Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights. Two tech titans rebounded in the third quarter. Find out if Morningstar’s analysts think Alphabet and Amazon’s stocks are cheap. Plus – a new path to save for retirement for workers without a company-sponsored 401(k) plan. Details ahead on BlackRock’s iShares Target-Date ETFs ahead. And – Morningstar’s senior U.S. economist shares his take on the Federal Reserve’s latest interest-rate decision. This is Investing Insights.
Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.
Amazon Impressed in Q3
Amazon.com's third quarter profitability impressed Morningstar. The e-commerce giant reported more than $11 billion in operating profit and surpassed its outlook. Revenue grew 13% year over year. Advertising and cloud-computing unit Amazon Web Services also improved compared to the same time last year. E-commerce results were solid as well and continue to rebound. Morningstar expects e-commerce, cloud-computing, and advertising to drive healthy long-term growth for Amazon. Consumer spending on goods rather than businesses spending on the cloud remains the company’s biggest short-term concern. Morningstar is raising its estimate for Amazon's stock to $155 from $150. Shares look undervalued.
Google Ad Rebound Lifts Alphabet
A rebound in ad spending lifted Google parent Alphabet’s third-quarter results. Revenue came in higher than last year at almost $77 billion. Google’s core advertising business remains strong with growth in both Search and YouTube. Cloud revenue growth aligned with Morningstar expectations. However, it was slower than growth at Microsoft's Azure. Demand for artificial intelligence drove Microsoft’s growth. It was likely a similar scenario for Google. However, it’s more exposed to high-growth and startup clients, who have been aggressive with cutting costs. Morningstar believes that reduced economic uncertainty and the increase in AI will bring in more cloud clients despite these hurdles. That should lead to accelerated growth in the fourth quarter. Management says it will continue to prioritize investments in AI and focus on increasing efficiency. Morningstar believes Alphabet’s value sits at $161 per share and is undervalued.
Visa Benefits from Travel Bounce Back
Visa benefited from a bounce back in travel spending in its fiscal fourth quarter. The world’s largest payment processor reported an 11% year-over-year revenue increase. Both payment volume and transactions grew. The results suggest payment trends are holding steady. Morningstar thinks the credit card company's growth remains healthy as consumer spending looks resilient. An increase in the number of cross-border transactions has boosted Visa because of the higher fees they incur. However, the growth rate has declined over the past few quarters. This pandemic-related tailwind is likely coming to an end. Management suggests that recent trends will carry over into fiscal 2024. Morningstar maintains that Visa's stock is worth $241.
BlackRock Brings Back Target-Date ETFs
A sort of Déjà vu has hit the target-date scene. BlackRock is bringing back target-date ETFs with some noticeable changes. The firm has designed the new series for workers who don’t have a 401(k) from their job. Morningstar Research Services senior manager research analyst Megan Pacholok covers the mutual funds that the ETFs are based on.
Megan Pacholok: Thanks for having me.
Changes to the ETF Space
Hampton: So this isn't the first time that BlackRock has tried this. What has changed in the ETF space to make another attempt worth it?
Pacholok: That's right. So this is actually BlackRock's second attempt of making target date ETFs a thing. And as you mentioned, the ETF industry has evolved. So back in 2014 when they closed that first attempt, ETFs were just shy of having $2 trillion in assets, whereas now they're closer to 7.2 trillion. So you're really seeing an investor embrace the vehicle and that's a big difference, especially for a first time investor. If they see more assets in the market, they may be more comfortable putting their money in that investment wrapper.
What is BlackRock Offering?
Hampton: Can you explain the nuts and bolts of what BlackRock is offering?
Pacholok: Sure. It is a target date ETF. In typical target date fashion, it is intended to be your total portfolio in saving for retirement. At the onset, you have a higher equity allocation and as you get older it decumulates or kind of decreases your equity allocation. The difference between this second attempt and that first attempt that you mentioned earlier is that it is an actively managed ETF target date. So that means that BlackRock is really able to put in their best thinking and the research that they do behind retirement savings is able to show through in this offering.
ETFs vs. Mutual Funds
Hampton: What are the differences and similarities between these target date ETFs and their mutual fund siblings?
Pacholok: Right. So BlackRock offers a target date mutual fund called BlackRock Life Path Index. And this series is very similar to that. They follow the same glide path. They have the same lead portfolio manager. They're using the same research and the same resources that that series is also utilizing. The difference is there are a couple of discrepancies in the underlying holdings. One bigger one is that the mutual fund version uses a international total stock market ETF, whereas the ETF version breaks down that exposure. So it's using two ETFs, one for non-US international developed equities and an emerging markets ETF. That allows the team to get a little bit more granular in the exposures that they're giving to investors, whereas you just get that broad stroke on the mutual fund version.
Can BlackRock’s Target-Date ETFs Be a Part of 401(k)s?
Hampton: Well, could workers eventually see BlackRock's targeted ETFs in their 401K or other workplace retirement plans? Why or why not?
Pacholok: It's unlikely. The main driver behind that is that record keepers can't really support the intraday trading that comes with ETFs. So these target date ETFs are really for investors that don't have a workplace account or they're trying to supplement what they already have. So they're going to be using these ETFs either in an IRA or through their brokerage account.
How to Judge the ETFs’ Success
Hampton: And what size are you watching for to determine if this latest try is successful?
Pacholok: The biggest driver is going to be the flows, is our people actually embracing these target date ETFs. And I think that's a big question whether they'll be successful or not. One of the main drivers why target date funds have been so successful is because they typically serve as the QDIA in your workplace account. So investors are really hands off. They don't have to select it, they're just automatically enrolled. Whereas if you have to do it through your brokerage or an IRA, you have to first open an account and realize how do you want to invest your assets and select this fund yourself. So there takes a lot more initiative for the investor. So that's something to watch whether they're going to do that or not.
Hampton: And when you say QDIA, you mean what?
Pacholok: Qualified Default Investment Alternative.
Hampton: Well, thank you for your time today, Megan, for explaining how these target date ETFs work.
Pacholok: Thank you for having me.
Fed Focused on Higher for Longer, But Rate Cut Talk Likely Coming
Hampton: The Federal Reserve makes it two in a row. Fed officials extended the interest rate pause for a second. Straight meeting. Inflation has moderated, while the job market and economy remains strong. The Fed has acknowledged that tighter financial conditions and credit conditions will weigh on economic activity. Let’s turn to Morningstar Research Services senior U.S. economist, Preston Caldwell, who’s here in studio today. Thanks for being here, Preston.
Preston Caldwell: It’s great to be here, Ivanna.
Hampton: So let’s talk about what are a couple of key takeaways from Fed Chair Jerome Powell’s press conference today?
Caldwell: Yeah, well the Fed didn’t hike today, so they paused again, which—just looking at what markets have expected over the last couple of weeks, was not a surprise. But if we look back a month ago, many people then, as well as the Fed projections, if you looked at them, were anticipating another rate hike. So what’s changed over the last month or so? Well, inflation has continued to trend in a more mild direction. That’s the big thing. And I would say the other factor too is the run-up in bond yields that we’ve seen. And so, all that has induced the Fed to move in a more patient direction.
Hampton: And you mentioned those bond yields. So long-term Treasury yields have climbed to highs we haven’t seen in a while. Talk about how the tighter financial conditions are factoring into the Fed’s inflation fight.
Caldwell: Right. So in short, we don’t know yet. It’s just happened, for example, mortgage rates have gone way up, and so, prospective homebuyers are just now kind of factoring that into their calculations and reacting to what’s happened. And so it’ll take a while for this run-up in bond yields to filter into the economy. Like so many other aspects, actually, I think of the Fed’s rate hikes that have occurred over the last year and a half, the impact has yet to be fully felt. So we will continue to see that. And we don’t know necessarily whether the increase in bond yields will persist, because there could be some supply and demand locations which have been pushing up yields and may reverse a bit. So like Powell said today in his remarks, we’ll have to wait and see whether the increase in yields persists.
Hampton: And Powell has said that officials haven’t been discussing rate cuts next year. What needs to happen for the Fed’s outlook to line up with Morningstar’s forecast?
Caldwell: Yeah, so although Powell did say that, I do think his recent remarks, including a speech a week or so ago, have moved in a direction that is more balanced in recognizing the risks of too-tight monetary policy versus too-loose. Previously it was really just focused on the risk of being too loose, which would cause inflation to remain too high. But now they’re starting to entertain the possibility that the path of policy could be too tight, and that could unnecessarily slow down economic activity more than needs to be done to win the war against inflation. So I think that’s a preliminary to them eventually discussing rate cuts, which I think the discussion will start to be brought up in early 2024, and we’ll start to see some rate cuts actually before the first half of 2024 concludes. And then really deploying aggressively in the second half of 2024 going into 2025.
So we expect the Fed-funds’ rate to ultimately come from its current range of 5.25% to 5.5%, to ultimately below 2%, just under 2% by early 2026. So in our view, that will be necessary to ensure a sustained, healthy rate of economic growth.
Hampton: Well, all right, Preston, thank you for being here in person today. I can’t get enough of it.
Caldwell: Yeah, thanks Ivanna. I enjoyed it.
Hampton: That wraps up this week’s episode. Subscribe to Morningstar’s YouTube channel to see new videos from our team. You can hear market trends and analyst insights from Morningstar on your Alexa devices. Say ‘Play Morningstar’. Thanks to senior video producer Jake VanKersen. And thank you for tuning into “Investing Insights.” I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.
