James Gorman On How Little The Market Prices In The Reality Around Rates

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James Gorman On How Little The Market Prices In The Reality Around Rates
Image source: CNBC Video Screenshot

Following is the unofficial transcript of a CNBC exclusive interview with Morgan Stanley Chairman & CEO James Gorman on CNBC’s “Closing Bell” (M-F, 3PM-5PM ET) today, Monday, December 13th. Following is a link to video on CNBC.com:

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Morgan Stanley CEO James Gorman: It Always Surprises Me How Little The Market Prices In The Reality Around Rates

WILFRED FROST: Jon, thank you so much. As you said, we're at Morgan Stanley headquarters with James Gorman. James, thanks so much for having us. It's great to be with you but particularly in person.

JAMES GORMAN: Yeah, it's great to be back. We're just talking I think the last time I did a live interview was with you right before COVID happened.

FROST: On the E*TRADE deal February 2020 so we hope it's not a bad, a bad omen. We're getting, we're gonna get to both E*TRADE and to in the office versus out of the office a bit a bit later if we can. But let's kick off with the markets because despite a bit of a selloff today, we're so close to record highs. Does the outlook you see over the next 12 months justify being at record highs?

GORMAN: I think the record high is a surprise. I mean by definition if you have global economic growth corporations are growing unless they're doing something wrong with their cost basis, their profits are improving and at the same p-multiple, actually by definition every day markets should close at a record high. I think what we're seeing though is within this market, there are some extraordinary moves in certain sectors and certain companies and that's the real risk at this point.

FROST: Is there a difference though? I mean, clearly every year every time markets have had a run we question, oh is it run too much but is there a difference now versus any point in the last decade because rates might be about to rise?

GORMAN: Well, it always surprises me how little the market prices in what is going to be the reality around rates. I mean, rates will rise with absolute certainty and I think it will happen as I'm sure we're gonna talk about probably sooner than most people do, I've felt that for a long time. With that will come more pressure on the economy, more pressure on growth, more pressure on credit, and therefore more pressure on equities. That's a given. But that kind of readjustment back to a more normal environment not necessarily a bad thing, a small correction here is not necessarily a bad thing.

FROST: So some of the areas of the market you did think were more than just facing a small correction. Which areas are we talking about? Crypto, SPAC, that kind of—

GORMAN: Yeah. I mean, if you look at just where have there been the obvious excesses. Companies, you know, trading new companies that 30, 40, 50 times revenues, the SPAC explosion, which appeared and then disappeared, obviously Bitcoin, whether it's worth 60,000 or 6, 000, but the rate of change, you know, what's gone on with some of the so-called Reddit stocks that have exploded. You're seeing these sort of moments of where you look at it rationally you say really is that does that make sense? But the aggregate market doesn't, is not crazy. The aggregate picture is not crazy.

FROST: Do you have any personal exposure to any of those areas particularly as they pull back like crypto for example or not?

GORMAN: Oh Wilf, I’m very conservative. No, I never, I never invested in crypto. I was told to by a lot of people. I obviously missed that. No, I'm obviously given my job, I'm pretty conservative.

FROST: Just a lot of Morgan Stanley stock, which I'm sure you won't say is overpriced like some of those areas—

GORMAN: It’s outperformed some of those actually.

FROST: It has. It's been, it's been a very strong performer. Congratulations on that. Let's talk about the rate outlook as you said. Last time we had you on again, you've been a bit ahead of the curve in terms of saying that the Fed is gonna have to play catch up. Do they still have to play catch up? I mean, expectations have come in a bit as to when they might first hike rates.

GORMAN: Well, let's sort of set the table for a minute. Right now, we have, we have economic growth and we have synchronized growth meaning in every region of the world is undergoing at some level of growth which is atypical. Normally one region is counterbalancing another so if global synchronized economic growth, we have record low interest rates pretty much in every country in the world and we have record fiscal stimulus in most countries in the world. Ordinarily, you don't need fiscal stimulus if you've got strong growth. Ordinarily, you don't have low interest rates if you've got strong growth. So, we are heading to a rising interest rate environment. I felt the Federal Reserve would be better off storing away some of the rate increases for when the inevitable turndown comes, you've got some ammunition to fight with. At the moment at zero interest rates, we have no ammunition with 10 rate increases 10 quarter point rate increases from normal. So, if I were the Fed, I would start moving earlier rather than later, store away some ammunition and accept the reality. Now this is before we even get to the inflation discussion so, we'll see. I guess the FOMC meeting is I think this Wednesday, we'll see where they come out. I would be very surprised if there aren’t more dots talking about rate increases next year.

FROST: And if that does materialize, and you're right on that front, could it derail the economy or you're still pretty confident that there's support for the economy overall?

GORMAN: Yeah, I don't think it derails the economy. I think this is what you need. You need, you need balance in the economy. If there's too much liquidity, too many, too many deals, too many transactions, too much growth happens under false pretenses because the money was too cheap. We need money to be normalized for stable economic growth. I don't think the economy is going to be derailed. I think the market may the market may have a setback for a little bit but that's fine. The Fed’s job is not to worry about the market. It’s to worry about the economy.

FROST: Lots of spots on the Fed to be filled. The White House saying today that they'll try and make announcements for Christmas. Do you worry that that regulatory pendulum will, will come back and that banks will get a lot more of the tightening regulation over the next five years?

GORMAN: Well, there's, there's a bit of a myth that somehow we've gone through a massive deregulation. I mean, I would say right at the beginning when our company became a bank holding company when the first GCPs were announced, there was an increase in the level of regulation, level of capital the banks had to hold in this country dramatically from 2008 and 2009 through it about 2016, 2017. There have been some modest changes. If it went from a scale of I don't know 40 to 100, we’re probably back at, you know, 92, 90, some modest adjustments to for example, the way the Volcker Rule was being applied. Do I think the banks need more capital given we’re there? Absolutely not. I mean, they’re functioning very well and if you reduce the bank’s capital, you might hurt growth in the economy. So right now, I think are there going to be some more adjustments? I'm sure there will be overtime under any new administration, but fundamental redo of what's been done over a decade on a global basis through the Basel rules internationally and with the Fed, I would be absolutely surprised if that happens.

FROST: Clearly the outlook on the economy is still ultimately constructive. It's been another very strong year for Morgan Stanley. Can next year repeat that, particularly when we talk about trading and investment banking?

GORMAN: Well, it's, you know, it's hard to know. We budgeted, we didn't budget what we delivered this year. We've had now through 2018, 2019 and 2020 were each consecutive records, and through the first nine months of this year, we're ahead of 2020 pace. So we're hitting our fourth consecutive record. You know, revenues of the company have gone from about 34 billion five or six years ago to 60 billion we're on track for this year and, you know, net income of 12, 13, 14 billion. I mean, it's been, it's been an extraordinary run here, and it has definitely been enabled and helped by what's going on in the broader economy. But it's also been driven by the business model choices that we’ve made. So next year, I think the business model choices will sustain us very well. I think we'll have, we'll have a very good year next year, how the broader economy plays out, how the markets play out, the IPO markets, the M&A will be driven a little bit by that. So that is less clear, but I think I think we'll have a great year next year.

FROST: You mentioned the business model changes. We mentioned that in the interview we did here almost two years ago when you bought E*TRADE, Eaton Vance followed soon after that. At the time, when you're on media interviews and analysts calls, you had to justify the price you were paying and you said, you know, to get a good asset you got to pay a full price. Since then, the price of asset management assets has only gone up further. So how are you thinking about those deals now and would you add more or is the price of asset management acquisitions gone too high now?

GORMAN: You know, we spent between E*TRADE and Eaton Vance I think about 20, 21 billion, I think it was about 13.78 something like that. The market cap since we did those deals since we closed, the stock price has doubled and the market cap has gone up by about 100 billion. So, there are a lot of people at the time who tell you that you should buy the company but pay a billion dollars less which they did. I said I agree unfortunately that's a null said, the seller wanted the extra billion dollars. So, you have a choice. You either pay the billion dollars get the company, don't pay the billion dollars get nothing. We will now own this E*TRADE has been around for decades, Eaton Vance has been around for 94 years. We're gonna own it for the next 94 years. I don't care about plus or minus a billion dollars for a company. We’re $180 billion company. You've got to focus on what strategically makes sense. The people who worry about pricing at that level of precision firstly, they wouldn't be able to tell me what we paid for it a year ago because nobody remembers. And secondly, you just don't get stuff done. Your job is to make the call when the moment arrives. We made the call, we're very pleased with it.

FROST: A couple more calls might materialize in the same vein over the next year or two?

GORMAN: I mean, you've got to be, you've got to be open. We're a growing global business, but we're not compulsively acquisitive. We doubled our dividend this year. We raised our buyback. So we're using our capital for that for our shareholders but also support the business. But since more deals come along, of course we'll be taking a look at them but we're not out there, we must do a deal kind of attitude.

FROST: Do you expect with E*TRADE in mind retail investor participation to fall? Has it already slipped and does that hurt Morgan Stanley's results overall if and when that happens?

GORMAN: It doesn't, I mean, it's the, the retail activity within E*TRADE is not a major economic driver for this firm. What E*TRADE is an economic driver for is a lot of the options type business that gets done there, the workplace business, the digital bank, the deposits now combined with our business, we've got about 330, 340 billion of deposits so transactional activity will come off from the peaks. Right now, it's held up. I mean, I'm a little astonished, but it will come off from the peaks at some point, that's fine. You know, we make no money on the transactions anyway. So that's not the economic driver.

FROST: Want to talk about operating in China. Do you do business in China proudly? Or do you do it begrudgingly?

GORMAN: Definitely not begrudgingly. I mean, we're, we're proud of our business. We're a global company. We've got to support global corporations, have dealt with Chinese state-owned enterprises and corporations for decades. Now, we've got, we've got hundreds of employees there. We've taken full control of our joint venture which was called Huaxin Securities and of our asset management venture and listen fundamentally Wilf, we don't try and front run US policy. We're a US headquartered, US regulated company, we follow US policy.

FROST: I totally get that. I do wonder if the temperature’s changed recently. The White House 10 days ago saying it's not sending government officials to the Olympics and said that was due to quote, the PRC’s ongoing genocide and crimes against humanity. I mean genocide confirmed by the White House. Does that not make you rethink whether you even want to be making money there?

GORMAN: That, that's, it's, I mean, that's strong language, obviously genocide, but again, we're guided by US policy. I'm not going to try and get in front of US policy and determine which countries we do or do not do business in if the US is saying they want us to do business. Last time I checked, the biggest trading partners in the world are US and China with each other. So it would seem it would seem like there's a lot of business being done at the government level between the countries. So no, we'll stand by policy. We continue to run our business in China as we always have.

FROST: In terms of here and well all around the world and back in the office, have you seen everyone that you wanted to come back to the office, come back to the office?

GORMAN: I mean it varies so much around the world. I mean, if you look in India, I think 5% of our 10,000, 12,000 employees are back in the office. In New York City, the building we're in today, we're running I think about 65%. We're 95% vaccinated. On any given day, about 65 of that 95 are in the office, you can't come in unless you're vaccinated. We set that up some time ago. Listen we're, we're in a transition period still. I was wrong on this. I thought we would have been out of it by Labor Day. Past Labor Day, we're not and I think we'll still be in through most of next year. Everybody's still finding their way and then you get the Omicron variant. You know, who knows, we'll have Pi, we’ll have Theta, we’ll have Epsilon, you know, we’ll eventually run out of letters in the Greek alphabet globally. But you know, it's, it's, it's continuing to be an issue. I just pray and hope everybody gets vaccinated and everybody gets a booster shot. That is our defense.

FROST: So you made some strong comments in the summer about wanting to get people back to the office. One of them even implied that people wouldn't get paid as much if they were not here in the office in New York, they wouldn't get New York salaries. Given as you you've said that we're probably going to be in this for another 18 months, is that that view on hold for those 18 months?

GORMAN: Well, we have what I said was if you think you can move and choose to where you want to live and everybody moves to I don't know some, some other low-cost part of the country and just chooses when their teams work in New York, that's going to create issues. But our employees haven't reacted that way. I mean, fundamentally, they've tried to do the right thing. And as I say on any day, 65% of 95% are sitting in this building in New York. You go down to the trading floors, 2, 3, 4, and 5, you'd find hundreds of people doing their job on those trading floors. So that hasn't been an issue.

FROST: In terms of the capital, lots of excess capital is the preference shifting between buybacks, dividends? You favoring the dividend now a little bit more?

GORMAN: Well, we doubled the dividend and that's big. So we're now paying on an annual basis $2.80 a share. By the way, we buying back about $100 million stock, 100 million shares a year so the actual dividend cost comes down because fewer shares are outstanding, but think of the $2.80. Post crisis, that number was 20 cents, five cents a quarter. So we've gone from 20 cents in 10 years to $2.80. We doubled last year. You know, obviously we'll, we'll look with the board of the dividend every year but as we continue to grow the business, I would expect we'd see dividend growth. In the meantime, we've got access capital, we buy back stock when it makes sense, we've been doing that for the last year, and we'll continue doing that. But then you're looking at investing in the business, investing in our people and if there are sensible deals to be done, we'll do it so you're toggling between all four but I've said for a long time I wanted this company to reflect the yield stock type capability that the wealth and asset management businesses bring and as a result with the dividend we're paying out we're paying out a bit over 5 billion in dividend now. That also is a show of real confidence in our business model.

FROST: I wanted to finish James if I may just touching on your leadership planning. You updated us on that earlier in the year and at the time said you thought three to five more years yourself. I'm not going to try and get you to answer specifically the number of years because I know you won't but has has it shifted in your mind as to what the factor will be on that timeline. Is it no longer a question of Morgan Stanley absolutely needs me day to day and more a question of when I know who the next person is and they're ready, then it'll be time to hand over the reins?

GORMAN: Well, succession is, is one of the hardest things you do as a CEO and as a board and obviously it's the board's decision ultimately. There are a number of things that go into it. One is the stability and evidence that strategy is working. I think we've got that. Second is one's own interest in the job. I love doing the job. But thirdly, what's the right thing for the organization to carry forward for the next 10 and 20 years? If you look at some of the people we put on the operating committee this year, I think we put four I don't think I know we put four people on since the beginning of the year all under the age of 45. That is setting up this company for the next 10 or 15 years. And in the meantime, we've got terrific executives who have been named who could replace me and, you know, we need to get, we need to get a few of those ready for the board that will take couple of years but I believe in succession. I believe in planning. I'm very proud of the team we've got. We've got some fantastic executives and I'm confident the place will thrive under them.

FROST: James it's always a pleasure to catch up. Thank you very much and great to do it in person as well for once.

GORMAN: Thank you. Yeah, thanks for coming over Wilf.

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Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver
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