20the%20market%20overall%20is%20pretty%20efficient.%20It%20will%20come%20in%20the%20form%20of%20people%27s%20decision%20making%20on%20where%20to%20live%20and%20what%20homes%20to%20buy%20and%20how%20much%20to%20pay%20for%20them.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20Insurance%20is%20in%20the%20news%20again%20following%20two%20damaging%20storms%2C%20and%20aside%20from%20the%20devastating%20human%20tolls%20from%20these%2C%20there%27s%20a%20big%20financial%20one%20as%20well.%20Some%20of%20it%20is%20insured%2C%20and%20in%20the%20case%20of%20North%20Carolina%2C%20much%20of%20it%20is%20not%2C%20as%20so%20much%20of%20that%20damage%20was%20due%20to%20flooding.%20This%20does%20beg%20questions%20about%20insurance%20pricing%20and%20whether%20it%27s%20finally%20priced%20right%20or%20needs%20to%20rise%20further%2C%20and%20whether%20this%20could%20drive%20more%20insurers%20away%20from%20the%20riskiest%20areas.%20Auto%20insurance%20has%20historically%20seen%20impact%20from%20storms%2C%20but%20the%20dynamics%20there%20are%20somewhat%20different%2C%20and%20that%27s%20been%20a%20great%20market%20for%20the%20last%20two%20years.%20But%20does%20the%20strong%20profitability%20there%20suggest%20more%20competition%20and%20a%20downturn%20on%20the%20horizon%3F%20We%27ll%20discuss%20these%20questions%20and%20more%20with%20Josh%20Shanker%2C%20who%20covers%20U.S.%20Insurance%20at%20BofA%20Global%20Research.%20Josh%2C%20thanks%20for%20joining%20us.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3EJosh%20Shanker%2C%20Senior%20U.S.%20Insurance%20Analyst%3A%20Thank%20you%20T.J.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20Josh%2C%20a%20few%20years%20ago%20we%20put%20out%20a%20note%20talking%20about%20how%20climate%20risk%20was%20starting%20to%20impact%20insurance%20premiums%2C%20and%20we%20wondered%20when%20or%20if%20that%20would%20start%20to%20impact%20real%20estate%20values.%20It%20turns%20out%20the%20impact%20on%20real%20estate%20happened%20pretty%20quickly%2C%20and%20we%20just%20experienced%20two%20major%20storms%20in%20Helene%20and%20Milton.%20The%20latter%20may%20come%20with%20more%20insured%20damages%20even%20than%20the%20first%2C%20but%20do%20personal%20lines%20insurers%20have%20more%20catching%20up%20to%20do%20in%20terms%20of%20raising%20price%3F%20We%20know%20they%27ve%20been%20raising%20price%2C%20but%20is%20profitability%20now%20good%20enough%20where%20maybe%20they%20don%27t%20need%20to%20push%20price%20quite%20as%20much%20going%20forward%3F%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3EJosh%20Shanker%3A%20It%27s%20really%20a%20state-by-state%20issue%20and%20with%20Milton%2C%20we%27re%20really%20talking%20about%20Florida.%20And%20Florida%20is%20a%20very%20unusual%20market%20compared%20to%20the%20rest%20of%20the%20world.%20Right%20now%2C%20maybe%2015-20%25%20of%20the%20homeowners%20in%20the%20state%20of%20Florida%20who%20buy%20insurance%20are%20buying%20their%20homeowners%20insurance%20through%20the%20state.%20The%20state%20has%20capitalized%20its%20own%20insurance%20company%2C%20an%20insurer%20of%20last%20resort%20for%20people%20who%20can%27t%20find%20insurance%20elsewhere.%20And%20what%27s%20happening%20with%20the%20citizens%20of%20Florida%20business%20is%20that%20the%20state%20really%20doesn%27t%20want%20this%20liability%20on%20its%20balance%20sheet%2C%20so%20to%20speak.%20And%20they%27re%20offering%20a%20number%20of%20insurance%20companies%20the%20opportunity%20to%20take%20business%20from%20them%20in%20what%27s%20called%20a%20depopulation%20wave%20to%20try%20and%20thin%20out%20that%20citizen%27s%20population%20base%20within%20their%20own%20balance%20sheet.%20An%20event%20like%20Milton%20comes%20along%20and%20it%20really%20tests%20the%20ade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closeTranscriptText="Close Transcript" closeDisclaimerText="Close Disclaimer" disclaimerTitle="Disclaimer" transcriptTitle="Transcript" carouselNextArrowText="Go to Next Item" carouselPreviousArrowText="Return to Previous Item" carouselDotsLabel="of" playlistItemLabel="Item {0} of {1} Play {2} video" validCloseCaptions="false" data-video-id="1_2tymekg4_Rising insurance prices becoming as dependable as active storm seasons"> <div id="1_2tymekg4" class="uc-media__player"> </div> <div class="uc-media-transcript" aria-hidden="true" aria-expanded="false"> <div class="uc-media-transcript__header"> <button aria-label="Close Transcript" class="uc-media-transcript__close uc-media-icon-close" tabindex="-1" title="Close Transcript"></button> </div> <div class="uc-media-transcript__container" tabindex="-1"> <h3 class="uc-media-transcript__title">Transcript</h3> <div class="uc-media-transcript__text"></div> </div> </div> <script type="application/ld+json">{"@type":"AudioObject","name":"Rising insurance prices becoming as dependable as active storm seasons","description":"No description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_2tymekg4/version/0","uploadDate":"2024-11-13T14:11:54-05:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_2tymekg4/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_2tymekg4/format/url/protocol/https","duration":"PT23M28S","transcript":"Helene and Insurance Impact Podcast T.J. Thornton, Head of Product Marketing: Hello and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research, and we're recording this episode on Thursday, October 10, 2024. Well, on the other side of things, suddenly the cost of insurance has been going up in a way unanticipated, and clearly it's affecting the valuation of homes, especially in areas that we're seeing more in California to begin with, where some homes can't find insurance and that's hurting the price. But the cost of living has been rising a lot in states like Texas and Florida as well because of the cost of insurance, and the market overall is pretty efficient. It will come in the form of people's decision making on where to live and what homes to buy and how much to pay for them. T.J. Thornton: Insurance is in the news again following two damaging storms, and aside from the devastating human tolls from these, there's a big financial one as well. Some of it is insured, and in the case of North Carolina, much of it is not, as so much of that damage was due to flooding. This does beg questions about insurance pricing and whether it's finally priced right or needs to rise further, and whether this could drive more insurers away from the riskiest areas. Auto insurance has historically seen impact from storms, but the dynamics there are somewhat different, and that's been a great market for the last two years. But does the strong profitability there suggest more competition and a downturn on the horizon? We'll discuss these questions and more with Josh Shanker, who covers U.S. Insurance at BofA Global Research. Josh, thanks for joining us. Josh Shanker, Senior U.S. Insurance Analyst: Thank you T.J. T.J. Thornton: Josh, a few years ago we put out a note talking about how climate risk was starting to impact insurance premiums, and we wondered when or if that would start to impact real estate values. It turns out the impact on real estate happened pretty quickly, and we just experienced two major storms in Helene and Milton. The latter may come with more insured damages even than the first, but do personal lines insurers have more catching up to do in terms of raising price? We know they've been raising price, but is profitability now good enough where maybe they don't need to push price quite as much going forward? Josh Shanker: It's really a state-by-state issue and with Milton, we're really talking about Florida. And Florida is a very unusual market compared to the rest of the world. Right now, maybe 15-20% of the homeowners in the state of Florida who buy insurance are buying their homeowners insurance through the state. The state has capitalized its own insurance company, an insurer of last resort for people who can't find insurance elsewhere. And what's happening with the citizens of Florida business is that the state really doesn't want this liability on its balance sheet, so to speak. And they're offering a number of insurance companies the opportunity to take business from them in what's called a depopulation wave to try and thin out that citizen's population base within their own balance sheet. An event like Milton comes along and it really tests the adequacy of the business being provided the state, we really feel the state has underpriced the business and they're going to be increasing their prices as well. But as this business moves to the private market, the private market has to make an equity rate of return on this business and they're going to price it more expensive. So, we should see over the next couple years significant increases to the price of insurance in the state of Florida. And some say, oh, Florida's already received enough rate increase, stop increasing the price. Just because the price of insurance is expensive in the state of Florida doesn't mean that it's adequate. And when people are evaluating what the cost of my home is, my mortgage payments, my cost of maintenance, whatnot, and suddenly the insurance costs are 1, 2, 3, 4, 5, 6 times what it was 10 years ago to ensure that property that's going to affect the value. We should expect, broadly speaking, as we understand it today, it's still fresh when we're recording this. We don't know what the actual loss of Milton are, but they're not going to be as bad as or anticipated before the storm made landfall. But we should anticipate that price is going to continue to go up in the state of Florida. You then have questions about states like Texas and the Carolinas, which have also benefited from population moves of people coming in for what was perceived as a lower standard of living cost to move to those states, and suddenly they're seeing higher insurance costs on their properties. I would expect Carolinas are going to see higher insurance costs going forward. Texas is going to see higher insurance costs going forward. And generally speaking, those states are much more capitalist, I guess in their orientation. They're not having this huge state-run facility which has been keeping pricing down. We should expect in hurricane prone states and maybe there's wildfire issues in California as well, those states are going to see continued increases in the price of homeowners insurance, and that's going to impact people's decisions on what the cost of living is to in those areas. I frankly don't see it abating for a while. T.J. Thornton: Okay. And getting back to Florida, I know they've had some specific issues. There was a big problem with fraud and the replacement of roofs. There was some legislation that was passed by the state. Has that made things any better in Florida or is that coming, and could that kind of offset what otherwise would be a rising price environment? Josh Shanker: It's to be determined. Let's just talk about what happened in Florida a little bit. One of the major obstacles in Florida was this issue called assignment of benefits that people could assign a beneficiary around who their policy was payable to. And a lot of cases that became a contractor working on improving the property and the incentives would create an issue where the magnitude loss was made better because the beneficiary was getting paid to fix a property, and then getting paid more to do more work, and there was this conflict of interest, and so a lot of this change in Florida was a reform around the AOB (assignment of benefits) opportunity and that should improve things in the state of Florida. Additionally, there was no penalty for filing nuisance lawsuits and whatnot, because if you won, you could claim payment on legal costs and whatnot. And these things all spelled a difficult legal market making it hard for insurance companies to want to participate in that market. And so, we have seen a good amount of legal reform and tort reform in the state that is convincing some insurance companies that Florida is more under writeable than it was previously. Now this is going to create a bifurcated system where policies dating back to 2023 and prior don't have the benefit of this tort reform. And you're still going to see litigation working through the system that on those older policies that hurts the potential for these companies to generate the kind of profitability that they would like to generate. For the newer liabilities, it seems like that's really like a green light to try and participate in the market and you're going to see a lot of companies come through and write and feel that they have comfort. There are other issues, it's not just about tort, it's obviously the cost of reinsurance is a big issue in the state of Florida as well, and that's not going to disappear whether you're writing legacy business or new business at all. Now, I can't prove it, but I was talking to some companies who said that lawyers have been leaving the state of Florida. They believe that the tort reform is going to be significant enough that there's less opportunity for them to participate in that market and get paid, and they've been moving to Georgia. I can't vouch for whether that is true or not, but lawyers are seeing Georgia as a more fertile environment for litigation as opposed to Florida. T.J. Thornton: Okay, that's an interesting point. Cause it does seem like every time I've been down in Florida about two thirds of the billboards are lawyers advertising their services, so it's probably bad news for those selling billboards. But I think that also your point about depopulation and the state trying to get private industry to take over some of those citizens' policies. Cause the timing of this tort reform is good, right? Because this is one of the things presumably that will make these new insurers more confident in maybe picking up some of those policies. Josh Shanker: That's true. And probably it reins in some pricing or where pricing would go, it's still going to be very expensive to buy insurance in the state of Florida. And one thing that we really didn't talk about, of course, flood, which I think you mentioned in your opening remarks, made about Helene is not really a covered peril. That doesn't mean you can't buy insurance for flood. The Federal government sells insurance for flood at a subsidized price, which sometimes people still feel is expensive, but it's actually a pretty good deal. And you have the entire state of Florida, which the southern part of the state now is a floodplain, and of course the whole state is the target of hurricanes. And if you truly wanted the right amount of coverage you need, your insurance costs are going to be expensive and that's going to continue to be the case, even if the pace of growth will be mitigated by these legal reforms, which are probably positive for reigning in some of the extraneous costs. T.J. Thornton: Got it. And just a quick follow up on that question because this dilemma of what parts of the country are actually safe has come up again, following what happened in Western North Carolina, which I know they've seen flooding there before, so it wasn't totally out of the blue, but are there certain markets where national carriers are looking to get more exposure? Where they see maybe risk as somewhat less or at least they're being compensated for that risk by getting high premiums? Josh Shanker: Let's break the marketplace into areas where there's very little catastrophe risk. You could say a growing state like Montana, it's not a real big cat (catastrophe) risk area. There's also areas of the country that have what are called 'non-modeled cat risk convective storm activities', which is hail and tornadoes and severe rainstorms and whatnot. And then thirdly, there are areas that have hurricane exposure and earthquake exposure, the modeled catastrophe zones. It tends to be that there's a lot of information about hurricane risk and whatnot, and it helps companies decide whether or not they want to engage in those areas. Some say yes, some say no. The ones that say yes, then they can get paid for it. The ones that say no, perhaps they don't want that exposure. But you do see a desire to be in the non-cat prone areas, number one and two, there's a right price in the non-mild cat areas, which tend not to be coastal, and therefore there's not really a big flood component, which seems part of the risk. Even though it's not born by the insurance company, it's part of the risk profile of that area, and you wanted to say look, the Midwest has tornadoes, but there's not a lot of coastal water risk. And so, the insurance penetration, the desire to be a competitive marketer is higher than it is on the coast, and general in these coastal areas where you tend to see disrupted markets. T.J. Thornton: Okay. And Josh, I think about 40% of homeowners (across the U.S.) don't have a mortgage cause their homes are completely paid off, so they're not required to have homeowners insurance. As prices have risen, have we seen an uptick in lapsed policies, people choosing just not to insure and is that a headwind for the personal lines insurers? Josh Shanker: I don't think so. The frame of the question seems to argue that people have homeowners insurance because it's an onerous requirement of the mortgage. For most people, their home is their most valuable asset and they can't live without it, and so they would desire to have some sort of protection of this very important asset they own. It's true that there are homes that have no insurance on them. Maybe there's an affordability aspect to it, the individual did not want to pay what it would've cost to insure that company, that home. Or it's also possible that the insurance was not available in a market like California where it's very hard to get insurance. But generally speaking, most homeowners want that protection. T.J. Thornton: Josh, this question is maybe partly unfair because I'm asking you to play housing strategists for a moment. But given these increasingly damaging storms, the high homeowner's premiums, the need maybe in some places to buy flood insurance, where that had never really been a consideration before. Do you think that home prices will correct in certain of these areas that have become very expensive to insure, and could it even push people to say multifamily housing, which does tend to be a lot cheaper to insure? Josh Shanker: Let's just take something completely different as a starting point and we can come back to that. Auto insurance has been going through some issues as well, and over the last 10 years we've seen a revolution from combustion engines to hybrids to electrical vehicles. And people like the idea of not having to pay for gasoline; they buy the electrical vehicles. But maybe at a certain point we didn't realize how much more expensive it is to repair an electrical vehicle. The potential for electrical vehicles to end up after a minor accident as being undrivable because the battery case was cracked or whatever. There's various reasons that the cost of repair and cost of replacement for electricals is much, much higher, and as such, the cost of electric vehicle insurance is notably higher than it is for combustion engine cars. And so, what we've seen happen early on is people bought EVs because they like the idea of it, but part of the reason why the EV growth is slowed to some extent is because the cost of ownership is higher than is for a combustion vehicle because the insurance costs are much higher. And yes, you save on the gas, but there are other costs as well, and the market is pretty adept over time of adjusting to the changing cost. It's clear you see a great migration into coastal states and with the advent of air conditioning, 50, 80 years ago, whenever that was the livability of being in hotter states, cause you can stay indoors all the time. But with this bad weather comes higher insurance costs, and so we had this huge wave of immigration associated with the people getting up and moving during the pandemic. Well on the other side of things, suddenly the cost of insurance has been going up in a way unanticipated, and clearly it's affecting the valuation of homes, especially in areas we're seeing more in California to begin with, where some homes can't find insurance and that's hurting the price. But the cost of living has been rising a lot in states like Texas and Florida as well because of the cost of insurance. And the market overall is pretty efficient. It will come in the form of people's decision making on where to live and what homes to buy and how much to pay for them. T.J. Thornton: Okay. Question about hedge funds getting involved in catastrophe bonds and in reinsurance. This was something, made a bunch of headlines years ago. Is this still a factor and what does that mean for the incumbent reinsurers? Josh Shanker: Let's go back to August 5, 2011, that's when S&P downgraded the U.S. Treasury to AA and maybe it wasn't exactly understood perfectly at the time, but it catalyzed another leg in the bull market for bonds, which brought interest rates lower over time, and an increase in credit worthiness among investors. U.S. Treasury were downgraded, and their attractiveness went up in the market. One of the problems is that the 10-year struggled to maintain a yield above 2% for a while. And you had a lot of pension funds with defined benefit obligations hoping to pay their retirees 6%, 7% annually, and it became difficult for them to find bonds that could accommodate those types of returns. And they discovered cat bonds as a small corner of the market, which had very good returns and entirely non-correlated returns. Also, the pool of money associated with cat bonds was collateralized. And really from 2012 through about 2020, this is a very vibrant market, even into as far as '22, even though there were a lot of cats, and maybe in fact, the returns were not as attractive because simply it was hard for a lot of these pensions to adequately service their obligations. What we saw happen in 2023 was a real uptick in the yields for very conventional bond securities. And this gave an opportunity for defined benefit plans to be able to engage the bond market in a more simple way and get adequate returns for their retirees. And the demand for a non-correlated bond-like asset class that could get a bond return to meet those obligations decline in particular. And so, if you look in 2023 and 2024, the price of catastrophe reinsurance is up dramatically. It's not dramatically cause a bunch of capital was destroyed, and it's not dramatic because there's more fear about climate change in the market, it's up because some capital out there significant billions and billions of dollars no longer was seeking to compete with reinsurance markets for the risk associated with cat losses. And whether or not that is able to be maintained going forward will really depend a lot on interest rates. But my hunch is that there will be a major loss in the not-too-distant future, and actually reinsurance price will be higher after that loss is today. T.J. Thornton: Okay, thanks Josh. One of your big themes, perhaps your biggest one over the last couple years, and it's been absolutely right, has been on auto insurance. We actually did a podcast on this a couple years ago in anticipation of what you expected to be a really hard market or strong pricing in auto insurance. So that's happened. Some of these stocks have acted very well. But I know that from a recent note of yours that growth in pricing has slowed. Do you think that's an issue for these stocks, cause things have been good now for a while, if that pricing is finally slow? Josh Shanker: Well, let's frame pricing into like three different timeframes. Insurance companies asks their state regulators for rate increases and they've been doing that for a couple of years now, and that's what I would call the regulatory ask period. Then you receive the rate increases, and you have your renewal book of customers that every time someone hits their anniversary on the renewal, you push through that price that was approved into the customer's policy, which caused a lift. And then finally, through the conventions of revenue recognition in the insurance markets, it takes about a year for those written premiums, as they're called, to become earned premiums, which is the revenue on the income statements for these companies. And so, the timing you get at the regulatory approval is 6-12 months before you see it in the statement of cash flows. And it's another 6-12 months before you feel it in the income statement. We right now, if you look at CPI, CPI (consumer price index) for motor vehicle insurances, about 15%, 16%, 17% compared to where it was a year ago, and it's been like that for a couple of years. The two-year price increases in acts of 30% are the biggest they've been since 1976, 1977, that's the experience of consumers paying cash out of pocket for their policies. But the regulatory ask for rate increases is probably only in mid-single digits right now and probably headed lower as profitability improves. First of all, if we're at 15% written right now, we should be at 15% earned in six, nine months, maybe 12 depending on which company, some policies are written on a six-month basis, some on a 12-month basis. We should see earnings for these companies continue to improve steadily for a while. On the regulatory ask, I don't think they're going to be asking for much increases. They've gotten to rate adequacy in most states. What will happen is an aftermath is companies are going to be very excited to take on new business because they're all profitable and we're going to see a very competitive market welcoming new business into their rosters. And that's a very interesting time because what's going to happen is the company that offers the best value, the most user-friendly experience, and the best ability to connect with customers is still going to benefit and see a huge inflow of business, which will probably be the case for the next few years. There's going to be winners and losers. Now, I tend to think that direct consumer is a huge theme in almost every retail facing business out there. And I would expect that experience of direct consumer is a huge share gainer in a marketplace where people are shopping aggressively and want to take on new business. And I think there's going to be a huge shift in market share towards those direct consumer plays. T.J. Thornton: Okay, interesting. Thanks Josh. And are these companies that are going to be offering, you're suggesting they're going to be competing on price to some degree, right? In addition to other things like technology, but are they going to be giving up margin in order to do that? And if so, is your point that they'll more than make up for that in volumes? Josh Shanker: I think competing on price is always a race to the bottom. For a company to be successful, what they really should be competing on is efficiency. Companies should work to lower the expense burden of their business models because the lower your general administrative costs are, the better price you can offer the consumer without sacrificing margins on the underwriting. Yeah, there will be some competing for price. If you compete with price, you're probably going to lose. The best thing that a company should do is try and match price to risk and run the most efficient model they can out there and therefore get the greatest value for the customer. And over time, if you can do that you will continue to grow and grow over time as an auto insurance company. T.J. Thornton: Okay. Alright. Josh, thanks very much for that discussion. We covered a lot, everything from EVs to flooding in Florida, to how to build an auto insurer, so I appreciate your time. Josh Shanker: Thank you very much and have everyone stay dry. T.J. Thornton: Steps that Florida has taken seem to have stabilized their insurance market, and there are smaller carriers looking to bid on business in the state. However, national carriers are generally still staying away in terms of new business and instead they're focused on areas far from the coast like the Midwest and Montana. All that said, insurance costs have and will continue to impact real estate values as people are increasingly aware that total costs of ownership include more than just mortgages and taxes, but insurance costs too, that's assuming you can even get insurance. And the auto insurance story remains a compelling one. Pricing is still strong and even though the next phase probably will be more competition for new customers, the best insurers will be able to compete on their value proposition through greater efficiency and grow as a result. Thanks for joining. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/pursuit-of-megawatts/Fowler_Obin_headshot_resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: september 30, 2024</div> <h4 class="tile__headline header--h4 header--blue "> The persistent pursuit of megawatts; meeting today’s energy demand </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>A big shift is underway on how the power grid could look in the future. We discuss the role nuclear and renewable energy will play.</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b><br/> <b>Ross Fowler</b>, Head of the North America Power & Regulated Utilities Research<br/> <b>Andrew Obin</b>, Senior Multi-Industry Analyst</p> <p> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_et4qwjkl" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" 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closeTranscriptText="Close Transcript" closeDisclaimerText="Close Disclaimer" disclaimerTitle="Disclaimer" transcriptTitle="Transcript" carouselNextArrowText="Go to Next Item" carouselPreviousArrowText="Return to Previous Item" carouselDotsLabel="of" playlistItemLabel="Item {0} of {1} Play {2} video" validCloseCaptions="false" data-video-id="1_et4qwjkl_The persistent pursuit of megawatts; meeting today’s energy demand"> <div id="1_et4qwjkl" class="uc-media__player"> </div> <div class="uc-media-transcript" aria-hidden="true" aria-expanded="false"> <div class="uc-media-transcript__header"> <button aria-label="Close Transcript" class="uc-media-transcript__close uc-media-icon-close" tabindex="-1" title="Close Transcript"></button> </div> <div class="uc-media-transcript__container" tabindex="-1"> <h3 class="uc-media-transcript__title">Transcript</h3> <div class="uc-media-transcript__text"></div> </div> </div> <script type="application/ld+json">{"@type":"AudioObject","name":"The persistent pursuit of megawatts; meeting today’s energy demand","description":"No description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_et4qwjkl/version/0","uploadDate":"2024-11-13T13:49:03-05:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_et4qwjkl/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_et4qwjkl/format/url/protocol/https","duration":"PT20M59S","transcript":"Power Podcast T.J. Thornton, Head of Product Marketing: Hello and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research, and we're recording this episode on Monday, September 30, 2024. From the infrastructure standpoint, we see ‘the cake is being baked’ for the next couple of years at least. We think companies have very good visibility. If you, for some reason, can't build the data center, there's plenty of people who will take equipment off your hands. T.J. Thornton: There's evidence over the last few years that electricity demand growth has returned, driven by many factors from efficiency gains being mostly in the rear-view mirror, to building electrification to reshoring, to everyone's favorite topic, data centers. But how much growth in demand should we expect and where will the generation come from? Also, how much do data centers really contribute? And aside from consuming lots of power, what sort of capital equipment will be demanded by these buildings? Joining us today to talk about all this is Ross Fowler, Head of the North America Power and Regulated Utility Sector at BofA Global Research and Andrew Obin, who covers the Multi-Industry Sector at BofA Global Research. Ross and Andrew, thanks for joining us today. Ross Fowler, Head of the North America Power & Regulated Utilities Research: Thanks for having us T.J. Andrew Obin, Senior Multi-Industry Analyst: Thanks for having me. T.J. Thornton: This question is for both of you. On the first question about demand growth, it's inflecting higher after a decade of flat demand, and that was driven partly by efficiencies from things like LED light bulbs. But how does that expected demand growth breakdown between data centers, which we talk a lot about, and other demand drivers like heat pumps, EV charging and reshoring? Ross Fowler: I think this is a really important question because electrification growth is actually coming from so many sources. I know a lot of the focus on data centers, but it's from all of the things you're talking about. The historical relationship between electricity demand and GDP (gross domestic product) growth runs about 60% of real GDP over history. But as you mentioned, for a little over a decade, that relationship was closer to about 60% of real GDP minus 1-1.5% for the energy efficiency you mentioned. And at our low GDP growth rate that was near zero or flat, so now it seems you're returning back to that 60% of GDP relationship. And then we could talk about GDP growth actually accelerating faster. We put out a note this morning showing that electric demand growth in '23 to '24 has actually accelerated faster than GDP at over 4%. But it's important to understand that there's a significant regional disparity and that the fastest growth is occurring across the south, from the southwest through Texas and Oklahoma and into the broader southeast. In terms of data centers, they have so far been focused on five geographies: Chicago, Texas, Silicon Valley, Northern Virginia, and New York/New Jersey. And that's because where they can connect quickly with low latency to the fiber network. We think that the southeast is actually one of the areas where you can add generation supply more easily, so that's where they're going to go to, and I think that's where they're going to spread out to over time. And that's where the demand can really show up because in our industry, it's long dated capital projects to build anything around generation, and so, you have to have supply meet demand. And so, where the demand is going to go follow where the generation can capably be built. Andrew Obin: From our standpoint, we are estimating that data centers represent maybe 20% of the step up, along with reshoring, EV (electric vehicle) adoption, roughly same order magnitude. And our work suggests that it's actually building electrification is going to be the single largest piece, but completely agree with Ross that data centers, while getting a lot of attention is not even the biggest piece, but it's just one of the pieces of the bigger puzzle. T.J. Thornton: Okay. And Andrew, looking at your recent, “who makes the data center” piece, our forecast for data center infrastructure suggests faster growth than even servers and networking, so we're talking about things like HVAC equipment. What are some of the faster growing areas that infrastructure spend? And are these numbers big enough to really be a substantial portion of growth for your companies that supply these products? Andrew Obin: The thing to realize is that the data center market consists of enterprise colo and hyperscale, and the enterprise market has actually been fairly stable for a while. And where we are seeing the growth is at hyperscale and co-location. So, from that perspective, there are definitely the areas of the data center market that are growing faster. Within the infrastructure, we highlight electrical, which we think is going to grow at 20% CAGR (compound annual growth rate) over the next several years. Thermal, which is cooling the data centers, which we estimate will grow close to 40%. And then backup generators, I would say is the third area. And yes, I would say these growth rates absolutely make a difference for the companies within our coverage. These tend to be very profitable for the companies in the electrical segment. They absolutely move the needle. T.J. Thornton: Okay. And I wanted to talk about powering these data centers and of course the other drivers of demand that we’re seeing, which you discussed previously. There’s been a lot of focus on base load power and hence an interest in nuclear, which is always on. But Ross, do you think nuclear is a solution in the U.S.? Could we actually see growth in U.S. nuclear generation after what’s been little growth over the last decade? Ross Fowler: It’s an important question. It’s getting a lot of attention right now. It can be part of the solution and ultimately, I’m not sure how we meet all this demand growth without it in the long term. If all the demand growth we’re talking about is actually real and not double or triple counted, or there’s not some efficiency bend out there in data centers and other electrification driven demand. But nuclear projects are very, very complex. There’s only three nuclear plants that can easily restart from what’s been shut down, otherwise, the decommissioning’s too far down the path. That’s Palisades, where you’re already getting $2.5-$3 billion of subsidies to restart it, and the recently announced TMI (Three Mile Island) restart. Other than that, if you're going to build large nuclear, look, the projects take 10-15 years, takes about $40 billion for about 2000 megawatts using the Vogtle plant that was recently completed in 2024 as an example. And here, the units were two to three times the initially estimated schedule and cost, but that's not a unique experience. The same thing happened in the 60s and 70s when we built new nuclear. Everything was two to three times the year initial schedule and budget. Nothing anytime soon, but hopefully that can be part of the solution in the very long term. Let me use the PJM queue here. PJM is just the Mid-Atlantic power market. There's 35-40 gigawatts in the queue for generation, only 4-6 gigawatts of that is gas. No gigawatts of that is nuclear. 20-25 gigawatts of that is solar, but solar doesn't run all the time. It only runs about 14% of the time. You need more base load generation, but really it's got to be a lot of gas backing up renewables. SMRs, small modular reactors, do enter the conversations, but the current pilot projects there aren't done until '28 is the first one, and 2030 is the next one. And I think they have to show a few years at least of operational capability before anybody builds those out in scale, so again, that's a 2030 plus issue for nuclear. And in the meantime, I think it's all gas and renewables. T.J. Thornton: Got it. And just a quick follow up on that nuclear question. We know that these plants are really expensive and difficult to build, but what about the cash costs of producing a megawatt of power at a nuclear facility? Are those high as well or is it mostly just the initial investment that's so expensive? Ross Fowler: It's both. It's the initial investment that's expensive, but the whole reason for putting the production tax credits, where you set a floor price on nuclear production, and the government makes up the difference essentially to that $43 a megawatt hour is nuclear plants also cost a lot to run, and it's much, much cheaper to run gas as long as gas is 2-3 dollars a MMBtu (Metric Million British Thermal Unit). It's the operational cost as long as gas stays low as well. Now you could do things like sign purchase power agreements, which is what they did to restart TMI, but that comes in an extremely high price of $110 a megawatt hour. I don't know how many contracts like that are out there when you could do other stuff much, much more cheaply as you connect it to the grid. T.J. Thornton: Okay. And another one you mentioned renewables and how much of PGM is going to be renewables? Batteries were a story from a couple years ago. What sort of role do you think they play, and can they effectively turn some of this renewable capacity into base load because they can essentially make solar power viable overnight? Ross Fowler: Yeah, the grid right now is managed to peak. And there's a lot of theoretical excess power capacity or generation capacity off peak, as everything's built to serve that peak. But what's happening now is we're not talking about this massive increase in residential demand, where we're all asleep at night and we run things when we go home at six, seven or for me eight o'clock at night. You're talking about industrial and data center demand, which is 24/7. It's really the demand across all hours that is increasing. It's about adding that natural gas generation to the stack, both in the short and intermediate term. That's batteries in a molecule, cause I could turn it on when I need it, and that's the most efficient thing I think you could do. Battery storage, which is what you're talking about here, can help renewables last longer, but lithium ion is only lasting about four hours. It can extend what you're using and the hours that you're using it, but without a technological breakthrough, you're constrained within, okay, the sun's shining, then it went down, and maybe I could extend it. Lithium-ion batteries only last about four hours. That can extend solar and wind when it stops flowing or when the sun goes down for that four hours, but after that it's not very effective to create essentially base load power out of renewables. Without a technological breakthrough on the storage side, from a battery perspective, it's hard to see batteries is more than a marginal help. And remember, batteries are a chemical process, not an electrical process, so breakthroughs track differently. We're not creating, we're not finding more chemicals on the periodic table. You have what you have and it's not a Moore's law process from an aspect of efficiency or cost. So, there can be breakthroughs for longer duration, but that's been tried and being driven at for a few years now with not much breakthrough at all. T.J. Thornton: Got it. Okay. Andrew, question for you, and this is pertinent to the power demand question, but also the capital goods question of course. All this focused-on data center builds, but I know they take a long time, not quite as long as a nuclear plant, but a long time to build. Could there be lack of flow through to these infrastructure names in the short term, as these facilities get planned, but maybe some of the equipment isn't bought and could that lead to some disappointment for the stocks? Andrew Obin: Yeah, so we don't think so. Everything that's being built right now has been ordered two, three years ago. In fact, if you have a shell these days, it's fairly useless because you would've had to arrange connection to the grid, and you would've had to get in line for equipment demand. We actually think there's plenty of visibility for the next couple of years. And if anything, things could accelerate from them, as the industry adopts high power chips, like Blackwell. From the infrastructure standpoint, we see the 'cake is being baked' for the next couple of years at least. We think companies have very good visibility. If you, for some reason, can’t build the data center, there's plenty of people who will take equipment off your hands. In fact, I'll give an example for medium voltage generators data centers are able to \"cut the line\", if they're willing to pay 20-30% premium for availability. Instead of waiting in line for 1.5-2 years, you can potentially get one in under a six months. But the plans right now reflect decisions that have been made a couple of years ago. So just appreciate that AI decisions that have been made over the past 12 months will not be expressed in hardware over the next 2-3 years. So, we think we have plenty of visibility through the middle and late parts of the decade. T.J. Thornton: Pivoting back to Ross, and this question about the supply side. There's been so much growth in renewables that wholesale power prices are at zero at certain times of day in certain parts of the country. The press has been focused on this a bit recently. How do you see power prices going forward? Because you do have all these demand drivers, but then you also have a lot of supply growth in things like renewables. And I guess from the standpoint of somebody who's paying residential electric bills and then also from the standpoint of an institutional user data center or a factory. Ross Fowler: It's a really good question because the grid is changing so much. As you add all this intermittent resources, as you said, there’s hours of the day where prices actually go negative connected to some of the tax credits around dispatching this solar and wind. But what we see is you can’t get a gas CCGT (combined cycle gas turbine) turbine from anybody for three years. There's a three-year bottleneck on the supply chain. You can go get simple cycle turbines, so that's the first thing we're going to try to build, and then we'll build some CCGTs behind that. But what that creates as you add this sort of 24/7 demand on the demand side of the picture is massive volatility in power prices. When the renewables are actually on and working, the wind is blowing, the sun is shining, you could see power prices be very low in those hours of the day. When that stuff goes down and the sun's not shining and the wind's not blowing, prices could go massively high. Overall, on an around-the-clock basis, I think there is upward pressure on power prices because that's the average of all of those hours. But that's not really telling the story of what's going on underneath that, where you have some hours that are significantly high prices, and then other hours where you're sitting there at zero or negative 'cause the renewables are running. Overall, you've seen this impact PJM market for capacity, which is not energy capacity, is just paying for resources to be there when you need them to run. That has increased from about $30 a megawatt day to about $270 a megawatt day in the last auction, and we think the next auction in December clears someone around $600, $700 hours a megawatt day. Significant pricing increases to have that capacity available when you actually need to run it, and the renewables go down, and I think that's indicative of where we are going for power prices when renewables aren't running. It's just going to get significantly more volatile across the hours of the day. T.J. Thornton: Okay. And Ross a follow up there, how, again, from the sort of residential as well as institutional perspective, how do you work around that as a customer? We've been talking about smart meters for like 20 years. I don't know how many people actually pay different power prices different times of day, but is that something that will start to happen? Is that something that not only residential customers could take advantage of, but other larger customers as well? Ross Fowler: There are time of use rates in some jurisdictions. It has to be set by your state regulator. There are not time of use rates in other jurisdictions. I think that's where we're moving to, is to have time of use rates to try to change residential usage patterns. But I think the problem with demand side management is on both the industrial and the residential side. Let's take the industrial side first. You're going to ask a data center or a big power user on the industrial side to shut off or run a shift down and pay them for it. That's hard in a growing economy when the profit margins on what they're doing are ostensibly high. Can be done, but why would you want to shut your data center off and not have all that stuff running in the background, the Internet needs to be up, that gets difficult. And the residential side, it's never really met its promise because what you have to do when you're a residential customer is you have to allow the utility company to raise your thermostat by 2, 3, 4 degrees at the worst possible time for you as a residential customer. You do that when it's 110 degrees out in Texas, and you want you’re A/C running. You get paid for it, but you're going to sweat on your couch in your living room while you're doing it. It really has never gotten paid enough to make people force their change of behavior. And I question whether people will actually change their behavior at all from a residential point of view, because people just want the power when they want it. They want their A/C running when it's hot out. You have to do the demand side management at the worst possible time for everybody. That makes it really hard. T.J. Thornton: Okay. And Ross, I can tell you that I'm cheap enough to definitely be excited about taking advantage of that opportunity. However, none of my other family members are. Ross Fowler: Yeah. Get everyone else to agree to sit in 85 degrees in summer. It's just not going to happen. I think there's also a fall on here for EVs as we talk about that. Now, I know EV demand has slackened a little bit, but as we get to EVs or even plugin hybrids, which is just as good as 70% of an EV from an electricity demand perspective. You really have to force behavior there because the grid is managed to that peak, and if everybody drives home and then plugs in right away, that peak is going to get crazy high from an electric use perspective and that rate is going to be massive. You really need to do rate design that forces people to charge that stuff overnight when it's cheap. I think that's easier than not running your air conditioner when you really need it. I think is at least possible as we add more EVs to the system. T.J. Thornton: Andrew, a follow up based on Ross's answer there. The grid is going to be become more complicated, as you've got different generation profiles at different times of the day. Are there companies in your universe that can take advantage of that more complex grid and also just the grid investment that we're going to see in general? Andrew Obin: Yeah, absolutely. We've written about the fact that we're probably in early innings of a first proper T&D cycle in 30 years. We're also in early stages of power gen cycles. As I said, we haven't had any of these for 10, 20, 30 years. What you should be thinking is at the power plant level just pumps and valves control systems, as you adding new capacity or if you're extending life of existing assets or bringing back things like nuclear power. The other area I would highlight is software for grid management. That's very interesting to us because if there are these bottlenecks to adding capacity, both physical in terms of supply chain, but also regulatory, managing existing grid becomes so much more important, so we definitely highlight software for grid management, and then companies I cover actually make things like gas turbines. They make medium and high voltage transformers, that's part of their core electric expertise. If and when we actually start adding capacity, both power producing assets and transmission distribution, which we have been actually doing, these material beneficiaries. T.J. Thornton: All right, Ross and Andrew, thank you guys very much for what was an excellent discussion. Ross Fowler: Thank you T.J. Andrew Obin: Thank you. Pleasure. T.J. Thornton: Data centers are an important source of power demand growth, but they're not the only source. In fact, Andrew Obin suggests building electrification is a bigger driver. The diverse set of demand sources is a positive for the visibility of growth, in case aspects of that prove to be overhyped. It's likely that nuclear will be part of the solution, but we're running out of plants that can be turned back on, and large scale nuclear takes a long time to build. Small nuclear will help, but natural gas will be critical. Also, there's a big shift underway in how the grid looks, especially with all these intermittent renewables being added. That makes for a lot of volatility in wholesale power prices depending on whether the demand is on or off peak. And all that is good news for some of Andrew Obin's companies is they can take advantage of the investment cycle and transmission and distribution in software and in Powergens and some of those companies actually have exposure to gas turbines. Thanks for joining us today. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/global-real-estate-conference/Spector-headshot-resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: september 20, 2024</div> <h4 class="tile__headline header--h4 header--blue "> Pleasant views from the Global Real Estate conference </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>REIT stocks have been great performers recently but rate cuts could usher in more transactions and other positives.</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b><br/> <b>Jeffrey Spector</b>, Head of U.S. REIT Research</p> <p> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_eupcdb79" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" transcriptText='[{"id":"1_eupcdb79","transcript":"%3Cp%3EReal%20Estate%20Conference%20Podcast%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%3A%20Hello%20and%20welcome%20to%20Global%20Research%20Unlocked%2C%20where%20we%20discuss%20what%27s%20rising%20from%20growth%20industries%20to%20rising%20risks%20and%20opportunities%20in%20global%20markets.%20I%27m%20T.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%20at%20BofA%20Global%20Research%2C%20and%20we%27re%20recording%20this%20episode%20on%20Friday%2C%20September%2020%2C%202024.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3EOffice%20is%20the%20first%20sector%20we%20look%20at%20and%20analyze%20when%20we%27re%20thinking%20about%20lower%20rates%20as%20one%20of%20the%20biggest%20beneficiaries%2C%20cause%20there%20has%20been%20so%20many%20issues%20in%20the%20office%20sector%20over%20the%20last%20couple%20years%20and%20heading%20into%20the%20pandemic%2C%20they%20entered%20with%20higher%20leverage%20and%20higher%20floating%20rate%20debt.%20Number%20one%2C%20you%27re%20right%2C%20this%20will%20help%20office%2C%20but%20it%20also%20helps%20all%20of%20real%20estate%2C%20it%20helps%20all%20the%20sectors.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20REIT%20stocks%20have%20been%20great%20performers%20over%20the%20last%20year%2C%20following%20about%20four%20years%20of%20sideways%20price%20action.%20The%20peak%20in%20interest%20rates%20enabled%20this%20performance%2C%20but%20rates%20have%20already%20dropped%20significantly%2C%20partly%20of%20the%20Fed%20cuts%20that%20we%20just%20heard%20about.%20Can%20fundamentals%20improve%20enough%20from%20here%20to%20carry%20the%20group%20even%20higher%3F%20Joining%20us%20today%20is%20Jeff%20Specter%2C%20Head%20of%20U.S.%20REIT%20Research%20at%20BofA%20Global%20Research.%20Jeff%20is%20fresh%20off%20his%20Global%20Real%20Estate%20Conference%2C%20where%20there%20were%20many%20discussions%20about%20the%20above.%20Jeff%2C%20thanks%20for%20joining%20and%20were%20the%20realities%20presented%20at%20the%20conference%20supportive%20of%20this%20excellent%20stock%20performance%20that%20I%20just%20recounted%3F%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3EJeffrey%20Spector%2C%20Head%20of%20U.S.%20REIT%20Research%3A%20Thanks%20T.J.%2C%20for%20having%20me%20today.%20I%20would%20say%20we%20had%20record%20attendance%2C%20which%20meant%20that%20generalists%20and%20international%20investors%20attended%20the%20conference.%20Investors%20have%20been%20underweight%20real%20estate%2C%20somewhat%2C%20let%27s%20say%2C%20ignoring%20real%20estate%20or%20public%20REITs%2C%20the%20last%20couple%20years%2C%20with%20the%20recent%20outperformance%2C%20it%20is%20pulling%20investors%20in.%20The%20tone%20at%20the%20conference%20was%20very%20positive%20and%20it%20should%20be.%20We%20wrote%20in%20our%20report%2C%20it%20is%20the%20%27perfect%20storm%27%20for%20out-performance%20in%20our%20view.%20You%20have%20healthy%20fundamentals%20for%20most%20sectors%20decreasing%20supply%20into%20%2725.%20Positioning%20has%20been%20underweight%20and%20we%20are%20forecasting%20higher%20earnings%20growth%20next%20year.%20We%20did%20not%20hear%20at%20the%20conference%20from%20our%2060%2B%20fireside%20chats%20with%20public%20REITs%20really%20limited%20new%20negatives.%20Yes%2C%20I%20would%20say%20it%27s%20warranted.%20And%20on%20lower%20rates%2C%20of%20course%2C%20the%20prospects%20to%20refinance%20it%20lower%20rates%20helps%20earnings%2C%20reduces%20that%20interest%20expense.%20At%20the%20same%20time%2C%20lower%20rates%20will%20help%20pick%20up%20transactions%2C%20meaning%20transactions%20will%20start%20to%20increase%2C%20as%20well%20as%20development%20and%20redevelopment%20opportunities.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20Thanks%2C%20Jeff.%20And%20right%2C%20that%27s%20one%20of%20the%20things%2C%20I%20think%2C%20that%27s%20striking%20about%20what%27s%20going%20on%20with%20rates%20is%20it%E2%80%99s%20not%20just%20that%20yields%20start%20to%20look%20more%20attractive%20as%20rates%20fall.%20There%20are%20a%20number%20of%20other%20positives%20that%20come%20along%20with%20lower%20rates.%20And%2C%20and%20I%20know%20that%20you%20posted%20a%20panel%20at%20the%20conference%20with%20Savita%2C%20our%20U.S.%20Strategist%2C%20and%20she%20said%20that%20this%20was%20the%20most%20bullish%20she%27s%20been%20on%20real%20estate%20in%2010%20years%2C%20which%20is%20a%20compelling%20endorsement.%20You%20just%20talked%20about%20how%20real%20estate%20transactions%20are%20picking%20up%2C%20are%20lower%20rates%20behind%20that%20uptick%2C%20and%20in%20the%20past%20when%20transactions%20have%20picked%20up%2C%20has%20that%20been%20supportive%20of%20REIT%20valuations%3F%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3EJeffrey%20Spector%3A%20Yes%2C%20I%20would%20say%20we%20heard%20consistently%20at%20the%20conference%20that%20the%20transaction%20market%20is%20pic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closeTranscriptText="Close Transcript" closeDisclaimerText="Close Disclaimer" disclaimerTitle="Disclaimer" transcriptTitle="Transcript" carouselNextArrowText="Go to Next Item" carouselPreviousArrowText="Return to Previous Item" carouselDotsLabel="of" playlistItemLabel="Item {0} of {1} Play {2} video" validCloseCaptions="false" data-video-id="1_eupcdb79_Pleasant views from the Global Real Estate conference"> <div id="1_eupcdb79" class="uc-media__player"> </div> <div class="uc-media-transcript" aria-hidden="true" aria-expanded="false"> <div class="uc-media-transcript__header"> <button aria-label="Close Transcript" class="uc-media-transcript__close uc-media-icon-close" tabindex="-1" title="Close Transcript"></button> </div> <div class="uc-media-transcript__container" tabindex="-1"> <h3 class="uc-media-transcript__title">Transcript</h3> <div class="uc-media-transcript__text"></div> </div> </div> <script type="application/ld+json">{"@type":"AudioObject","name":"Pleasant views from the Global Real Estate conference","description":"No description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_eupcdb79/version/0","uploadDate":"2024-10-17T15:01:33-04:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_eupcdb79/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_eupcdb79/format/url/protocol/https","duration":"PT25M28S","transcript":"Real Estate Conference Podcast T.J. Thornton, Head of Product Marketing: Hello and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research, and we're recording this episode on Friday, September 20, 2024. Office is the first sector we look at and analyze when we're thinking about lower rates as one of the biggest beneficiaries, cause there has been so many issues in the office sector over the last couple years and heading into the pandemic, they entered with higher leverage and higher floating rate debt. Number one, you're right, this will help office, but it also helps all of real estate, it helps all the sectors. T.J. Thornton: REIT stocks have been great performers over the last year, following about four years of sideways price action. The peak in interest rates enabled this performance, but rates have already dropped significantly, partly of the Fed cuts that we just heard about. Can fundamentals improve enough from here to carry the group even higher? Joining us today is Jeff Specter, Head of U.S. REIT Research at BofA Global Research. Jeff is fresh off his Global Real Estate Conference, where there were many discussions about the above. Jeff, thanks for joining and were the realities presented at the conference supportive of this excellent stock performance that I just recounted? Jeffrey Spector, Head of U.S. REIT Research: Thanks T.J., for having me today. I would say we had record attendance, which meant that generalists and international investors attended the conference. Investors have been underweight real estate, somewhat, let's say, ignoring real estate or public REITs, the last couple years, with the recent outperformance, it is pulling investors in. The tone at the conference was very positive and it should be. We wrote in our report, it is the 'perfect storm' for out-performance in our view. You have healthy fundamentals for most sectors decreasing supply into '25. Positioning has been underweight and we are forecasting higher earnings growth next year. We did not hear at the conference from our 60+ fireside chats with public REITs really limited new negatives. Yes, I would say it's warranted. And on lower rates, of course, the prospects to refinance it lower rates helps earnings, reduces that interest expense. At the same time, lower rates will help pick up transactions, meaning transactions will start to increase, as well as development and redevelopment opportunities. T.J. Thornton: Thanks, Jeff. And right, that's one of the things, I think, that's striking about what's going on with rates is it’s not just that yields start to look more attractive as rates fall. There are a number of other positives that come along with lower rates. And, and I know that you posted a panel at the conference with Savita, our U.S. Strategist, and she said that this was the most bullish she's been on real estate in 10 years, which is a compelling endorsement. You just talked about how real estate transactions are picking up, are lower rates behind that uptick, and in the past when transactions have picked up, has that been supportive of REIT valuations? Jeffrey Spector: Yes, I would say we heard consistently at the conference that the transaction market is picking up, and specifically we heard from several REIT executives across various sectors since Labor Day. We did ask our executives when will we actually see the transaction volume increase versus just the rhetoric that the market's picking up? And we're told it most likely 4th quarter of this year into the first half of next year. Historically, that has been the case. We have been hearing all year the gap between buyers and sellers was narrowing, and so lower rates helps that. I think it also will help if the stress in the marketplace has been limited, but it will also start to help clear the market there. We'll start to see more transactions as well, maybe on the distress side. The public REITs are limited there. They own high quality institutional real estate, but it's important for the entire real estate market transactions to pick up to see health. On lower rates, yes, transactions picking up, and that will support valuations because with limited transactions over the last couple years, analysts are doing their best to estimate where our values with higher transactions, there's more transparency on where valuations or what we call cap rates are, today in the market, and that would hopefully be across sectors. T.J. Thornton: Jeff, to that point, I know that folks on your team recently upgraded a couple apartment REITs actually on a transaction. It indicated the cap rates for some of these public REITs were looking really attractive based on the price at which this thing took place, so I wanted to talk a little bit about the flow through of lower rates. Lower rates have been a relief for owners of office properties. In particular, they have faced cash flow pressure from lower occupancy and now they get some relief on the debt side. But is the rate relief meaningful for public non-office REITs too? And if so, how significant is that? Jeffrey Spector: You're right. Office is the first sector we look at and analyze when we're thinking about lower rates as one of the biggest beneficiaries, cause there has been so many issues in the office sector over the last couple years and heading into the pandemic, they entered with higher leverage and higher floating rate debt. Number one, you're right, this will help office, but it also helps all of real estate, it helps all the sectors. While the public REITs have low leverage around 30%, and they've done an excellent job with their debt maturity schedules, over 80% of financing is through the unsecured markets, capital markets are wide open. The office sector entered the pandemic with higher leverage and higher floating rate debt than the other sub-sectors we cover within real estate. That said, lower rates will help all sectors. So, it will help reduce that interest expense or reduce the impact of higher rates with rates coming down recently and the prospects of lower rates over the next year. Additionally, tying into our prior conversation, we believe strongly that the public REITs are well positioned to be opportunistic, cause many are under levered, and they have access to the capital markets. Over 80% of financing is through the unsecured market. Lower rates, we believe will present those opportunities, whether it's acquisitions, possibly some lending, but that's a small part of our property REITs business, and the lending typically leads to ownership of the asset, but it could also lead to development, redevelopment, densification efforts. There are multiple ways that lower rates would help public REITs, not just office, but all sectors. T.J. Thornton: Okay. And Jeff, on that topic of office, I know one of the big conference takeaways of yours was that offices actually generating interest from high profile buyers. And so maybe some of the positives for office go beyond just the fact that rates have fallen and it's cheaper and easier to refi and just cost lower. What were your key takeaways from the conference on office, especially on kind of the demand flow? Jeffrey Spector: I would say 'the drop the mic moment' at the conference was one of the most respected private owners of real estate for the first time that we've heard him say that his company is selectively looking at office, that there is a price to enter office today, again, selectively. That was a really important comment given the negative rhetoric over the past couple years on office. Back to the office mandates are helping. Leasing volumes are picking up. The comment was significant, but it also ties into what we heard from some of the office landlords. There is still a market of haves and have nots. We started to recommend New York City office over a year ago. We've been more cautious on West Coast office. We also prefer Sunbelt office. Every market is seeing different dynamics. It really has come down to the companies strictly enforcing those back to office mandates. In New York City, those started a few years ago. But the new important at the conference, which keeps us excited about New York City, and one could argue New York City, submarket Midtown is one of the best and strongest markets in the country. We are seeing leasing volumes really pick up, and that's broadened out. In May when we do a New York City tour, we heard there were a couple tech firms in the market, now it sounds like that's in the high single digits. The leasing was concentrated on Park Avenue, Grand Central, that's now expanding in other sub-markets within the New York City. That said, as I mentioned, not all of office is in the clear. In fact, a broker just put out the latest stats that companies continue to take less space when they renew or sign a new lease, so office is not out of the woods. And as I mentioned, some markets are not as healthy, again, we remain cautious on the West Coast. The mandates in San Francisco or Los Angeles, where our public REITs do own some office buildings, it's just not the same as New York City. The tech firms have not been as strict, and so we're seeing some leasing pick up in San Francisco. For every lease signed, tech firms are still cutting space or removing space from their use. It's evolving, but I would say in general improving. T.J. Thornton: Got it. Thanks Jeff. As an example, I'm sure you've experienced this yourself. You leave the office at noon to grab lunch, and you can barely fit on the sidewalk. It's so busy in Midtown, which is funny to think about, because I think four years ago people would not have maybe predicted that. I did want to talk about Fed cuts. Earlier this week we got to 50 basis points, but interestingly in the short amount of time since then, there's been a risk on trade. The S&P rallied the percent and a half in the day or so since, actually REITs have been flattish. If the market takes a more risk on pro recovery stance, in light of the start of these cuts, which it has done so far, could REITs actually be at risk, or could they perhaps underperform? Jeffrey Spector: That's a great question and how the stocks reacted yesterday on a full day, and you're right, real estate did underperform, and tech outperform. Something we'll continue to watch, based on history of Fed cuts, real estate typically outperforms post the first cut. Go back to 2000 timeframe, real estate outperformed before the Fed cut, similar to today, and again, continued to outperform for many years post that cut. It does depend on, as you said, T.J., risk on versus risk off. If the market believes in soft landing, which by the way, soft landing lower rates still is a dream scenario for real estate. Soft landing, lower rates, lower supply to '25, I would say our estimates are conservative and we again are modeling a fairly significant increase in earnings next year for real estate versus Savita at our conference mentioned she currently was estimating a decrease in S&P earnings next year. We have acceleration versus S&P deceleration, but it's something to watch. If that hard landing scenario comes back into the conversation, then I would imagine that would maybe help real estate pick up some traction. But again, hard landing, there could be issues in real estate we would watch carefully. Our demand is tied to jobs and income growth. T.J. Thornton: Got it. And as a follow up, are there parts of real estate that you think would perform better in more of a risk on the barn? Jeffrey Spector: Interestingly, risk on risk off, we did an analysis at looking at sub-sectors in the past when the Fed cuts, it actually ties to one of the sectors that we really favor today, and that is healthcare. We walked away from the conference, and we said one of our key takeaways is healthcare is still best positioned for internal growth and external growth. It's a sector that actually could do well in both scenarios, risk on and risk off. It has those defensive characteristics. A lot of the product is need based. There's limited to no supply, but at the same time, on risk on that can go on the offense, there are external opportunities in terms of accretive acquisitions. Healthcare is one sector in risk on and risk off. I would also say risk on lower rates, risk on soft landing, softer job market, but resilient, we would want to focus on apartments because of the short lease, one year lease. T.J. Thornton: Jeff, you also mentioned in your report the challenges that developers face today. Where is their supply today? Where are your expectations and why has it become so difficult to develop new projects? Jeffrey Spector: As we head into 2025, the silver lining across a lot of sectors is that there's either limited supply or supply is decreasing. That said, in Sunbelt Apartments, we've seen records supply the last year plus. Now, based on forecast that is starting to decrease into the yearend '24 and as I said, into '25, but there's still supply pressure as those operators lease up the projects. The other area of supply has been industrial. Industrial supply is also expected to decrease significantly into '25. But I would say the negative this year, and still probably the one negative from the conference we continue to hear is that there are still pockets of supply and industrial in markets like Phoenix or Inland Empire Las Vegas, that are impacting existing projects, and there will continue to be some supply in industrial, but lower, so it is very market specific. The opposite end of the spectrum is retail, where we haven't seen supply for over 12 years now. Retail, there's really limited to no supply. And I would expect office to be very similar to what happened to retail coming out of the world financial crisis in terms of, it would be very difficult to pencil new development today. And as I mentioned, it's difficult to develop, first you need construction financing, which is challenging to get today from a bank, and then the numbers are just not penciling. One of the benefits of owning property because of inflation is replacement costs. The cost of the materials has increased significantly over the past couple years. Plus, there are still challenges to get certain materials to develop, and so combine all of that, it creates a challenging environment to develop new projects and it's something we'll continue to watch as we head into '25. T.J. Thornton: Okay. And to follow up on that point about retail, I certainly get why there would be little supply growth, because we've been talking about e-commerce now for over a decade and we continue to see share gains. But what else is positive about retail? Cause I know that that was one of your takeaways from the conference, which is that retail is a bright spot. What about the demand side? Jeffrey Spector: The positive for retail today is that brick and mortar is back. We wrote a couple years ago that we believe brick and mortar will be the comeback kid in real estate, and that's really played out. In fact, today we have record low vacancy in retail. And again, yes, it helps tremendously that there's not new supply, but the demand has significantly picked up. We've had two record years of leasing in retail real estate, and that is across all formats. Yes, it's shopping centers, grocery anchored, big box lifestyle, but it's also been in malls and outlets. And the key reason, which was discussed on a panel at the conference, is retailers are laser focused on omnichannel/omnipresence. Brick and mortar has become critical, important. Many brands, including luxury fashion are not just looking to use wholesale or department stores, they've been opening their own stores. And it's a great experience for their customers. It's their salespeople, they can control the inventory when they want to put the merchandise up for sale. But what's important is omnichannel generates profits. There's a couple very large, big box tenants that put in tremendous money before COVID to leverage their stores, and they're benefiting today because of that, and now other retailers are trying to mirror that. T.J. Thornton: Okay. It's mostly positive, but it's not all super positive. You talked about some more mixed areas. You mentioned industrial. A little bit more there on the lower visibility in both industrial and self-storage. We'd love to hear more about that. Jeffrey Spector: I would say one of the most important takeaways from the conference was we said that we believe there's the least visibility right now in self-storage and industrial. It's been a challenging year for self-storage. Positive is that the existing customer has been resilient. This has been a big surprise with all the headlines over consumer health. It's amazing. The existing customer in industrial for the most part is staying. But over a year ago, the new customer became price sensitive, and we've just seen less demand for self-storage over the past year and that persists today. And then in industrial, the negative that we discussed with one of the largest private industrial real estate companies, as well as public, is that lack of visibility on shadow supply. Supply, it's really been weighing on select markets this year and then demand for larger boxes. We walked away from the conference feeling that there's still this uncertainty on when we'll see equilibrium. Equilibrium is critical, and then what that hopefully will lead to is an improvement in market rent, but that typically lags by a few months. As we end the year in '24 and enter '25, it seems clear that pockets of industrial will continue to try to find that equilibrium. T.J. Thornton: Okay, thanks Jeff. And last question, I think you touched on this a little bit when you were talking about healthcare earlier, but there are some big trends in the market affecting real estate and many other things, demographics, so aging population, technology, things like AI data centers. Which part of your coverage do you think has the most or the strongest secular tailwinds over the next 5-10 years? Jeffrey Spector: It's a great question, and we’re always focused on demographics as a driver of demand. As mentioned, we continue to favor healthcare because it is need-based, they do have the product that caters to aging Americans. And so, the baby boomer generation is now at the age where they're entering senior housing facilities, and again, unfortunately is more need-based, and that is just starting to happen. And that wave of baby boomers entering could last another 15 years. And at the same time, there's really limited new development in senior housing. Healthcare, specifically senior housing, and even skilled nursing facilities are uniquely positioned. At the same time, I would also say we have a housing shortage. So, when we think about demographics and needs, shelter, apartments, and single-family rentals will also benefit. Apartments cater to that younger professional, 22-35-year-old, depending on the market. And then single-family rentals, average age is typically 38-40 family, two children, dual income earners, very resilient asset class, and the past year we've seen record demand in both. And then as we watch migration trends, they continue into the Sunbelt, which prompted those recent upgrades. While there's some noises I mentioned over the coming 6-9 months, we believe that the Sunbelt entering the back half of '25, but for sure 2026, Sunbelt Apartments, Sunbelt Single Family Rentals will be one of the biggest beneficiaries. T.J. Thornton: Jeff, thanks a lot for your insights, colored by your 25 years of knowledge, plus a very recent conference where I know you heard from a lot of very influential and thoughtful people. I really appreciate your time. Jeffrey Spector: Thanks so much for having me today. T.J. Thornton: Lower rates help REITs in a number of different ways, which helps explain the bullishness from Jeff, from Savita and from many at our conference. REIT yields look more attractive as rates fall, interest costs for the companies can drop, transactions can pick up and growth opportunities like development start to present themselves. Of course, if lower rates come alongside a recession, that's not as positive, especially for cyclical groups. But you also have areas like senior housing that are more structural. On office, it's interesting to hear that one of the most respected real estate buyers is selectively looking to buy. Also, that Midtown Manhattan is one of the strongest markets in the country. That probably means we'll see even more supply of salad shops. And supply, particularly in office, retail and next year in apartments has been light, another positive. Things in industrial and self-storage though aren't quite as bullish. Thanks for joining. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/rate-cuts/Jadrosich-headshot-resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: september 17, 2024</div> <h4 class="tile__headline header--h4 header--blue "> Rate cuts are underway but home buyers await more </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>The rate cutting cycle is underway and housing stocks are expected to perform well in the months after the first cut.</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b><br/> <b>Rafe Jadrosich</b>, U.S. Homebuilders and Building Products Analyst</p> <p> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_7kdyg4v0" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" transcriptText='[{"id":"1_7kdyg4v0","transcript":"%3Cp%3ERate%20Cuts%20and%20Housing%20Podcast%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%3A%20Hello%2C%20and%20welcome%20to%20Global%20Research%20Unlocked%2C%20where%20we%20discuss%20what%27s%20rising%20from%20growth%20industries%20to%20rising%20risks%20and%20opportunities%20in%20global%20markets.%20I%27m%20T.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%20at%20BofA%20Global%20Research%2C%20and%20we%27re%20recording%20this%20episode%20on%20Tuesday%2C%20September%2017%2C%202024.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3EWhere%20building%20product%20companies%20perform%20best%20is%20when%20you%20have%20improving%20on%20employment%2C%20and%20then%20strong%20consumer%20spending.%20Building%20product%20stocks%20performed%20exceptionally%20well%20relative%20to%20the%20market%20from%202012%20to%202017.%20But%20we%20look%20at%20home%20builders%2C%20they%20tend%20to%20do%20better%2C%20while%20you%20actually%20have%20financial%20easing.%20Again%2C%20lower%20rates%20are%20good%20for%20both%20of%20them%2C%20but%20probably%20more%20of%20a%20tailwind%20to%20home%20builder%20stocks.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20The%20rate%20cutting%20cycle%20is%20underway%2C%20and%20as%20someone%20on%20the%20radio%20was%20telling%20me%20on%20my%20way%20to%20the%20train%20this%20morning%2C%20that%20should%20be%20a%20good%20thing%20for%20rate%20sensitive%20areas%20like%20housing%20and%20autos.%20But%20is%20it%20that%20simple%3F%20Because%20housing%20stocks%20in%20particular%20have%20anticipated%20Fed%20cuts%2C%20mortgage%20rates%20have%20already%20come%20down%2C%20and%20it%20could%20be%20that%20lower%20rates%20also%20mean%20more%20housing%20supply.%20And%20aside%20from%20rates%2C%20there%20are%20other%20drivers%20of%20housing%20too%2C%20including%20elections%2C%20demographics%2C%20and%20even%20technology.%20Joining%20us%20today%20to%20discuss%20all%20this%20is%20Rafe%20Jadrosich%2C%20who%20covers%20U.S.%20Home%20Building%20and%20Building%20Products%20Companies%20for%20BofA%20Global%20Research.%20Thank%20you%2C%20Rafe%2C%20for%20joining%20us%20today.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ERafe%20Jadrosich%2C%20U.S.%20Homebuilders%20and%20Building%20Products%20Analyst%3A%20Thanks%2C%20T.J.%20It%27s%20an%20exciting%20time%20in%20the%20housing%20market%20and%20appreciate%20you%20having%20me.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20Absolutely.%20One%20of%20our%20favorite%20topics.%20I%20wanted%20to%20start%20with%20mortgage%20rates.%20They%27ve%20fallen%20significantly.%20The%2030-year%20was%20around%207.5%25%20last%20fall.%20It%27s%20now%20at%20close%20to%206%25.%20Is%20there%20any%20evidence%20that%20drop%20has%20boosted%20home%20sales%20yet%3F%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ERafe%20Jadrosich%3A%20If%20you%20look%20at%20the%2030-year%20mortgage%20rates%20like%20you%27re%20referencing%2C%20that%27s%20the%20agency%20loans%20that%20make%20up%20the%20majority%20of%20what%20home%20builders%20are%20offering%2C%20primarily%20the%20entry%20level%20buyers.%20Like%20you%20said%2C%20they%27ve%20declined%20from%20about%207%25%20in%20early%20July%20to%20around%206.1%25%20today.%20That%27s%20a%20pretty%20sharp%20decline%20in%20a%20short%20period%20of%20time%2C%20and%20we%27re%20basically%20back%20to%20the%20lowest%20level%20in%20two%20years.%20In%20terms%20of%20what%20that%27s%20meant%20for%20housing%20demand%2C%20if%20you%20look%20at%20June%20and%20July%2C%20they%20were%20pretty%20soft%2C%20partially%20because%20rates%20were%20higher%20and%20then%20there%20was%20a%20lot%20of%20macro%20uncertainty%20out%20there.%20But%20in%20August%20we%20did%20see%20a%20little%20bit%20better%20demand%20and%20uptick%20on%20the%20new%20home%20side%20in%20terms%20of%20traffic%20that%20home%20builders%20saw.%20We%20do%20think%20home%20builders%20increased%20the%20level%20of%20incentives%20toward%20the%20end%20of%20August%2C%20so%20sales%20did%20pick%20up%20a%20lot.%20But%20this%20hasn%27t%20been%20as%20robust%20of%20a%20response%20to%20a%20decline%20in%20rate%20as%20what%20we%27ve%20seen%20over%20the%20last%20few%20years.%20We%20think%20part%20of%20that%20has%20to%20do%20with%20a%20bit%20of%20deferral%20that%27s%20going%20on%20in%20the%20market.%20A%20lot%20of%20potential%20home%20buyers%20expect%20rates%20to%20drop.%20They%20expect%20them%20to%20continue%20to%20fall%2C%20so%20there%27s%20not%20really%20a%20great%20sense%20of%20urgency%20that%27s%20going%20on%20in%20the%20market%20right%20now.%20It%27s%20a%20little%20bit%20better%2C%20but%20we%20haven%27t%20seen%20a%20really%20strong%20response%20yet.%3C%2Fp%3E%0D%0A%3Cp%3E%C2%A0%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20We%20can%20appreciate%20that%20lower%20rates%20are%20a%20positive%20for%20housing%20demand%2C%20but%20there%20are%20potential%20offsets.%20For%20one%2C%20the%20economy%20is%20slowing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closeTranscriptText="Close Transcript" closeDisclaimerText="Close Disclaimer" disclaimerTitle="Disclaimer" transcriptTitle="Transcript" carouselNextArrowText="Go to Next Item" carouselPreviousArrowText="Return to Previous Item" carouselDotsLabel="of" playlistItemLabel="Item {0} of {1} Play {2} video" validCloseCaptions="false" data-video-id="1_7kdyg4v0_Rate cuts are underway but home buyers await more"> <div id="1_7kdyg4v0" class="uc-media__player"> </div> <div class="uc-media-transcript" aria-hidden="true" aria-expanded="false"> <div class="uc-media-transcript__header"> <button aria-label="Close Transcript" class="uc-media-transcript__close uc-media-icon-close" tabindex="-1" title="Close Transcript"></button> </div> <div class="uc-media-transcript__container" tabindex="-1"> <h3 class="uc-media-transcript__title">Transcript</h3> <div class="uc-media-transcript__text"></div> </div> </div> <script type="application/ld+json">{"@type":"AudioObject","name":"Rate cuts are underway but home buyers await more","description":"No description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_7kdyg4v0/version/0","uploadDate":"2024-10-29T14:36:36-04:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_7kdyg4v0/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_7kdyg4v0/format/url/protocol/https","duration":"PT19M49S","transcript":"Rate Cuts and Housing Podcast T.J. Thornton, Head of Product Marketing: Hello, and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research, and we're recording this episode on Tuesday, September 17, 2024. Where building product companies perform best is when you have improving on employment, and then strong consumer spending. Building product stocks performed exceptionally well relative to the market from 2012 to 2017. But we look at home builders, they tend to do better, while you actually have financial easing. Again, lower rates are good for both of them, but probably more of a tailwind to home builder stocks. T.J. Thornton: The rate cutting cycle is underway, and as someone on the radio was telling me on my way to the train this morning, that should be a good thing for rate sensitive areas like housing and autos. But is it that simple? Because housing stocks in particular have anticipated Fed cuts, mortgage rates have already come down, and it could be that lower rates also mean more housing supply. And aside from rates, there are other drivers of housing too, including elections, demographics, and even technology. Joining us today to discuss all this is Rafe Jadrosich, who covers U.S. Home Building and Building Products Companies for BofA Global Research. Thank you, Rafe, for joining us today. Rafe Jadrosich, U.S. Homebuilders and Building Products Analyst: Thanks, T.J. It's an exciting time in the housing market and appreciate you having me. T.J. Thornton: Absolutely. One of our favorite topics. I wanted to start with mortgage rates. They've fallen significantly. The 30-year was around 7.5% last fall. It's now at close to 6%. Is there any evidence that drop has boosted home sales yet? Rafe Jadrosich: If you look at the 30-year mortgage rates like you're referencing, that's the agency loans that make up the majority of what home builders are offering, primarily the entry level buyers. Like you said, they've declined from about 7% in early July to around 6.1% today. That's a pretty sharp decline in a short period of time, and we're basically back to the lowest level in two years. In terms of what that's meant for housing demand, if you look at June and July, they were pretty soft, partially because rates were higher and then there was a lot of macro uncertainty out there. But in August we did see a little bit better demand and uptick on the new home side in terms of traffic that home builders saw. We do think home builders increased the level of incentives toward the end of August, so sales did pick up a lot. But this hasn't been as robust of a response to a decline in rate as what we've seen over the last few years. We think part of that has to do with a bit of deferral that's going on in the market. A lot of potential home buyers expect rates to drop. They expect them to continue to fall, so there's not really a great sense of urgency that's going on in the market right now. It's a little bit better, but we haven't seen a really strong response yet. T.J. Thornton: We can appreciate that lower rates are a positive for housing demand, but there are potential offsets. For one, the economy is slowing, that's one of the reasons why the Fed is cutting. Also, a reason there's been such little existing home supply is because people don't want to give up low-interest rate mortgages. But as rates fall, there's less of this lock in and that could unleash some more supply. How do lower rates net out in your view? And how have home builders performed in past rate cutting cycles? Rafe Jadrosich: Like you said, there's definitely cross currents in the housing market right now. Lower rates are good for demand; weaker employment backdrop is bad for demand. In general, when we put it all together the new home market and renovation demand will benefit from lower rates, if we assume the macro environment is generally stable. Lower rates just increase demand. They help pricing for home builders because the affordability gets better for a potential home buyer. If you look at something like building products, lower rates can drive an improvement in existing home sales because there's less of a lock in effect. Like you spoke about, more people are willing to sell their house and then you'll get a benefit from turnover related home improvement spend. There's also some lower borrowing cost if people want to borrow money for larger discretionary products. There is this interesting dynamic right now, where existing home inventory, so the resale market, the inventory levels are very depressed versus where they've been historically. And lower rates will bring some incremental supply on the market, and the new home market, home builders have to compete against that incremental supply, and they haven't had a lot of that recently. But in addition to incremental supply, almost everybody that sells their house is still in the housing market. You sell your house usually to buy another one or at least go into the rental market. And then as rates fall, there's a lot of renters that will then enter the housing market that can now afford a house that couldn't before. I think a great stat that the National Association of Home Builders always puts out is there's over 3 million renters in the U.S. that make over $150,000 a year. There's a fair amount of pent-up demand that's out there. And when you net it all together, we think lower rates, you have more incremental demand relative to the supply that comes into the market. It's an interesting point on how do home builders perform in an environment where employment's a little bit weaker, but rates are coming lower. After the first rate cut in three of the last five rate cutting periods, we saw home builders continue to outperform in the three-month period after that initial cut. And that's happened in the past, even as you saw unemployment rise. Generally, while rates are falling, even in a tougher macro backdrop, you still see home builder stocks outperform the market. T.J. Thornton: Okay. I guess one potential difference though this time is that home builder stocks are sitting at all-time highs going into this rate cutting cycle, and on valuation they look fairly expensive at least versus history. How does that factor into your view? Rafe Jadrosich: As you mentioned, home builder stocks are trading at a higher valuation going into this Fed rate-cut period than any of the last five periods where the Fed started to cut rates. We do think there's good reasons why home builder stocks should be trading at a higher level than where they have historically. First, just the return on equity is higher than it's been in the past. Second, if you go back to prior periods for home builders, the capital allocation has really improved. If we look pre-global financial crisis, home builders were repurchasing less than 1% of their market cap a year, now they're repurchasing around 4% or 5% each year. They also have very little debt on their balance sheet. They have higher market share versus the private home builders, and they continue to gain share and they're just generating a lot more cash because they're using asset light balance sheets and optioning a lot of land instead of owning it. We do think that as businesses, they've improved. Some of the rerating is justified. And then just from an industry perspective, some of the problems that the industry's had in the past was related to oversupply, too much building, which pushed down prices. Supply is just a lot tighter now. It's harder for home builders to get land entitled and to build and that's kept the market a lot healthier. T.J. Thornton: Okay. And Rafe, you mentioned that home buyers tend to think that rates will fall, and so that they're inclined to wait, I guess that's because they know that the Fed is going to be cutting and think that maybe that will lead to lower mortgage rates. But what is the evidence of this, and does it mean that it's just a matter of time before these people get forced off the sidelines? Either rates do fall more, or they don’t, and they wind up having to just deal with rates where they are now. Rafe Jadrosich: We definitely agree that there's some deferral that's happening in the market right now. It just doesn't feel like there's a lot of urgency for buyers, because the expectation that mortgage rates will continue to fall further or at least that they won't go higher. For context, our mortgage-backed security team does expect rates to settle at a little bit lower level by year end, even after the decline we've seen so far. I think another factor here that's driving addition to the deferral is the inventory that's available on the resale side of the market isn't particularly attractive right now. Anybody that's been looking for a house will probably agree with this, but a lot of the inventory is pretty old, and it needs work. It's also very expensive. If you look at existing home prices in the U.S. are higher than new home prices right now, historically, it's the other way around where there's a 15% to 20% premium for new home prices relative to existing home prices. Current homeowners, because they're locked in at attractive rates, they want to be compensated for that rate that they have. And they're listing their houses at very expensive prices. The inventory isn't quite matched with what the buyers are looking for. People are deferring until they can find something that works better for them. T.J. Thornton: Got it. Okay. Housing has become an issue this election. Depending on the survey, it's among the top three issues on the part of the voter. Both candidates have outlined possible solutions. What's behind the proposals, and from the standpoint of your coverage of builders in building products companies, how could they benefit from some policy change? Rafe Jadrosich: Housing is a lot more of a focus for both voters and the candidates in this election cycle compared to prior election cycles. You called out that recent polling housing affordability is a top two economic issue for voters. In terms of the specific policies that have been laid out by both potential administration, on the democrat side, they're more focused on supply side policies. The Harris administration has a few supplied side policies that they've proposed. The first would be some tax incentives for entry level builders. The second is an expansion of the low-income housing tax credit, which could support housing for lower income buyers. They're also talking about opening some Federal land for new construction, which is a policy that both the Democrats and the Republicans share. And then the Harris administration has also proposed a potential home buyer tax cut or down payment assistance, which has polled very well, but generally, historically has been unlikely to get broad support and pass. On the Republican side, they're more focused on reducing regulation. They also want to utilize more Federal land for new construction, but they're more focused on reducing Federal regulations to just reduce the cost of home building. If the Democrat proposals go through, some of the tax incentives that could go to entry level builders, we think, would actually incentivize them to increase the amount of supply. It could be a margin tailwind and help pricing at that end of the market. T.J. Thornton: Okay. And you cover both home builders and building products. Which group do you think is better positioned in this backdrop of falling rates and still strong demographic trends? Rafe Jadrosich: Falling rates are good for both of them, from a fundamental standpoint. But if you look historically in periods of lower rates where you have stable or rising unemployment, what we've seen is home builder stocks have outperformed the market. Where building product companies perform best is when you have improving on employment and then strong consumer spending. Building product stocks performed exceptionally well relative to the market from 2012 to 2017. But we look at home builders, they tend to do better, while you actually have financial easing. Again, lower rates are good for both of them, but probably more of a tailwind to home builder stocks. T.J. Thornton: Got it. And just a quick follow up on that. On the topic of HELOCs, I think HELOC rates are still really high, but they should fall. And obviously homeowners have a ton of equity in their homes, especially generated in the last few years. If we do see those rates fall, is that something that could be helpful and would it be more helpful for building products than for home builders? Rafe Jadrosich: Similar to some of the trends we're seeing on the new home market, we have heard some of the home improvement retailers speak more recently about deferral of large discretionary projects. And like you mentioned, the home equity or the equity that people have in their houses is extremely high. It's at record levels, but people have been hesitant to tap into that because it's very expensive right now with higher rates. Lower rates for building products, there's two tailwinds. One is the potential improvement in existing home sales, and that'll increase turnover related home improvement spend around the sale of a house. But also, lower borrowing costs could help people tap into the equity in their house, which usually is used to fund a lot of the larger discretionary projects. This is another example where, if rates are going to go lower, you might wait to actually see the lower rates before you start that type of project. T.J. Thornton: Got it. Okay. Your companies may not be sending people into space like some other companies out there, made the news recently, but there are some interesting technologies in housing and building products from composite materials, ceramic flooring that looks like stone, more energy efficient appliances. Are there technologies that you think can gain more share, such that investors can benefit both from maybe the cyclical upside that we've been talking about for the past 15 minutes, but also structural tailwinds over the next cycle? Rafe Jadrosich: Sure. There's innovation, but the adoption of innovation in this industry tends to be pretty slow. It's a very fragmented trade base, and it takes a while to educate the field on how to install everything and what the benefits are to the homeowner. Where we are seeing some traction in terms of innovation is, like you mentioned, on some of the material conversion trends. A really good example of that is some composite materials that just last longer. Really good example would be composite decking, which has been replacing pressure treated lumber. You're seeing siding is another category, where you've shifted to some new materials that last longer and take a lot less maintenance to upkeep. That's where you've seen on the exterior side, a little bit of a shift there, which is just improving the quality of the home. On the construction side, we are seeing a shift towards more offsite construction. More builders are building things like roof trusses or they're buying roof trusses that are already assembled so you don't have to build it on site. That shortens the construction time, reduces waste, have like better accuracy, more consistent quality control, so that's been a trend that we've seen over the last half decade that continues to gain penetration with the builders. And then we've also just seen a shift to more energy efficient homes. There's better quality insulation. There's been a shift to spray foam, which helps houses get energy star compliant, which now you actually get some tax credits for, from a home builder perspective. Obviously, you've seen things like increased use of solar. One of the reasons why we think new homes are performing better, new home sales have outperformed the resale market is that older homes need a lot of work, and the newer homes are built to higher quality standards and have a lot of these features that home buyers are looking for. T.J. Thornton: Last question. Every time you've been on the podcast, I've asked about demographics, and we know that the millennial tailwind has a few years left, but over the next 10 years, we'll also have a more sharply declining population of boomer, sadly. The oldest boomers today are close to 80. When did these two forces become a problem for the housing market, where the millennial tailwind fades and then this boomer headwind, if you will, takes over? Rafe Jadrosich: It's interesting right now, but boomers are actually the largest buyers in the housing market right now, boomers and millennials are the two primary drivers. But partially because rates have gone up and there's been a shift towards more cash buyers that are less rate sensitive and just the wealth effect that boomers are benefiting from, that they've now become the biggest buyer in the housing market. The millennial tailwind is positive, we think, until around the end of the decade. You probably get to around 2030 before that starts rolling off, and there's fewer Gen Zs than there are millennials. And then just overall, population growth or the birth rate has slowed, so you have smaller families and that's negative for population growth. But there are a couple pretty big offsets. One is, we've had an uptake in immigration over the last year, and some of the recent data that's come out there is supportive of overall population growth. It's probably what's helped keep the rental market pretty tight out there. And then the second piece, the other side of some of the boomer headwind that you're talking about is there's a large potential wealth transfer. It's around 30 trillion each for Gen X and millennials that their set to inherit. An increase in wealth is supportive of demand in the housing market. There's definitely some demographic tailwinds that are set to fade as we get towards 2030. But there could be potential offsets depending on what happens with immigration and then what's happening, just in terms of the overall wealth effect. T.J. Thornton: Okay. Rafe, very much appreciate your time. Thanks for joining us. Rafe Jadrosich: Great. Thanks for having me T.J. T.J. Thornton: Home builder stocks are going into the rate cut cycle trading at high valuations versus their own history, but Rafe thinks that's mostly justified given that the industry is more focused on returns than in the past, and supply of housing is much tighter, partly as it's a lot harder to find and permit land. While builders have performed well versus the S&P into the first Fed cut, they've also performed well in the three months after the first cut. And it's interesting that while mortgage rates have fallen significantly in the last year, we haven't seen much of an uptick in demand yet, other than some signs of better traffic for builders in the last month or so. That could be because buyers are thinking rates will fall further. If so, that does suggest pen up demand is still likely coming. And those looking to invest in more than just the cycle can find secular winners in products like insulation to composites. Thanks for joining. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/rate-cuts-boost/Feniger-headshot-resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: august 19, 2024</div> <h4 class="tile__headline header--h4 header--blue "> Rate cuts to boost some construction segments with a lag </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>As AI adoption grows, construction spend could rise from growth in data centers. But macro factors like elections will play a factor.</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b></p> <p><b>Michael Feniger,</b> Machinery, Engineering and Construction & Waste Analyst</p> <p> <br/> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_6teu7lmg" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" 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description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_6teu7lmg/version/0","uploadDate":"2024-09-30T13:37:45-04:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_6teu7lmg/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_6teu7lmg/format/url/protocol/https","duration":"PT17M36S","transcript":"Construction Podcast T.J. Thornton, Head of Product Marketing: Hello and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research and we're recording this episode on Monday, August 19, 2024. We cannot understate enough how much of an impact reshoring is having on the construction market. When you analyze a construction market, it used to all just be one cycle and now you're seeing all these different verticals move in different directions. You're seeing winners and losers and one of the winners right now is the manufacturing area. That's the largest and fastest growing segment in the construction market. T.J. Thornton: Construction offers a useful look at the economy because there are areas of impressive strength like data centers, but also areas of weakness including multifamily or apartment construction. And then there are verticals including semiconductor fabs, which have been boosted by government incentives. That all begs a few questions, including where we are in the construction cycle and whether elections and policy are an upside or downside risk? Also, how much benefit we might get from Fed cuts. Joining us today is Mike Feniger, who covers Machinery, Engineering and Construction and Waste for BofA Global Research. Thanks Mike for joining us today. Michael Feniger, Machinery, Engineering and Construction & Waste Analyst: Thanks for having me. T.J. Thornton: There's been some debate about just how much impact higher rates have on the economy. There are some offsets, including the fact that people get income from these higher rates that they're savers, and then also a lot of people have fixed mortgages. But thinking about construction specifically, have certain areas been impacted by the big increase in rates that we've seen and by how much? Michael Feniger: Yes, T.J. Construction is at the epicenter of the tailwinds and headwinds facing the industrial economy. If we look at construction spending, exclude housing, it's roughly $1-$1.2 billion of spending annually for the non-residential construction market, it's near a record level spending. Yet when you look underneath the surface you see that some markets and areas are under significant pressure. Construction's not immune to higher rates and slowing economy. Projects breaking ground in warehouses, private office hospitality are all down this year. A weakness is building through 2024. Lodging hospitality down 11% year over year, commercial is down 14%, retail shopping starts are down 18%, warehouses are down double digits. When you look at lead indicators such as the architecture billings index, it remains depressed. These verticals that are very rate sensitive have remained under pressure until visibility on the Fed easing cycle merges. Even with construction spending hovering near record highs, underneath the surface, you're definitely seeing a slowdown with higher rates and the economy really pulling back project starts in some of these rate sensitive areas. T.J. Thornton: Got it. And of course, you also mentioned that construction spending is around all-time highs. Has all that weakness just been offset by things like IRA (Inflation Reduction Act), other federal and local spend that may be bolstering other parts of construction? Michael Feniger: T.J., so far the answer's yes. It's been pretty remarkable. So, if we take a step back, typically when rates are high and the economy slowing, construction spending fall 6-12% in a downturn. The fact that spending still hovering at these levels tells you that these three hallmark legislative acts, the CHIPS (Creating Helpful Incentives to Produce Semiconductors) Act, IRA, Infrastructure are plugging in the hole. Let's just take IIJA (Infrastructure Investment and Jobs Act), better known as the Infrastructure Stimulus Act, 40% of construction is publicly funded. That 40% is observing strong growth right now because of the stimulus measure. That's stimulus alone is adding $550 billion a year of new funding into the system, this is definitely helping offset that rate pressure. Just to put some numbers around that, T.J., public construction spending is up 7% year over year right now compared to those rate sensitive construction markets like offices, commercial real estate, retail shopping warehouses, which are all down 5%-10%. That's why you're still seeing construction spending hovering at these levels. T.J. Thornton: Mike, can you talk a little bit more about reshoring? We hear about the IRA. You talked about the CHIPS Act and how manufacturing is coming back to the U.S. To what extent is that showing up in the construction data? Michael Feniger: Yes, T.J., we cannot understate enough how much of an impact reshoring is having on the construction market. When you analyze a construction market, it used to all just be one cycle and now you're seeing all these different verticals move in different directions. You're seeing winners and losers and one of the winners right now is the manufacturing area. That's the largest and fastest growing segment in the construction market. Manufacturing sector comprises of 30% of private non-res construction spending, that was just 15% in 2020. Construction spending in the manufacturing sector has increased 19% year over year on top of a 50% growth rate in 2023 and another 50% growth rate in 2022. And the reason why it's so strong right now is because of this reshoring theme you're seeing. You're seeing an unprecedented level of spending and projects breaking ground. If you look at other manufacturing indexes like the ISM (Institute for Supply Management), it's been in contraction territory for a year and a half. To see this level of construction spending growth right now in the manufacturing space is telling you that something special is happening right now in the U.S. in terms of reshoring a lot of these facilities. It's the semiconductor plants, it's the EV (electric vehicle) battery plants. That's why you're seeing in the construction spending data, the manufacturing being the fastest and strongest growth vertical that we're seeing today. T.J. Thornton: Mike, you write a lot about mega projects and the importance for construction. Could you give us some examples of these projects and what exactly constitutes a mega project? What's happening with those projects at the moment and are we at peak levels or is there more to go? Michael Feniger: Yeah, T.J., great question. There's a seismic shift going on right now in the construction market. The big are just getting bigger, a mega project is a project that breaks ground that is of $1 billion or more of value. When we speak to contractors, T.J., they used to have one mega project in their backlog, now they have several. It's creating a bigger elongated cycle right now because of how big these projects are and they could take three to four, five years to complete. In 2023 we saw 39 mega projects break ground. That's a record number that compares to 12 mega projects breaking ground in 2020. What is interesting is the type of mega project that's breaking ground. We're seeing a broadening out. Two years ago, it was really just focused on semiconductors and EV battery plants, we're now seeing mega projects for LNG facilities, infrastructure, stadiums and data centers. We track this work at the data center category is where we're seeing the most momentum right now. We are starting to see the overall number of mega projects breaking ground, starting to slow a bit in 2024. It could be because of higher rates, it could because of election timing coming up. It's just a cadence right now. It's still at a decent pace, but the number of projects breaking ground has slowed a bit. That's something we're going to have to monitor as we get to November and maybe past that to see if the momentum will continue. But what is clear is that you're seeing the amount of projects are starting to shift into different categories and data centers is one that has seen the most momentum. T.J. Thornton: Got it. And another big topic in construction of course is data centers. How big of a market could this be with the hyperscalers continuing to ramp up capex? Michael Feniger: Yes, it's a big talking point right now, and some context is required when you think of it in terms of construction. The annualized capex for big tech has increased from $138 billion to $229 billion year over year. That's an incremental of $91 billion in run rate spending. We think that's probably a good proxy around new AI data center construction. That's still an enormous investment, something we haven't seen before. How is that playing out in the private non-res construction space? It's essentially offsetting the decline you're seeing in private office construction. We all see the headlines; we all know about the overcapacity in private construction space. The fact that data center construction right now is offsetting it is showing you how the small market is becoming bigger and bigger. We estimate data centers is probably 5%-10% of private non-res construction, it's clearly not at the scale of the manufacturing space and sector, and it's still not as big as maybe some of the other rate sensitive areas. But the growth and the speed of that growth is helping offset some of those categories. And to be clear, these projects aren't as equipment intensive as a big semiconductor plant, an LNG or EV battery plant, but you're hearing more and more about contractors on the west coast, in the south in Texas, having to actually turn away work right now because they're so busy with the backlog in terms of servicing this data center demand. T.J. Thornton: Okay. I wanted to talk about Fed cuts of course. Now that they are a near certainty, the market has been willing to look through weakness in some companies and parts of the economy, as the market looks forward to rate cuts and the impact that those will have. How do you think about construction in this backdrop of what will be lower rates? Especially since parts of construction have held up pretty well, despite rates being as high as they are and maybe they're less responsive to lower Fed rates? Michael Feniger: Yeah, this is definitely the biggest point of discussion right now with investors and industry observers. A Fed easing cycle is clearly a good thing for the construction space. It helps lower the cost of capital and greenlight projects or perhaps on the sideline. And we have been hearing more and more projects have been pushed to the sideline this year. It does take time to filter through to the non-res portion of construction market. You typically see easing first show up in housing. Housing, residential construction leads non-residential construction by one to two years, so there is this lag. As you can imagine, you build a home, a new residential district, then you have to add commercial enterprises, stores, a dentist office, coffee shops, lodging to support that area, so you always have this one to two year lag. What will be interesting this time around is if that lag is narrowed, 'cause we do not have a lot of overcapacity, maybe outside private office construction, and the economy is not in as bad of a shape as you typically get when the Fed starts cutting. We think you will see gradually more projects come back off the sidelines, and I think you're going to see more growth in the areas that are already doing well right now, when the Fed eases rather than maybe see a revival in the private office construction space. T.J. Thornton: Quick follow up there. Even on things like mega projects you think they could benefit from lower rates even though there are other drivers behind, what's going on there? Michael Feniger: Yes, T.J., I think that's probably what we're going to see. I think right now the biggest impact from the higher rates is hitting the local markets, the smaller projects, the rate sensitive areas. Once you get past the election, once you actually get more clarity around a Fed easing cycle, the trajectory there, visibility there, you will see some of these bigger projects come back. And again, I think you're going to start to see, T.J., the broadening out. Not just in the semiconductor space, not just an EV battery, but broadening out into other areas like stadiums, larger infrastructure project, renewable projects that are getting bigger and more complex because of the grid. We're starting to see signs of that happening, yet it feels like it might have been put on ice the last few months. I think that is probably the area that you'll see come back, maybe instead of seeing retail shopping come back or private office construction. T.J. Thornton: Okay. And as you think about Fed cuts once again, are there particular parts of your coverage that you think are really poised to benefit from these lower rates? Michael Feniger: Yeah, T.J., I think what I would highlight is the rental equipment sector. I think it's very interesting, especially as we're having a discussion in this conversation about mega projects and the bigger are getting bigger and scale matters. When you look at these rental equipment names and the space, they have large fleets, but most importantly, T.J., they have diverse fleets. They have telehandlers, scissor lifts, dozers, all construction equipment, products that you would think about at a site, but now they also have light towers, backup power generators, installation equipment to really help service these projects. Because these projects are getting bigger and more complex, a lot of contractors need someone to be there with them holding their hand, making sure that they can get the equipment on time and service appropriately. I think you're starting to see the rental equipment sector really benefit from these bigger projects that need more scale. These companies are also uniquely positioned because if commercial construction, let's say in New York City is struggling, they can move some of that excess fleet and equipment and bring it to sites in Arizona, in the Southeast, to service a larger infrastructure project or a larger manufacturing plan. T.J. Thornton: Got it. And right to that point, LaGuardia was under construction for what, 25 years and that said, it's finally done. That may be reason alone for a slowdown in New York. I did want to talk about ag (agriculture). You've been right to prefer construction equipment to agricultural equipment. Ag commodity prices rallied when Russia invaded Ukraine, but it's been a really tough stretch since then. And ag equipment names have been range bound at best, while a lot of your other construction oriented names have actually acted really well. Looks like this is going to be another year of record corn yields in the U.S. Production is near record levels. What do we need to get that ag cycle to turn? Michael Feniger: Yeah, that's a great question. I think it's going to come down to the commodity market. When you look at the ag equipment space, there are some positive long-term qualities there. You have an ag tech angle, where you see farmers embracing more and more technology on the equipment. It is consolidated. There's only really three, four players in the space. They're very disciplined, good balance sheets, but the cycle’s just really challenging right now for the ag equipment names. Because as we were discussing, lower rates can really move the needle in terms of bringing projects off the sidelines. Rates are only one part of the issue that farmers are citing right now. Farmers are struggling with breakeven levels at sub $4 a bushel corn right now. They're struggling to stay profitable. What you're seeing is them saying, when they look at their own balance sheets and their own capital spending, what are some purchases that they can defer? And we saw a huge spending spree after the Ukraine/Russia, after COVID, where everyone really replaced equipment, got the age of their equipment down, bought newer equipment that had better technology, where we think right now they're willing to take a year or two off those purchasing schedules because of right now just really managing their P&L (profit and loss) and their cash flow. So, I think what we're going to have to see is, as we go through the election year, are we going to see any differences in the supply demand equation when it comes to some of these grain markets? And right now, to your point, it's right now a little bit tilted to the oversupply, which means right now farmers are looking at their balance sheet, they're looking at their P&L and saying, what are some areas that I don't have a gun to my head where I have to make purchases right this second. And I think that's where farm equipment, which is more a discretionary purchase, is continuing to get pushed out each year. T.J. Thornton: Okay. Mike, thanks for your insights. Really appreciate your time today. Michael Feniger: Of course. Thanks for having me guys. T.J. Thornton: This cycle seems a bit different than usual. The Fed is likely to be cutting at a time when growth is okay, and from a construction perspective, we didn't see much overbuilding going into the Fed cuts. So as far as Mike is concerned, some of the areas that had been strong can hold up and areas that had been weak, from warehouses to multifamily to retail, could respond positively to lower rates. That said, housing usually leads commercial construction by 1-2 years, as the Fed cuts. There are reasons to believe the lag could be a bit shorter this time, and scale is another theme Mike discussed. Larger construction and equipment rental companies benefit from the shift toward mega projects and these companies can pivot to different regions or verticals as demand shifts. Thanks for joining today. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/normalizing-consumption-keeping-inflation-civil/Bhave_headshot_resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: august 14, 2024</div> <h4 class="tile__headline header--h4 header--blue "> Normalizing consumption keeping inflation civil </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>July payroll data led to some concern in markets but data including U.S. consumer spending suggests merely a normalization</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b><br/> <b>Aditya Bhave,</b> Senior U.S. Economist</p> <p> <br/> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_7ehb1ap7" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" 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description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_7ehb1ap7/version/0","uploadDate":"2024-09-16T11:03:45-04:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_7ehb1ap7/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_7ehb1ap7/format/url/protocol/https","duration":"PT19M22S","transcript":"Economics of Consumption Podcast T.J. Thornton, Head of Product Marketing: Hello and welcome to Global Research Unlocked, where we discuss what's rising from growth industries, rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research, and we're recording this episode on Wednesday, August 14, 2024. The labor market is going to be the key driver of consumer spending. The reason that spending has held up so well, defying expectations that the consumer was going to get crushed by inflation, is the amount of income growth that has been generated. Wage inflation on average has outpaced price inflation and it's done so across the income distribution and that's obviously been very, very helpful. T.J. Thornton: In the last few months, investors have become increasingly convinced that the U.S. economy is finally slowing. July payroll data led to some concern that the slowdown might be even sharper than expected. The U.S. Economics team at BofA looks at many data points including BAC (Bank of America) card data, which they get weekly for contemporaneous look at the U.S. consumer. Today we're going to talk to Senior U.S. Economist Aditya Bhave about what this data tells us about the health of the U.S. consumer. We'll also discuss other economic realities that impact spending like the savings buffer. And although our economics team isn't expecting a recession, they certainly do expect rate cuts, and we'll talk about how soon these rate cuts may start to impact the economy. Thanks Aditya for joining us today. Aditya Bhave, Senior U.S. Economist: Thanks T.J. Thank you for having me. T.J. Thornton: Aditya, you published the monthly BofA on U.S.A. earlier this week with the full July data, has the BofA card data over the last few months shown evidence of an incremental consumer slowdown? Aditya Bhave: I think you're right that the economy is slowing down, but the way we see it is more of a return to trend, like economic activity after a pace of activity that simply wasn't sustainable. If you look back to the second half of last year, we grew at 4%. We're not an economy that grows at 4%, so we're back to, in the first half of this year, a little more than 2% GDP (Gross Domestic Product) growth. That's healthy. That's where we were in the first half of '23 as well. And the consumer is also performing along those lines, and that's what we're seeing in the card data. It isn't super strong, it isn't super weak, it's just very trend like. And we think that basically continues through July as well. T.J. Thornton: Okay. Card spending, according to that data series, is flat to down on a year on year basis over the last few months, which, considering that prices are still rising, according to the PCE (Personal Consumption Expenditures) and CPI (Consumer Price Index) at least that seems pretty weak. Could you talk about how you think about that data and whether that's an accurate look at what's going on with the consumer? Aditya Bhave: There's a few things to keep in mind there. The first one is that the card spending data are measured on a per household basis, whereas the aggregate data that's reported officially is obviously not. That's going to also account for growth in the number of households in the U.S. economy. On average, that adds about a percentage point or so per year, relative to the card data, so that's the first source of discrepancy between the card data and then what you know we’re all spending, which is a little bit stronger. The other thing to keep track of, which is very relevant for your question around inflation, is which components do we actually see in the card data? We don't see a lot of the bigger ticket services components in the card data. For example, most folks don't pay their rent via credit cards, right? We don't see medical spending in our card data, and then on the good side also, we don't see autos, but really a lot of the services, the big ticket services don't show up in our card data. What we see is goods ex autos, that's what we probably get the best read on retail spending ex autos. And most of those components are in outright deflation. The difference between nominal and real spending growth rates is going to be quite small. And in fact, there's going to be periods where the difference is actually negative in the sense that inflation adjusted spending is actually higher than nominal spending. T.J. Thornton: I did want to talk a little bit more about services. As you point out, some parts of services like rents, healthcare are not in our data, but I know we do have some parts of services that are in there like air travel and people buying plane tickets or spending money at restaurants. For a while, good sales have been weak because of all the COVID forward and because there's been disinflation or deflation. Spending has shifted to services, but now there's increasing concern that services are slowing. What are you seeing on that front? Are you seeing evidence to suggest that in fact there has been a slowdown there? Aditya Bhave: Let's just step back and think about what's happened over the last few years. 2021 and '22, the story was definitely the services recovery after the initial pandemic shock. Discretionary services obviously were the fastest growing part of consumer spending off of a very weak base from 2020. Then you get to 2023, you get this big stimulus to start the year in the form of the social security cost of living adjustment. The COLA (Cost of Living Adjustment), which was almost 9%, and retail spending just shoots off higher at the start of the year. A lot of that was actually in durables for a couple reasons. One, that's what people tend to spend on when they have cash lying around, a sudden injection of liquidity that was unexpected. And then two, 2023 was around when goods inflation really cooled off. Folks were getting used to these large increases in goods prices and then suddenly prices started to fall. And maybe there were some people saying, look, this is our chance, right? Prices will start going up again, so let's get in and buy some durables while we have the cash. Durables were actually the strongest performing component of consumer spending in 2023, which is somewhat counterintuitive. This year, it's been more balanced, especially in the second quarter. The most recent quarter of data, if you look across durable goods, non-durable goods services, everything was quite solid in terms of the components of services. Yes, it is true that some of those have been softening up a little bit. Food services, for example, the last couple of quarters haven't been great. Other discretionary components such as travel. Travel is an interesting one because the TSA basically tells us in real-time how many people are going through airport terminals. And what we're learning from that is at the start of the year, we were up 8%, sometimes even more than 8% year over year relative to 2023, which had already caught up with 2019 levels. Now, we're running more like four or 5% above last year's levels. On a sequential basis, things seem to have slowed down a little bit. It could be that the spent up demand for discretionary services has cooled off a little bit, but again, is that normalization or is that because of a cyclical downturn? When we look at the retail sector, it looks for now, barring potential revisions in the data or soft data going forward, it looks for now that retail spending is actually held up quite well. There were concerns about retail sales earlier this year, and then if you look at May and June, you actually had pretty solid retail sales prints. For now, it looks like normalization rather than an outright slowdown. T.J. Thornton: Okay. And Aditya, you've been keeping an eye on savings rates. We had huge excess savings during the pandemic, which has subsequently gotten worked down, but where are we now in terms of that excess savings? And looking at consumption data, do you think that the smaller savings buffer has started to impact spending? Did spending get impacted when that buffer got worked out? Aditya Bhave: We've made the argument that these measures of excess savings are not particularly useful in terms of thinking about the consumer outlook just because they are so discrepant. I've seen our back of the envelope calculation is that there's around $400 billion of excess savings that could last through the end of the year, roughly. I've seen estimates much larger than that and also estimates much smaller than that are deeply negative. Now, if you just eyeball the performance of consumer spending over the last few months, that's not consistent with deeply negative excess savings. I would just say the range is too large, and we don't know what excess savings really means in excess of what. Should the saving rate be the same as it was before the pandemic when we've added probably $40 trillion plus of net worth since the start of the pandemic? Or is it the case, which we think is more plausible, that consumers save less on a flow basis when they are more asset rich? And by the way, this is true across the income spectrum. There's some slices of the population that don't have excess savings. For example, if you look at data from our partners at the Bank of America Institute, they have measures of checking and savings balances relative to before the pandemic, and all of those are up significantly across the income distribution and much more than what would be accounted for just by inflation. I would say basically balance sheets look good, and I would not view balance sheets as necessarily the most important headwind to the consumer going forward. T.J. Thornton: Got it. And that's an interesting segue then to this next question 'cause right, if you think about how people are much more asset rich, how do you tap into those assets? You could sell, you could borrow against your home, rates have been really high, but they are falling. So, the market expects the Fed to cut rates at the next meeting that's already impacted equity market sentiment. But when do those cuts start to impact the real economy in your view? And are lower income consumers, 'cause we know or we believe that they're under more pressure, partly because of higher rates, do they benefit more from these cuts? Aditya Bhave: That's a really interesting question because the concern, on the way up, was that the Fed's hiking rates and it's not affecting the economy. Could we have the reverse of that on the way down? I would say yes and no. To the extent that there are some sectors that still haven't been impacted as much as you would expect by Fed hikes, those sectors are not going to benefit as much as you would otherwise expect on the way down. Housing is a great example of this. Before the Fed started hiking rates, you had 13 years or so of close to zero rates, two big waves of refinancing when the fed cut to zero around 2010 and 2021. Basically, everyone was locked into a very low fixed rate, 30 year mortgage. Then the Fed hikes and the effective mortgage rate, the average across what people pay in the population has only gone up about 50 basis points or so, even though the actual mortgage rate that you see in markets is obviously up several percentage points. Even if the Fed starts cutting now, housing isn’t going to benefit that much. But then there’s other sectors that initially weren’t impacted by Fed hikes for a variety of reasons. Maybe it was all of the fiscal stimulus that was done during the pandemic, PPP (Paycheck Protection Program), whatever the case may be. And then recently they might have started feeling the pain from Fed hikes. To the extent that they have started feeling the pain from Fed hikes, they would also benefit from Fed cuts. In terms of lower income consumers, they could benefit more than higher income consumers just because they tend to have a smaller saving buffer, even setting aside what the idiosyncratic stuff that's happened in the last few years around excess savings. Typically, lower income consumers have a smaller saving buffer and more of their liabilities are tied up into credit card debt, which if you are delinquent, becomes a floating rate debt. Whereas mortgages are obviously locked in. So, if you look at overall consumer debt, 70% of it is mortgages, and then you also have auto loans, a lot of stuff that's just locked in low fixed rates. But then if you focus on lower income consumers, that 6% of the total, that's credit card debt, is going to show up as a much larger percentage in liabilities of lower income consumers. Yes, they probably will benefit more from rate cuts in that sense. T.J. Thornton: Okay, got it. And I wanted to follow up on the rate sensitivity question. In theory, if you think about corporate capex, if you think about commercial real estate projects, all that would seem to be pretty rate sensitive. Because you've got a hurdle rate for a project, and if rates are high, that hurdle rate's going to be that much higher and maybe you won't embark on it. But there are other considerations too, your view on the health of the economy. Is there a lot of capex and sort of commercial development that could be unleashed if we get a rate cutting cycle that lasts 12 to 18 months? Aditya Bhave: It's going to depend on why the Fed is cutting rates. Usually, demand is a bigger driver of investment than interest rates, so a super strong economy with high policy rates should see stronger investment growth than an economy that's in recession and the Fed is at zero. If the Fed is cutting because the economy's going into recession, which to be clear is not our base case, but if that's the reason that the Fed is cutting, then it's probably not, you're not going to see a big increase in investment because the hurdle rate, like you said, will go down. But demand, like you also said, will be quite soft. It's going to depend a lot on why the Fed is cutting. If the Fed is cutting to get back to neutral and we're able to avoid a recession and we end up with the soft landing that's in our forecasts, then yes, rate cuts could stimulate investment. There too, I would just add a caveat that there's some crosswinds from fiscal policy. You had this huge increase in structures investment last year, manufacturing structures, because of the CHIPS (Creating Helpful Incentives to Produce Semiconductors) Act and the IRA (Inflation Reduction Act), in fact, that component of GDP structures investment, it's small, but it doubled. It went from just south of $100 billion to almost $200 billion. That acceleration obviously can't last. The incentives are still in place, maybe structures investment can remain at these elevated levels, but it can't keep growing. And because it was growing at a pace that had absolutely nothing to do with the policy rate, so the stimulus from rate cuts isn't really going to help. T.J. Thornton: Okay. And I did want to ask one more question. We've been focused on the last few questions about the next cycle when we think about Fed cuts, but what about this cycle? What would you need to see to change your soft landing view? Which economic metrics are you watching most closely? Aditya Bhave: I would say first and foremost it's the labor market. The labor market is going to be the key driver of consumer spending. The reason that spending has held up so well, defying expectations that the consumer was going to get crushed by inflation, is the amount of income growth that has been generated. Wage inflation on average has outpaced price inflation and it's done so across the income distribution and that's obviously been very helpful. As long as we keep generating income growth, especially with inflation now cooling off, you're seeing real income accelerate. As long as that continues, we're probably in good shape. But if the labor market were to roll over, if this recent print of 114,000 in job growth was not just an aberration, if we go from 200 to a 100 in a couple months and then we quickly go down to zero and then maybe negative payrolls, then the outlook changes significantly, and then we become much more concerned about the economy. So, beyond our non-farm payrolls, I would also look at jobless claims that comes out every week. So, it's very timely. I would focus on that and then also the unemployment rate. We do think that the household survey is generally not as reliable as the establishment survey, but if the unemployment rate keeps ticking up and the increase to 4.3% wasn't a one-off that gets paid back soon, then we would start to get more concerned. T.J. Thornton: Thank you very much for an excellent discussion. Aditya Bhave: And thanks for having me. T.J. Thornton: A few times in this podcast, Aditya used the words 'trend' and 'normalization'. Yes, things have slowed, but some of that is inevitable, even desirable as things have been too strong. Of course, this normalization also helps the disinflation story. The team is watching labor markets closely for signs of bigger slowdown, but so far the data suggests an easing not a cliff, particularly since the July data was impacted by a hurricane. And in terms of Fed cuts, they'll be helpful, but they'll be unlikely to unleash a torrent of mortgage refinancing since so many were refinanced back when rates were close to zero. Commercial development and capex could be helped too. But those things are also highly dependent on confidence in the economy and aspects of capex have been boosted already by policy and other measures. Thanks for joining. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/the-ai-evolution-could-become-a-revolution/Shah_headshot_resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: august 12, 2024</div> <h4 class="tile__headline header--h4 header--blue "> The AI evolution could become a revolution </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>We're in the early earnings of the "AI revolution" and the list of beneficiaries should broaden. AI should drive S&P margin improvement.</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b><br/> <b>Alkesh Shah,</b> Head of U.S. Software Equity Research</p> <p> <br/> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_5c73osa2" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" 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closeTranscriptText="Close Transcript" closeDisclaimerText="Close Disclaimer" disclaimerTitle="Disclaimer" transcriptTitle="Transcript" carouselNextArrowText="Go to Next Item" carouselPreviousArrowText="Return to Previous Item" carouselDotsLabel="of" playlistItemLabel="Item {0} of {1} Play {2} video" validCloseCaptions="false" data-video-id="1_5c73osa2_The AI evolution"> <div id="1_5c73osa2" class="uc-media__player"> </div> <div class="uc-media-transcript" aria-hidden="true" aria-expanded="false"> <div class="uc-media-transcript__header"> <button aria-label="Close Transcript" class="uc-media-transcript__close uc-media-icon-close" tabindex="-1" title="Close Transcript"></button> </div> <div class="uc-media-transcript__container" tabindex="-1"> <h3 class="uc-media-transcript__title">Transcript</h3> <div class="uc-media-transcript__text"></div> </div> </div> <script type="application/ld+json">{"@type":"AudioObject","name":"The AI evolution","description":"No description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_5c73osa2/version/0","uploadDate":"2024-09-12T15:09:48-04:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_5c73osa2/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_5c73osa2/format/url/protocol/https","duration":"PT15M47S","transcript":"AI Survey & Addressing AI Headwinds Podcast T.J. Thornton, Head of Product Marketing: Hello and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research and we're recording this episode on Monday, August 12, 2024. Spending on AI infrastructure could be above a trillion dollars over the next few years, and we're very early in application development and launches. Initial winners will be the picks and shovels, but that's going to broaden from just semis to tech hardware and software. T.J. Thornton: It's clear that certain semiconductor companies are enjoying the fruits of billions of dollars invested in AI infrastructure. But what about other groups of companies that touch the technology from software to those that can harness the tech to drive efficiencies? When do they see benefits and what's the magnitude? Also, with the volatility in so many of the stocks that touch AI, are there real concerns or is the market just recalibrating multiples and growth rates? Joining us today to discuss all of this fresh off an AI related survey of 130 BofA Global Research analysts is Alkesh Shah, Head of U.S. Software Equity Research. Thanks, Alkesh for joining us today. Alkesh Shah, Head of U.S. Software Research: Thanks for having me on T.J. T.J. Thornton: Alkesh, first question. There is still confusion about what is AI and what is GenAI and why all the excitement now? Can you provide some perspective? Alkesh Shah: Sure. Over the last 10 years we've had major advances in computing power, major declines in the cost of storing data, and companies are storing more data than they ever have in the past, to the extent that over 90% of data stored by companies has never been used. This is a perfect combination for the use of AI software and that's one of the reasons why we're seeing adoption accelerate. Here's how we frame this major AI tech cycle. The first major tech disruption of the last 50 years was the launch of microprocessors in the 70s. That's what enabled people to have PCs. PCs democratized access to computing power. PCs weren't the first computers, up to that time computing power was in mainframes and only a few people could actually work with those computers. But the PC democratized access, so everybody had computing power. The second major wave was when web browsers launched in the 90s, enabling access to the Internet, that democratized access to information, meaning the Internet, and lowered the cost of distribution sales. Up to that time, the Internet was hard to use even though it started in the 60s as ARPANET (Advanced Research Projects Agency Network) because you needed to know a bunch of non-intuitive commands and that really kept it only for use by government and university users. The third major wave that we're living through right now is GenAI. GenAI enables access to the AI algorithms that have been developed over the last 80 years and that democratized access to powerful computer intelligence that was previously only available to data scientists and quants. A few years ago, AI capabilities were at the level of a preschooler. They've now reached the level of a college grad and within a few years they will likely reach the level of a PhD or what we call a polymath and everyone can have one or many of these experts in their pocket. That's why AI is the biggest theme in tech, and generative AI, GenAI represents the third major tech cycle of the past 50 years and we're only in 1996 relative to the Internet for this build out. T.J. Thornton: At the top, I mentioned a survey that you just conducted. Can you tell us a little bit about that survey and what the takeaways were? Alkesh Shah: We have a global research department with really experienced and knowledgeable industry analysts and macro strategists. We surveyed these 130 fundamental analysts and 27 macro strategists to get their perspective on the financial and economic impact of AI across the 3,400 companies they cover that have a combined market cap of over $90 trillion. Here are three takeaways. First, is our analysts expect real impact. They expect about 200 basis points of offering margin improvement for the S&P over the next five years. What that means is $55 billion of annual savings. Now that's a little less savings than we thought last year when we did this survey, but our analysts now have higher conviction than they did a year ago because they're seeing what the companies are actually doing, what the pilots are really showing, and an average large company is doing 25 to 200 AI pilots with the goal of finding 5-10 use cases with real ROI (Return on Investment) to deploy widely starting next year. The second takeaway we saw is our strategists are evenly split on the long-term implications for jobs. Some are expecting job displacement, as consensus expects, but others are actually expecting job creation. Remember, 60% of U.S. jobs today didn't exist in 1940. And then the third takeaway, this is again from our macro strategists, that AI is likely to be long-term deflationary. And you can imagine that if robots are working in factories and professional services are being done with virtual AI, costs are going to come down. Now that's likely non-consensus. We also asked our analysts and strategists about winners and benefits should broaden to other semis, then the hyperscalers and cloud companies. In the second phase, the rest of tech: software, hardware and networking are the beneficiaries. And then finally in the third phase, when you actually see these AI pilots translate into deployments, you'll probably see a shift from picks and shovels to sectors such as consumer media and entertainment, financials and healthcare. Our analysts are most cautious though on the impact for commercial services because of virtual AI potentially causing much more disruption there. T.J. Thornton: A pushback that we often hear is why hasn't all this investment in new AI products resulted in incremental revenue for software companies? What's happening with enterprise adoption? Alkesh Shah: Let's take a step back. AI has been evolving for about 80 years and most companies are using some form of AI already, machine learning or natural language processing, and we expect that most companies will keep investing there. But the only people actually using the AI, that most companies have, are data scientists, quant people and programmers. What's new is that the GenAI that now is being used is an architecture that was described in 2017 that lets you run lots of semis in parallel, and you can create software that you can talk to with those parallel running semis and ask it to do things without being a data scientist or a programmer. The first real application ChatGPT only launched in 2022, less than two years ago, and enterprise applications are less than a year old, so really version 1.0. But despite the software being so immature, the productivity gains are fairly obvious to companies that are doing these pilots. And as I mentioned, an average large company is doing 25 to 200 pilots this year, and they're asking the team managers to quantify the savings. That's taking time, especially since the software is still getting better and the data that the companies are using still needs to be cleaned up, so they can trust the results. We expect that out of the 25 to 200 pilots companies are testing this year, 3-5 or 5-10 at each company will actually have quantifiable results and could see significant investment in 2025. And that's when we'll start seeing that incremental revenue for many of the new products that have and are launching. T.J. Thornton: Hyperscalers have almost unlimited ability to spend on AI and so far they've mostly been rewarded by the market for the spending. Based on what you know about how companies will use AI, could these hyperscalers actually be overspending on infrastructure now? Alkesh Shah: Usually when I get that question, it's also with respect to parallels with the Internet, so I definitely have a perspective as I covered tech in the 90s. How today's investment is similar to the Internet in the 90s is telecom companies invested billions of dollars into making the Internet faster and more accessible, but they had no real strategy on how they would get a return on that investment. And investors are asking, with today's GenAI investment of over $100 billion already and only $5-$10 billion of return, is this the same scenario? And our view is, it's not the same scenario. During the Internet, telecom companies were investing money they raised by selling botins and taking on a lot of debt. At the same time, regulators weren't allowing these telecom companies to charge extra for all the investment they were making, so they couldn't get a real return. What's happening now with GenAI is very different. Cloud or hyperscaler companies are likely to spend up to a trillion dollars over the next few years for large foundation models that will be the base for revenue generating applications. These companies are investing out of profits and are not constrained by regulators for how much they can charge. And they're already seeing demand far exceed the capacity they have today, even after spending over $100 billion. T.J. Thornton: Aside from concerns that stocks might price in just too much optimism on AI, what's the main pushback you hear from investors when it comes to buying into the AI enablers? Alkesh Shah: We’re really back to how tech cycles work here, you have to build infrastructure before you can get applications. And since it's hard to tell which new companies win, investors tend to buy the picks and shovels and that's what's happening now. The AI enablers or picks and shovels of today are semiconductor and Cloud are hyperscaler companies and business is pretty good for them. This brings us back to our view that we're only in 1996 relative to the Internet, there's a lot more build out to come. It won't necessarily be a straight line, but there's clear demand and there's clear ways for these guys to make money and it's clear that this cycle actually increases productivity. The way to think about it is there will probably be about 10-20 of these massive models like ChatGPT globally, but there will be tens or hundreds of thousands of little models that companies will use for proprietary data and to maintain client privacy. And we haven't even started building these small or specialized models yet, that's happening over the next few years, so the AI enablers still should have good demand over the near and intermediate term. T.J. Thornton: And Alkesh, just as a quick aside on that point, do you think those models will be run on company's own infrastructure or will they be run in the Cloud or will it be a combination of the two? Alkesh Shah: It'll probably be a combination of the two. There are companies that are going to want to keep all of the code available to themselves and also all of the data available to themselves. And so, they're going to probably want to build their own small language models and specialized models. Whereas there'll be other companies that actually may not have as strong proprietary data or privacy concerns, and you're already seeing some of the Cloud companies, as well as other very large tech companies offering access to small models that these companies can use and those small models are just beginning to be built today. T.J. Thornton: Alkesh, in the past you've talked about AI Native companies. What are those companies and what's happening there? Alkesh Shah: These are the dotcoms of this cycle, private companies that have launched or pivoted in the last couple of years and are GenAI at their core. These are companies creating solutions that you couldn't do today. They're not just cheaper, but by using virtual intelligence, they're creating applications like a tutor in your pocket or a movie production company in a box, or virtual nurses. They're 90% cheaper and are likely to transform every industry. We're tracking hundreds of these companies across every industry with really interesting ones in healthcare where we have shortages of medical personnel and also legal applications. These AI Native companies are also rewriting the rules of company building. They're building companies with a lot less people but making a lot more profit. These companies are especially focused on going after the $12 trillion professional services market, and that gives them a massive market to attack. However, it's not going to be great for all of them since many are not differentiating. To be successful, these new companies have to capture users with a product that is right for the market, but then they actually have to find a way for users to pay for the product and then they finally have to keep those users. Cool technology won't be enough. They're going to actually have to build real businesses, but those real businesses will impact every sector around the world. T.J. Thornton: Getting back to software, how do you think about assessing the AI winners versus the AI losers? Some companies could be disintermediated by AI and others in the same sector could be real winners. What's your method? Alkesh Shah: Remember, AI and GenAI are also just software. For the public software companies, many launched quick me-too products that were interesting, but just version 1.0. Companies are playing with them and testing them out, but many of those products aren't ready for prime time yet, so it's still too early to figure out which of the public companies have the right products. We've created a framework to assess software companies and it really comes down to data. Does the software company have or manipulate important data such as sales data or employee data or email, which contains lots of data? If so, they're best positioned to succeed, especially as they offer 2.0 and 3.0 versions of their AI products. T.J. Thornton: All right, so Alkesh, what's your bottom line? Alkesh Shah: We're in the very early innings of a major disruptive tech cycle that we're calling \"AI revolution\", and GenAI is its catalyst. The GenAI revolution is putting PhD level intelligence in everyone's pocket. Spending on AI infrastructure could be above a trillion dollars over the next few years, and we're very early in application development and launches. Initial winners will be the picks and shovels, but that's going to broaden from just semis to tech hardware and software. And then ultimately every sector will be affected with a combination of job disruption but also creation. And there's likely to be a major deflationary trend as AI impacts the services industry, which is $12 trillion in the U.S. We expect companies to see the real benefits of AI in cost savings and revenue growth over the next two years. T.J. Thornton: Alkesh, thank you very much for joining. Alkesh Shah: Thanks for having me on, T.J. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/electricity-meets-towering-supply/Blanch_headshot_resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: july 30, 2024</div> <h4 class="tile__headline header--h4 header--blue "> Powerful demand for electricity meets towering supply </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>Power demand growth should remain compelling, supply dynamics mean that the case for power and commodity price gains is less clear.</p> <p> </p> <p> </p> <p> </p> <p><b>Featured Guest</b><br/> <b>Francisco Blanch,</b> Head of Global Commodity Cross Asset and Equity Derivatives Research</p> <p> <br/> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_txkc7pes" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" 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closeTranscriptText="Close Transcript" closeDisclaimerText="Close Disclaimer" disclaimerTitle="Disclaimer" transcriptTitle="Transcript" carouselNextArrowText="Go to Next Item" carouselPreviousArrowText="Return to Previous Item" carouselDotsLabel="of" playlistItemLabel="Item {0} of {1} Play {2} video" validCloseCaptions="false" data-video-id="1_txkc7pes_Powerful demand for electricity"> <div id="1_txkc7pes" class="uc-media__player"> </div> <div class="uc-media-transcript" aria-hidden="true" aria-expanded="false"> <div class="uc-media-transcript__header"> <button aria-label="Close Transcript" class="uc-media-transcript__close uc-media-icon-close" tabindex="-1" title="Close Transcript"></button> </div> <div class="uc-media-transcript__container" tabindex="-1"> <h3 class="uc-media-transcript__title">Transcript</h3> <div class="uc-media-transcript__text"></div> </div> </div> <script type="application/ld+json">{"@type":"AudioObject","name":"Powerful demand for electricity","description":"No description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_txkc7pes/version/0","uploadDate":"2024-08-26T14:08:23-04:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_txkc7pes/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_txkc7pes/format/url/protocol/https","duration":"PT21M47S","transcript":"Power Prices and Powergen Podcast T.J. Thornton, Head of Product Marketing: Hello, and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research, and we're recording this episode on Tuesday, July 30, 2024. This net effect of rising solar and wind generation is a shallower relationship between temperatures and natural gas usage in the power generation sector, particularly during the hot days that we've seen this year compared to last. There's a weakening relationship between natural gas and temperatures, as we see more of this renewal power coming through. T.J. Thornton: AI queries and model training, EV chargers, heat pumps, heat waves that have AC units running like never before, many believe that we've seen an inflection in electrical demand, and that we have years of growth ahead. But looking at the commodities, which would help to generate and transmit all this electricity, prices have been somewhat weak. That is true for uranium and copper, at least recently, and it's true for U.S. natural gas prices, which are at multi-year lows. The question is why? Are the prospects for demand growth less compelling than the narrative would suggest, or is there just too much supply, especially when you factor in growth in renewables? Today we're joined by Francisco Blanch, Head of Global Commodity Cross Asset and Equity Derivatives Research at BofA Global Research to address these questions. Thanks Francisco for joining us. Francisco Blanch, Head of Global Commodity Cross Asset and Equity Derivatives Research: Thank you for having me, T.J. It's a pleasure to be here with you. T.J. Thornton: Okay. So far this summer, we've seen at least two days where global temperatures were the warmest ever, and we continue to break records in terms of the number of power hungry AI queries that are processed. Yet as mentioned, natural gas prices are the lowest in years. European gas prices are way off highs, uranium is down. Power prices themselves have been weak. Why this apparent disconnect? Is demand not as strong as the bulls had hoped? Is it further out or is there just a surplus of supply? Francisco Blanch: It is an important question, and the way I would start by addressing it is obviously we had very, very high prices of power, very high prices of gas in both the U.S. and Europe, two years ago during the Russia/Ukraine invasion. And of course, the war is not over, but the demand-destruction that the war created and the big rotation that we've seen in global energy flows is here to stay. Now, different things have driven different markets, but for example, in the U.S., natural gas has struggled for nearly two years to cope with a storage surplus. We've had inventories at the end of October, exceeding 4 TcF (trillion cubic feet) early in the year. And again, this has been one of the factors that has really pushed prices lower and we now see, coming out of winter, storage levels at around 2 TcF into 2025. But that's been one factor. And if you think about the warm winter weather last year, coupled with this big surge in supply that was propelled by the high prices that we saw in '22 and '23, that's the reason we found that with such a very weak market. Also, remember, solar power generation has jumped to new highs this summer and is on track to add about four gigawatts higher year on year. And of course, the strength in solar generation during the summer months, which is when the sun's most intense from a radian perspective has lowered the call on thermal power in the U.S. but also in Europe. And the net effect of rising solar capacity and improved wind generation has also led to a shallower relationship between temperature levels, which you alluded to in your initial comments, and natural gas generation during those hotter days that you referred to. Now, as we look into 2025, we think solar capacity additions will remain very strong, and gas generation will fall next year as well in '25 as a result of it. There's the effects of substitution, there's effect of supply destruction, and in Europe, we've had a similar effect. We've had really a complete collapse in the use of natural gas in power generation. Production, unfortunately, because of the higher prices that we had for a few weeks in June jump back up and we need to bring it back in. That’s the story in the U.S., a rebalancing story around supply being too healthy and prices continuing to push producers to keep gas volumes in the ground. And then internationally, I think it's been much more about demand destruction, really. Europe's still short gas, and it's been much more of a demand-destruction story, which we've seen in the industrial sector, but also in the power generation sector. T.J. Thornton: As it regards this longer term demand driver of sort of AI and data centers, but also other areas of electrification like EVs and heat pumps. Do you buy that story? What is your work on supply and demand suggest as we look out a few years? Will demand outstrip supply because of all those factors that I just noted or will supply pick up just as it has over the last couple years? Francisco Blanch: I think the answer is, it depends, right? I think in the U.S. most likely the answer is yes, but some of the regions of the world may not see as much power demand growth. Even in the U.S., I think you're going to have to look for different segments of the U.S. economy that will see strong demand, others maybe not so much. Now remember, U.S. electricity consumption has been more or less flat for more than a decade with total demand rising just 2.9% over a 13 year period since 2010 through 2023. That's roughly growth of 0.2, 0.3% year on year. Now, power demand stalled partially because of sluggish economic activity in the early 2010s. But also remember, we have had enormous efficiency gains at the residential, commercial industrial levels, facilitated by innovations like LED lightning, more efficient appliances, better insulation and so on and so forth. Now, power demand is also affected by weather, which has been milder in recent years. If you look at particularly the last year, if you adjust for that weather effect, U.S. electricity demand has been very strong in 2023. And growth, we believe should continue into 2030, driven by this data center, but also, things like electric vehicles, energy transition, manufacturing, and other drivers. Now, let me just give you some numbers here to round this up. Total U.S. electricity demand averaged about 457 gigawatts in 2023, which is pretty phenomenal. And we are going to see that number going from 400 around, say, 460 gigawatts to around 520 gigawatts, so we're going to have an outright 80 gigawatts of demand. And the commercial sector is going to drive, I would say, more than half of this, and then data centers will be slightly under half. But of course, this data center demand, that you mentioned, has leapfrogged electric vehicles to become the most immediate and meaningful source of growth. And even though EV adoption has faced headwinds recently, we still think electrification will play a key role in the medium term with more than 110 gigawatts of incremental demand across passenger and commercial vehicles. Now, other sources of demand growth are going to be more obscure and more difficult to assess, but there is potential growth across batteries, across semiconductor plants, hydrogen electrolyzers, there's other elements of the green economy that will also take electricity. Now, having said all that, Europe has actually seen a contraction in power demand, and this year things are not looking any better. And then a lot of these data centers would like to have clean energy, but they also want to have base load energy. They want to be running 24 hours a day and they want to have carbon free electricity. That's a very hard combination because most truly green carbon free electricity is kinetic, meaning that it's just generated when the sun is shining or when the wind's blowing, that's ultimately a solution that some data centers are going after right now. T.J. Thornton: I wanted to talk about renewables. You mentioned before the growth that we're seeing in renewables this year; you expect that to continue next year. Later on, we're going to talk a little bit about politics and how that may play a role, but how much growth is ahead looking beyond '25 in renewables and is that enough to maybe take care of the increased demand that we're expecting? And if not, where do you expect the other sources of electricity come from? Francisco Blanch: When you look at renewable power generation, there's tremendous growth in wind and solar across both the U.S. and Europe, but even in Asia. And part of it has to do with the fact that the levelized cost of energy has come down a lot for this two sources of power. The U.S. is set to add a record amount of solar capacity this year, north of 30 gigawatts, which is already visible in the generation data, and then we'll keep adding into next year. We're looking at a pretty strong pace of additions. And in Europe, when you think about solar, the growth is twice as much as what we are seeing in North America with additions, which are 80, 90 gigawatts year into year '23 versus '24 versus '25. Similarly, wind power is growing fast in the U.S. and in Europe, although not as fast, we are seeing additions more in the range of 10 gigawatts a year in '23 versus '24 versus '25. In Europe, that number is about twice as large. There is rapid expansion without the doubt of wind and solar, which is biting into natural gas demand and this net effect of rising solar and wind generation is a shallower relationship between temperatures and natural gas usage in the power generation sector, particularly during the hotter days that we've seen this year compared to last. There's a weakening relationship between natural gas and temperatures, as we see more of this renewal power coming through. We are generally very constructive, and we think that the more power that we produce with wind and solar, the less fossil fuels we’ll need over time. But remember, many of this clean energy sources are intermittent, so you're always going to need natural gas, but ultimately also creates a volatile outcome for natural gas prices, which is exactly what we're seeing today. T.J. Thornton: Okay. And Francisco, I wanted to switch gears a bit to transportation fuels. What's been happening with overall miles driven in the U.S. and Europe? And you mentioned EV adoption growth slowing in the U.S., but what's happening in the rest of the world? Francisco Blanch: U.S. driving activity, for sure, has been slowing down since mid-2023, and we've seen year in year change in vehicle miles travel going from around 3% in June '23 to around 2% more recently. Now, activity is still rising, but the pace of growth is slowing down. And in turn, that's no longer supporting a rising gasoline consumption profile, which is a function of this slower pace of miles driven, but also increased fuel efficiency, as we've seen a lot of model hybrids hit in the market, and of course, increased electric vehicle penetration, which knocks off gasoline consumption to zero in the case of those vehicles. Now, if you look at the monthly data provided by the U.S. Department of Energy, gasoline consumption is about minus 1% in the first quarter or 90,000 barrels a day, the base is around 9 million barrels a day. Clearly, structural headwinds from fuel efficiency and electric vehicles, plus of course, the pain that lower income consumers are already starting to face on the back of this higher interest rates, suggests that driving activity is going to be a little less robust than many were expecting in the U.S. In Europe, diesel and gas oil usage has contracted very steeply by about a quarter of a million barrels day year on year, during this past quarter. But gasoline and jet fuel demand, on the other hand, have been relatively stronger at 80 and 70,000 barrels day year on year. And if you think about that, in Europe, you're still displacing diesel vehicles after the whole “Dieselgate”scandal several years ago. And consumers in Europe are buying either electric vehicles or gasoline vehicles. And then finally, I would say, looking at the other big market for transportation fuels in China, we've seen electric vehicle sales being quite firm, despite all these fears about consumer confidence, and again, this is true really for all vehicles, particularly for electric vehicles, and penetration rates have really ramped up, so we're looking at 30% EV penetration rates across the entire amount of cars sold into China today. Although, because most of the cars are additive to the Chinese economy, they're not replacement cars, like we see in Europe and the U.S., gasoline demand growth continues to rise year on year. T.J. Thornton: Okay. Got it. I wanted to talk about elections. There are puts and takes for energy prices depending on what happens with the U.S. elections in November and depending on whether we're talking about power prices or oil prices. Starting with oil, what are the scenarios for crude that you see in case of Republican victories in November? Francisco Blanch: Let's maybe talk a little bit about what a Republican White House and a Republican Congress would mean. Potentially we could see de-escalation in the Ukraine war and the Middle East, and that could shorten supply lines for energy, but also metals in agriculture, potentially releasing working storage into the market and reducing the geopolitical risk premium. And particularly, I think, production and volumes to Europe could rise in the case of natural gas, if there is some settlement with Russia, although, I think many European investors would question that. Meanwhile we could see stricter enforcement of Iran trade restrictions, which could reduce some crude supply into the market. But I think more importantly, I think a restrictive trade policy may drive up the U.S. dollar, which has a bearish commodities net effect in the near term. Now, there's a medium term positive story that could build around new supply chains and near shoring. And that scenario overall could also lead to a rollback of some decarbonization initiative in relation, which could positively impact fossil fuel demand and weigh negatively on industrial metals. There's a bit of a mixed change of policies that you could have under a Republican administration and a Republican Congress that would shake things around quite a bit. And there under a divided Congress, this will be a lot harder to do, of course, so we would see similar backdrop in terms of the policy tools that are privy to the White House and then those that are more in the hands of Congress. I think we could see still similar set of changes in terms of strong dollar potentially, stricter Iran sanctions, de-escalation of tensions, but potentially we could see a narrower U.S. budget deficit and potentially, we could see that also translating into lower interest rates, which I think would potentially help as well. Cyclical commodities would be a little more supportive to commodities overall than the Republican sweep scenario. T.J. Thornton: Okay. And Francisco, if we're essentially status quo and the Democrats keep the White House and Congress wind up split, any reason to think that things would be much different under, obviously a different, but still Democratic administration? Francisco Blanch: It remains to be seen. I think it would be generally quite similar. Perhaps we could see a more proactive approach to decarbonization than we have seen so far. I mean, the Inflation Reduction Act has created incentives and let the market make the investments and benefit from the tax credits. I think a democratic sweep or even a Democratic White House under a Harris presidency would likely be a little more friendly towards environmental measures and would likely accelerate the move away from fossil fuels and be very supportive, I think, of the energy transition, at least looking at the background of Harris and her prior statements. T.J. Thornton: Okay. And I wanted to switch to power markets. Similar question, I know the implications could be a bit different. If a Republican administration were to take over, in case of victories in November, what would happen to some of the programs that have tried to encourage heat pumps, obviously electric vehicles, EV chargers, are there risk to those things? And what happens to this electrification story in that case? Francisco Blanch: Look, the Republican administration, most likely we would see some changes to the policies implemented by the Democrats, no doubt. But remember, the biggest beneficiaries of many of these policies are the red states. And the irony is that the majority of the renewal power in America sits in the Southwest, but also across the Midwest, near the Rockies. Effectively you're looking at wind power going all the way through the center of the United States, and solar power going from Texas all the way out to California. It's hard to take that away, because there'll be a lot of people that will be very unhappy in some of these red states, if you do that. And remember, Texas is now generating more power using renewables than California, which some people may find ironic, but some people are calling Houston the new energy capital of North America, right, also of course, the old energy capital. That's the first argument. And again, you're benefiting mainly the red states, which are the ones that have the wind and solar resource. The sun doesn't shine everywhere in the same way. And I think the other element of course on the electric vehicles and some of these new energy economy elements is that, look, you have from democratic funding, but you also have people that are funding the Republican party that are strong advocates of electric vehicles. I'm not sure you can completely kill EVs in America. There's still a strong demand for some of them, maybe not for all of them. There's definitely protectionism with China facing high ties on their cheaper electric vehicles. But I do think that there's a pretty good chance that we'll see some elements of the IRA stay in place, even under a Republican administration. T.J. Thornton: I guess, Francisco, a somewhat related question to the points that you've made about more renewables and more EVs is the downward sloping oil curve, meaning that you can buy oil for delivery next year at a lower price than where it's trading today in three years for an even lower price than what you could buy it for next year. Your oil price forecast also assumes prices will be lower next year. Between you and the market, why is there such conviction that prices will be lower as time goes on? And and how much does this sort of energy transition have to do with that? Francisco Blanch: Look, I think the reason why the curves in backwardation has to do, a spot prices being above forward prices, is because inventories are below the five year average. And why are they below the five year average? Well, because OPEC (Organization of the Petroleum Exporting Countries) has done a pretty substantial amount of work by curtailing production to keep those inventories from building. Now, the way a commodity curve operates is that the backend of the curve is going to always be anchored to the marginal cost of production. Particularly in commodities that have relatively fast ability to respond like oil and gas. If you think about the backend of the oil curve, let's say WTI (West Texas Intermediate) five years from now, it is trading around $65 a barrel, which happens to be the price of extracting a marginal barrel of oil in, let's say, tier two acreage in the Bakken or one of the other basins in the U.S. Now when we think about prices, we of course look at the curve, but we also think more importantly at how the balances are looking into the following year. And in our balances, we have a surplus building, which means that we expect the curve to flatten, and as the curve flattens, we think the spot price comes down relative to a forward price. Now, the big question of course is if demand doesn't recover on the back of lower interest rates, if we don't see China stimulus, which in our mind are two of the biggest elements that we need to get support to the commodity complex, we could see further downside risks. And in fact, one of the key concerns we have is that a large round of tariffs in a strong dollar eventually creates strong headwinds for particularly China, but also in the markets, and that in itself, ends up shaving off consumption. And if we end up with less consumption than what we expect next year, which is about 1.2 million barrels a day above this year's levels, we would likely build even more inventory, which would lead to an even flatter curve. Remember, every half a million barrels a day or so, if OPEC doesn't react to the surplus, leads to a $10 move in oil prices. If we end up with a rising surplus, vis-a-vis our projections, oil won't be $80 a barrel, Brent won't be $80 a barrel, WTI won't be $75 a barrel, there'll be 10 barrel lower and we'll have a much flatter oil curve over the next 12 months. T.J. Thornton: Alright, lots to think about there, Francisco, between the structural and clearly the cyclical that's also impacting oil. I really appreciate your comments. Francisco Blanch: Thank you very much. It's been a pleasure joining you and I look forward to the next discussion. T.J. Thornton: Now that solar accounts for such a large portion of electricity generation, the formerly strong relationship between temperature and nat gas consumption, at least in the summer, has broken down. Today with tremendous AC demand, tend to be long, sunny summer days with lots of solar generation. And despite headlines about offshore wind, about residential solar in California, solar and wind utility generation should continue to grow in the U.S. and Europe. That will supply some of the increased power demand that we expect. And Francisco makes the point that there are many reasons to believe that there will still be support for both renewables where much of the generation is in red states, and for EVs, even in case of Republican victories in November. All that said, it's not just a structural story. Commodities could get a bid if rates come down, and industrial activity, which has been fairly weak in the U.S. and Europe, partly because of inventory destocking and headwinds from higher interest rates, does re-accelerate. Thanks for joining. \"Bank of America\" and “BofA Securities” are the marketing names for the global banking businesses and global markets businesses (which includes BofA Global Research) of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, trading, research, strategic advisory, and other investment banking and markets activities are performed globally by affiliates of Bank of America Corporation, including, in the United States, BofA Securities, Inc. a registered broker-dealer and Member of FINRA and SIPC, and, in other jurisdictions, by locally registered entities. ©2024 Bank of America Corporation. All rights reserved.","@context":"http://schema.org"}</script> </uc-media> </div> </div> </div> </div> <div class="aem-wrap--tile"> <div class="tile js-tile "> <div class="tile__image-container"> <img class="tile__image " width="576" height="244" src="/content/dam/flagship/global-research/bucket-list-checked/Didora_Kelley_headshot_resized.jpg" alt aria-hidden="true"/> </div> <div class="tile__body-container no-vertical-padding"> <div class="tile__lead-in header--power2-eyebrow header--blue ">podcast episode: july 16, 2024</div> <h4 class="tile__headline header--h4 header--blue "> Bucket list checked, consumers back to viewing travel as discretionary </h4> <div class="tile__body " data-props-tagging-label="Text_Link-_-Hyperlink-_-" data-props-tagging-class="t-track-text-link" data-action="text-component"><p>A strong value proposition has led travelers to "re-find" Las Vegas. Cruise demand has also been bolstered by compelling value.</p> <p> </p> <p> </p> <p><b>Featured Guests</b><br/> <b>Shaun C. Kelley,</b> Senior Gaming, Lodging & Leisure Analyst <br/> <b>Andrew Didora</b>, Senior U.S. Airlines & Cruise Lines Analyst</p> <p> <br/> </p> </div> <div class="tile__media "> <uc-media version="v1_3.10.1-flagship" class="uc-component uc-media" data-action="unityMedia" buttonAnimation="false" buttonPosition="center" entryId="1_z003mebm" infiniteCarousel="false" isAudio="true" isAuthorMode="false" isPlaylist="false" isVertical="false" partnerId="4699762" playerId="51133253" playlistAutoContinue="false" playlistFilter="false" playlistTheme="black" showDisclaimer="false" theme="black" transcriptText='[{"id":"1_z003mebm","transcript":"%3Cp%3ETravel%20and%20Lodging%20Podcast%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%3A%20Hello%20and%20welcome%20to%20Global%20Research%20Unlocked%2C%20where%20we%20discuss%20what%27s%20rising%20from%20growth%20industries%20to%20rising%20risks%20and%20opportunities%20in%20global%20markets.%20I%27m%20T.J.%20Thornton%2C%20Head%20of%20Product%20Marketing%20at%20BofA%20Global%20Research%2C%20and%20we%27re%20recording%20this%20episode%20on%20Tuesday%2C%20July%2016%2C%202024.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3ECruise%20pricing%20is%20about%2015%25%20ahead%20of%202019%20right%20now.%20So%2C%20pound%20for%20pound%2C%20it%20is%20cheaper%20to%20take%20a%20cruise%20than%20any%20other%20form%20of%20vacation%2C%20which%20just%20continues%20to%20drive%20very%20solid%20core%20fundamentals.%20However%2C%20just%20like%20every%20other%20travel%20vertical%2C%20we%20do%20expect%20normalization%20in%20cruise%2C%20and%20that%20has%20been%20happening%20both%20in%20numbers%20and%20in%20our%20most%20recent%20Bank%20of%20America%20card%20data%20through%20the%20first%20half%20of%20this%20year.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20From%20exercise%20bikes%20to%20fire%20pits%20to%20trips%20to%20Miami%2C%20there%20have%20been%20bouts%20of%20strong%20demand%20for%20various%20goods%20and%20services%20as%20we%E2%80%99ve%20moved%20through%20COVID%20and%20the%20post-COVID%20world.%20Goods%20demand%20came%20first%20and%20then%20demand%20shifted%20to%20services%2C%20including%20travel.%20But%20the%20question%20is%2C%20is%20that%20recovery%20over%3F%20Was%20there%20pent%20up%20demand%20that%E2%80%99s%20bound%20to%20fade%2C%20especially%20as%20consumer%20spending%20also%20fades%20a%20bit%3F%20Here%20to%20discuss%20these%20questions%20as%20they%20relate%20to%20travel%20in%20particular%20is%20Shaun%20Kelley%2C%20who%20covers%20Gaming%2C%20Lodging%2C%20and%20Leisure%2C%20and%20Andrew%20Didora%2C%20who%20covers%20Airlines%20and%20Cruise%20Lines.%20A%20cruise%20to%20Alaska%20sounding%20very%20good%20right%20now%20based%20on%20weather%20in%20New%20York%20City%2C%20although%20I%20see%20it%E2%80%99s%20raining%20there%2C%20so%20maybe%20not%20that%20great.%20But%20thanks%20both%20of%20you%20for%20joining%20us%20today.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3EAndrew%20Didora%2C%20Senior%20U.S.%20Airlines%20%26amp%3B%20Cruise%20Lines%20Anaylst%3A%20Thanks%20for%20having%20me%2C%20T.J.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3EShaun%20Kelley%2C%20Senior%20Gaming%2C%20Lodging%20%26amp%3B%20Leisure%20Analyst%3A%20Thank%20you%2C%20T.J.%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3ET.J.%20Thornton%3A%20This%20first%20question%20is%20for%20Andrew.%20The%20number%20of%20people%20going%20through%20TSA%20Security%20at%20airports%20is%20it%20highs%2C%20it%20keeps%20climbing%2C%20has%20kept%20climbing%20over%20the%20summer%20and%20it%E2%80%99s%20well%20above%202019%20levels.%20I%E2%80%99ve%20seen%20this%20chart%20passed%20around%20a%20lot%2C%20but%20a%20major%20airline%20recently%20warned%20that%20profits%20would%20be%20worse%20than%20expected%20because%20of%20weak%20pricing.%20What%E2%80%99s%20happening%3F%20Did%20airlines%20just%20add%20too%20much%20capacity%3F%20Are%20passengers%20avoiding%20peak%20pricing%20because%20work%20from%20home%20gives%20them%20more%20flexibility%20or%20what%20explains%20this%20apparent%20disconnect%3F%3C%2Fp%3E%0D%0A%3Cp%3E%26nbsp%3B%3C%2Fp%3E%0D%0A%3Cp%3EAndrew%20Didora%3A%20That%E2%80%99s%20exactly%20right%2C%20T.J.%20There%20were%20a%20lot%20of%20headlines%20after%204th%20of%20July%20week%20that%20TSA%20throughput%20surpassed%203%20million%20people%20on%20Sunday%2C%20July%207th.%20This%20was%20the%20first%20time%20that%20over%203%20million%20people%20passed%20through%20airport%20security%20in%20a%20single%20day.%20And%20when%20we%20look%20at%20the%20entire%20week%20of%204th%20of%20July%20in%20aggregate%2C%20the%20TSA%20throughput%20was%20nearly%208%25%20higher%20than%20the%20same%20time%20period%20in%202023%2C%20and%20it%20was%20around%2010%25%20higher%20than%20the%204th%20of%20July%20week%20in%202019%20pre-pandemic.%20And%20we%E2%80%99ve%20always%20viewed%20airline%20demand%20as%20growing%20at%20about%201.5-2%20times%20GDP%20%28Gross%20Domestic%20Product%29%20growth%2C%20so%20the%20fact%20that%20these%20throughput%20figures%20are%20where%20they%20are%20is%20not%20too%20surprising%20to%20us.%20Just%20some%20fun%20facts%20here%3A%20the%20highest%20throughput%20day%20in%202023%20was%20just%20over%202.9%20million%20people%2C%20and%20that%20was%20on%20the%20Sunday%20after%20Thanksgiving.%20And%20in%202019%2C%20the%20maximum%20number%20was%20just%20under%202.9%20million%20people%2C%20also%20on%20the%20Sunday%20after%20Thanksgiving.%20I%20think%20it%E2%80%99s%20pretty%20fair%20to%20say%20we%E2%80%99ll%20see%20another%20day%20la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closeTranscriptText="Close Transcript" closeDisclaimerText="Close Disclaimer" disclaimerTitle="Disclaimer" transcriptTitle="Transcript" carouselNextArrowText="Go to Next Item" carouselPreviousArrowText="Return to Previous Item" carouselDotsLabel="of" playlistItemLabel="Item {0} of {1} Play {2} video" validCloseCaptions="false" data-video-id="1_z003mebm_Bucket list checked, consumers back to viewing travel as discretionary"> <div id="1_z003mebm" class="uc-media__player"> </div> <div class="uc-media-transcript" aria-hidden="true" aria-expanded="false"> <div class="uc-media-transcript__header"> <button aria-label="Close Transcript" class="uc-media-transcript__close uc-media-icon-close" tabindex="-1" title="Close Transcript"></button> </div> <div class="uc-media-transcript__container" tabindex="-1"> <h3 class="uc-media-transcript__title">Transcript</h3> <div class="uc-media-transcript__text"></div> </div> </div> <script type="application/ld+json">{"@type":"AudioObject","name":"Bucket list checked, consumers back to viewing travel as discretionary","description":"No description","thumbnailUrl":"https://cfvod.kaltura.com/p/4699762/sp/469976200/thumbnail/entry_id/1_z003mebm/version/0","uploadDate":"2024-08-08T09:25:25-04:00","contentUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_z003mebm/format/url/protocol/https","embedUrl":"https://cdnapisec.kaltura.com/p/4699762/sp/469976200/playManifest/entryId/1_z003mebm/format/url/protocol/https","duration":"PT22M42S","transcript":"Travel and Lodging Podcast T.J. Thornton, Head of Product Marketing: Hello and welcome to Global Research Unlocked, where we discuss what's rising from growth industries to rising risks and opportunities in global markets. I'm T.J. Thornton, Head of Product Marketing at BofA Global Research, and we're recording this episode on Tuesday, July 16, 2024. Cruise pricing is about 15% ahead of 2019 right now. So, pound for pound, it is cheaper to take a cruise than any other form of vacation, which just continues to drive very solid core fundamentals. However, just like every other travel vertical, we do expect normalization in cruise, and that has been happening both in numbers and in our most recent Bank of America card data through the first half of this year. T.J. Thornton: From exercise bikes to fire pits to trips to Miami, there have been bouts of strong demand for various goods and services as we’ve moved through COVID and the post-COVID world. Goods demand came first and then demand shifted to services, including travel. But the question is, is that recovery over? Was there pent up demand that’s bound to fade, especially as consumer spending also fades a bit? Here to discuss these questions as they relate to travel in particular is Shaun Kelley, who covers Gaming, Lodging, and Leisure, and Andrew Didora, who covers Airlines and Cruise Lines. A cruise to Alaska sounding very good right now based on weather in New York City, although I see it’s raining there, so maybe not that great. But thanks both of you for joining us today. Andrew Didora, Senior U.S. Airlines & Cruise Lines Anaylst: Thanks for having me, T.J. Shaun Kelley, Senior Gaming, Lodging & Leisure Analyst: Thank you, T.J. T.J. Thornton: This first question is for Andrew. The number of people going through TSA Security at airports is it highs, it keeps climbing, has kept climbing over the summer and it’s well above 2019 levels. I’ve seen this chart passed around a lot, but a major airline recently warned that profits would be worse than expected because of weak pricing. What’s happening? Did airlines just add too much capacity? Are passengers avoiding peak pricing because work from home gives them more flexibility or what explains this apparent disconnect? Andrew Didora: That’s exactly right, T.J. There were a lot of headlines after 4th of July week that TSA throughput surpassed 3 million people on Sunday, July 7th. This was the first time that over 3 million people passed through airport security in a single day. And when we look at the entire week of 4th of July in aggregate, the TSA throughput was nearly 8% higher than the same time period in 2023, and it was around 10% higher than the 4th of July week in 2019 pre-pandemic. And we’ve always viewed airline demand as growing at about 1.5-2 times GDP (Gross Domestic Product) growth, so the fact that these throughput figures are where they are is not too surprising to us. Just some fun facts here: the highest throughput day in 2023 was just over 2.9 million people, and that was on the Sunday after Thanksgiving. And in 2019, the maximum number was just under 2.9 million people, also on the Sunday after Thanksgiving. I think it’s pretty fair to say we’ll see another day later this year at over 3 million people going through TSA checkpoints and the peak periods continue to be the strongest areas of demand. When you think about this 4th of July period, think about Thanksgiving, those are the two biggest travel periods of the year. Despite even some of the travel patterns shifting a little bit post-COVID, given the ability to work from home more, we’re certainly seeing peak periods continue to outperform off peak periods. But when you take a step back and you think about this type of throughput at the airports, you raise a great question in terms of the weaker pricing environment, right now, that is driving a lot of the stock movements. We view it as your typical airline over capacity situation. This June and July, the industry is growing capacity in the market by about 6%. And of core airline demand typically grows at 1.5-2 times GDP, that would imply core airline demand is growing about 4-5%. We’re just in an oversupply environment that’s leading to a very active promotional environment today within airline fares versus at any point earlier this year. And we certainly see this pricing pressure as well in our Bank of America card data. Total airline spend over the last few months has been down year over year despite higher capacity, so that certainly implies prices down even more than the overall spend figures. The good news is that we do expect this supply demand balance to recalibrate, as we move through the year, as industry capacity growth moves back towards the low single digits. While there’s a lot of promotions going on right now, the expectation is that the capacity will come down and sort of even out that weaker pricing environment. T.J. Thornton: Okay. And what’s interesting about excess capacity for airlines is that there are all these production difficulties for aircraft that you hear about. Has that had an impact on capacity or maybe there’s difficulties more impactful in other parts of the industry and what happens when that airline production or aircraft production finally catches up? Andrew Didora: Yes, that’s a great question and I think one that I don’t think gets much attention amongst investors these days. Despite the near term over capacity, most investors think of capacity constraints across the industry. It’s no secret that aircraft manufacturers have had their own issues in terms of producing and delivering aircraft on time. Further, there have been some engine recalls out there in the market that are keeping planes out of service for longer than expected. And the medium term capacity picture certainly remains more in check than what we’re seeing today. This is what I like to call capacity constraint as opposed to capacity discipline in the marketplace. Manufacturers and repair shops are driving capacity down to the low single digits as we move into the back half of the year, so we do think what’s going on right now is very temporary, driven largely by some changes in utilization. Once manufacturers get back to normal production schedules and planes start coming out of maintenance shops, the capacity is certainly going to come back into the market. However, the reason why this is less important to investors today is that the expectation is that this capacity will not come into the market until very late 2025 or even into 2026. The next 18 months looks certainly favorable from a capacity constraint perspective. Despite everything that is going on right now. T.J. Thornton: Got it. So, some overcapacity now that should improve and then we get some more capacity adds starting in kind of late 2025. Andrew Didora: Exactly right. T.J. Thornton: Okay. Shaun, hotel prices, like the prices of just about everything else rose rapidly, then that growth slowed. But have hotel prices actually fallen or has the growth just come down, and if prices have fallen, in what types of hotels have we seen lower prices? Shaun Kelley: Yeah, thanks T.J. Maybe it would help to just start by level setting where exactly we are in the hotel recovery. Coming off of the 2019 level, what we’ve seen in the hotel sector is a modest decline in the number of hotel room nights that are stayed, but about an 18% increase in overall average industry revenue. What that translates to for pricing is prices are up about 19% across the hotel industry broadly since 2019. While that may sound like a lot in an aggregate or absolute basis, that actually trails both broader CPI (Consumer Price Index) levels and broader price levels across most categories of consumer discretionary services and goods. Where that leaves you out on the price landscape is, the consumer may feel differently based on their own individual hotel stay, pricing's not on an aggregate across the industry up nearly as much as I think many consumers think they are. That said, we are seeing some periods or points of modest normalization in hotel pricing. The biggest softness that we're seeing are at the luxury price point at the high end, and then we're seeing some incremental softness at the actual lowest price points in what we call 'the economy or mid-scale subsegments', think of these as one and two star motels on the low end. We're seeing an extreme barbell where we're seeing pricing is actually continuing to increase both broadly across the industry and at normal middle level hotels, but at the extreme high end and at the low end, that's where we're actually seeing prices start to come in a little bit. It also fits to task that those areas of the hotel sector tend to be the ones that are the most consumer oriented, whereas those areas in the middle tend to be more business travel oriented. We're seeing price decreases where the consumer's being a little bit more sensitive, but we're actually not seeing it in the middle where businesses and groups are traveling more. T.J. Thornton: And I wanted to talk about cruise lines as well. They were late beneficiaries of the COVID travel recovery. Cruises opened up after some other modes of transportation, which made for a quite a positive story. There's also a structural story. The stocks look like they sell semiconductors to data centers, given how well they've performed. How do you think about them though? Is there an inevitable slowdown in cruise? And do the stocks anticipate that? Do valuations look attractive relative to where they have been over history? Andrew Didora: You bring up great points here on cruise, T.J. The past year and a half has certainly proven to be beneficial to cruise equities. I'd say most of the companies in the group were trading where they were back in 2022. Now remember, these were companies that literally went 18 months without any revenues during COVID, so they were companies on the brink of bankruptcy for some time. However, they were able to raise enough capital to get through the pandemic, they survived and they benefited from the reopening and the pent up demand for cruises that certainly ensued. I think the stocks have been driven by a few things. First, it was just surviving the pandemic and not going bankrupt, then it was generating profits, which allowed them to service all the incremental debt that they had taken on during the pandemic, and then there was just a strong rebound in cruise demand as all the vessels got back to full operation by the spring of 2023. And lastly, I think what we're seeing today, and certainly over the past, call it 6-12 months, is that cruise is just a strong value proposition versus other forms of travel. Shaun's given some hotel statistics before and cruise pricing is about 15% ahead of 2019 right now. So, pound for pound, it is cheaper to take a cruise than any other form of vacation, which just continues to drive very solid core fundamentals. However, just like every other travel vertical, we do expect normalization in cruise, and that has been happening both in numbers and in our most recent Bank of America card data through the first half of this year. Our expectations are that the industry reverts to a much more normal earnings algorithm as we move past the initial reopening over the course of 2023, and this earnings algorithm returns in 2025. And our sense is that the market is pretty much expecting something similar. These equities are priced right at the midpoint to actually the lower end of historical valuation ranges. Investors are clearly not expecting any sort of meaningful acceleration in top line today. In fact, I'd say most investors are expecting that normalization trend back down to low to mid single digit type pricing power that we've seen over time. But just given general slowdown in other areas of consumer spend, where we see valuations right now, we do get the sense that there's that heightened focus on a potential slowdown in cruise spend as well. T.J. Thornton: Okay. And Shaun, I did want to talk a little bit more about your point on the high end. Yes, there's been weakness in economy lodging that's consistent with other signs of lower income weakness that we've seen. But then you point out that there's been some weakness at the high end too. I know that skier visits were weak this past winter, of course there can always be weather impact there. What do you think is driving that weakness in the high end? Shaun Kelley: The first point starts with this concept of normalization. Luxury hotels in particular benefited from extremely low supply, and I think this is a bit of the opposite dynamic from what Andrew was calling out on some of the pricing dynamics that he sees in airlines. Big picture here, luxury hotels are extraordinarily expensive to build and open and operate, as a result, the supply curve didn't change much for basically the decade going into COVID. And the result of that was very strong pricing power for many of these resort hotels in particular coming through the pandemic. The demand was also obviously off the charts. And so, what we saw were the biggest price increases at a number of these resorts, particularly in specific destinations, especially drive to destinations where the customer had limited options, they really wanted to get out of the house, and what we saw behaviorally was people were even trading up within those categories. They would take the room with the balcony or they would take the extra experience at the hotel or resort. They would pay up for the higher floor, whatever it was, they were willing to treat themselves. What we're seeing is not a wholesale step back in luxury, but we are seeing a bit more elasticity as travel patterns normalize back to where they are and frankly as alternatives have increased for where they can go. One of those alternatives that only came back online, within the last 18 months or so, was the cruise line industry itself. Other examples though, and a huge one that's impacted the luxury hotel boom in specific micro markets in the hotel sector, including skiing, is return of outbound international travel. The dollar being as strong as it is, has created a significant amount of interest for Americans, especially wealthy Americans to go overseas. The world is on sale for Americans traveling overseas, and that has been a real boon to outbound travel, but obviously those were the same people that were willing to and able to pay absolute top dollar for some of these domestic resorts. Think of wine country, particularly in the shoulder seasons. Think of Miami at some of its peak and not in its shoulder seasons. Some of those places, especially coastal Florida, are seeing a bit of mean in reversion now as again, the guest still spending, but they have a lot more options of places where they can stretch their travel dollar and they no longer are just confined to drive to leisure resorts. Resorts and luxury are really where we see that change in travel pattern or behavior the most acutely. T.J. Thornton: Okay. And a quick follow up, Las Vegas, maybe that fits into the middle. You pointed out low end weakness and high end weakness. But I think Las Vegas has been quite resilient. How do you explain that? Shaun Kelley: This is one of the most interesting travel patterns we've seen, and I'm going to come back to a concept that Andrew mentioned, which is the value proposition. On the one side, Vegas has seen some of the largest price increases we've seen of any domestic hotel market. As we look at it, pricing in Vegas is up nearly 40% from where it was prior to the pandemic, and that's almost double what we see for the hotel industry broadly. On the one side you'd say there should be more mean reversion potential in Vegas than almost any other domestic travel market. At the same time, Vegas has both really adapted well to its traveler and they've offered a lot more on the entertainment options. You've had the opening and the programming at Allegiant Stadium, the opening of the Sphere, a huge amount of airlift that's been willing to come in and flexible to come into the market because this is where travelers want it to go with a lot of airport capacity, and it's a very easy place for people to travel into. But I think the biggest single thing that's driven Vegas is really that it was a bargain to begin with. The low rates and the lack of pricing power that Vegas had, if we go back to 2017 to 2019, has translated into outsized growth now as effectively the consumer, let's call it 'Re-found Vegas', and really enjoyed their experience when they went. One last thing is, we do see some travel patterns and some migration of behavior, particularly on the corporate and group side, that has also moved or migrated to Las Vegas from a number of west coast destination markets that have been a little less friendly to travelers or perceived as less friendly coming out of the pandemic. If you look at San Francisco and Los Angeles, maybe even stretching out to Seattle and Portland, those markets are some of the markets that have been the most difficult to recover and the slowest to recover. Vegas has definitely been a market share gainer, particularly on corporate and group business from a number of those markets. T.J. Thornton: Okay. Very interesting. All you can eat buffets. I guess that adds to the value proposition, assuming those still exist. I want to talk about the expense side as well though for lodging. We've focused a lot on the demand side. Our econ team has made the point that leisure and hospitality hiring is pretty much caught up from the deficit that it was in post-COVID. Now that these very tight labor markets are behind us, wage growth is slowed, maybe a lot of the hiring is done. Is there a margin expansion story that still exists for parts of your coverage? I know there's been a lot of pricing, so maybe not, but maybe there is again, on the cost side. Shaun Kelley: Margin expansion in owned hotels and owned and operated hotels really comes down to the basic concept of you have to grow revenues faster than you grow costs. What you said on an aggregate basis across the pandemic is true. Pricing grew very substantially. Pricing comes with traditionally better margins than occupancy 'cause you don't actually have to clean your hotel rooms as frequently if you're taking it on the price side. While that dynamic has been favorable to margins, we are now in an environment where revenue growth is not keeping up with inflation. If anything at the operating or unit level of the hotels, hoteliers are still in a challenging, I wouldn't call it really challenging, but I would definitely say it's a challenging operating environment. In general, our outlook is actually for margins at the unit level to be under a little bit of pressure. A big headwind last year was property insurance, which had a very significant amount of growth to it. We're not yet in a margin expansion story. We did have a more procyclical sort of positive outlook as it relates to the economy, especially coming through or changes that could result from an election year, it could be seen. T.J. Thornton: Got it. Okay. Andrew, a really big theme in the market has been Fed rate cuts. Fed rate cuts got pushed out again and again, and now they're actually getting pulled forward a little bit with many economists in the market expecting Fed cuts to begin in September. I think that's one of the things that's driven such strength in small caps that we've seen and just a much broader market over the past week or so. How do you think about your space, assuming the Fed does cut over the next few months? How have these stocks acted historically and how do you think they could act in a Fed rate cutting cycle that may be ahead of us? Andrew Didora: Yeah, I think of Fed rate cuts and the impact on my sectors really from two perspectives, balance sheets and core demand. In general, my coverage has always had highly levered balance sheets. Post-pandemic, this is even more acute. My companies have meaningful debt coming due that was taken out at high rates during the pandemic. Airlines and cruise lines will all generally benefit from a lower rate environment as it relates to the balance sheet. And then from an earnings perspective to the extent the rate cuts put more money in consumer pockets, that would also be a benefit to demand. I would say the bigger impact is more around market sentiment and valuations and the ability to refinance the balance sheet debt. Lower rates in general, it's generally good across my coverage, but there's also a bigger market and industry drivers that I think over time typically drive earnings more than just the pure rate environment. I think the overall impact of lower rates is probably much less meaningful to my sector than to maybe other parts of the market. Shaun Kelley: I think this sort of knee jerk reaction across my area's gaming, lodging, and leisure would be, you'd be looking for a fairly similar setup to probably Andrew's companies. The more leveraged and low end equities are probably going to be the ones that are going to rally the most. Similar here, we would probably look for areas like regional gaming, timeshare, and possibly portions of our more leveraged lodging REITs or lodging Real Estate Investment Trusts as areas where we would like to see, or we would probably see the biggest reactions as it relates to a Fed cutting environment. Again, some of this stuff happens really quickly. We're probably seeing that reaction happen in real time here. And then I think the real question that most of our clients have for us is, are we going to see the follow through to fundamentals? Meaning we see this reaction in these types of equities, but are we actually going to see a revenue reaction or a policy environment which could result in better top line growth and better earnings growth for these companies? And the truth is, that sort of remains to be seen. T.J. Thornton: Shaun, Andrew, thanks again for joining us today. Shaun Kelley: Thank you for setting it all up. Andrew Didora: Appreciate it. T.J. Thornton: Domestic airline capacity is up 6% this summer, and that's higher than low single digit demand growth. That helps explain why pricing in airlines has been so difficult despite strong unit demand. But this over capacity situation should improve over the next few quarters before it potentially gets worse again, as these airline capacity constraints ease. Strength in cruise stocks is really impressive, but it makes more sense when you think about the cruise value proposition and that prices are only up 15% since 2019. Vegas has also benefited from a strong value prop, along with a new music venue and NFL stadium, and a lot of airline capacity growth that can bring people in and out. 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