Speaker 1: Hello, and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Allaway and I'm Joe. WI isn't all Joe.
Speaker 1: I feel like it's pretty hard to be an investment
Speaker 1: manager at the moment, Like I feel, I feel like
Speaker 1: it's hard at the best of times, but at the
Speaker 1: moment you have this intense volatility. So stuff that is
Speaker 1: normally volatile, like stocks and commodities, is even more volatile.
Speaker 1: And then you have stuff that isn't really supposed to
Speaker 1: be volatile but definitely is in the new environment. And
Speaker 1: I'm thinking mostly about bonds well, and also, you know,
Speaker 1: the underlying macro situation is just extremely complicated and contested.
Speaker 1: I mean, like there's a debate about whether, you know,
Speaker 1: the last two quarters considered are characterized as a recession,
Speaker 1: and there's kind of legit questions about that in you know,
Speaker 1: setting aside NBA vers two quarters, Like how should you
Speaker 1: call this environment in which consumer sentiment is really low,
Speaker 1: growth is down, employment is booming, inflation is still hot,
Speaker 1: consumption is still high. Like these are just like really difficult,
Speaker 1: uh environments understanding part because it is kind of unprecedented. Yeah,
Speaker 1: and it seems like everyone kind of feels bad, and
Speaker 1: all the survey based economic measures suggest that sentiment is deteriorating,
Speaker 1: but at the same time, the hard numbers are really resilient,
Speaker 1: so actual spending and investment just keep going. And yeah,
Speaker 1: you're right, it's a really weird environment, particularly if you're
Speaker 1: trying to put money to work. And then I would say,
Speaker 1: over the last two years, like everyone kind of got
Speaker 1: it wrong at every turn, right, Like everyone said, Okay,
Speaker 1: COVID hit in early. Here comes a big downturn and
Speaker 1: a recession, and it's like, actually, we had the shortest
Speaker 1: recession in history, and then stocks were at all time
Speaker 1: has a few months later, then you know, fast forward
Speaker 1: a little bit to people are super positive. Yeah, inflation
Speaker 1: was ticking up, but he's likely transitory. It's like reopening.
Speaker 1: And everyone got that wrong, particularly a lot of investors,
Speaker 1: judging by the reprist how fast the repricing happened. The
Speaker 1: FED had to pivot pretty quickly when it realized inflation
Speaker 1: would persist for longer than expected. Pivot really started in November.
Speaker 1: So it's like, at no point has it felt like
Speaker 1: the consensus has been like had a good feel on
Speaker 1: this cycle. At no point has it felt like anyone
Speaker 1: really knows what's going on? Correct, is that what you're saying? Yeah? Okay.
Speaker 1: On that note, we are going to be speaking with
Speaker 1: someone about all of these very very big topics. Really
Speaker 1: the perfect guest we're going to be speaking with Dan Ivson.
Speaker 1: He is, of course the group Chief Investment Officer and
Speaker 1: Managing Director over at pimco's Newport Beach. For those that
Speaker 1: don't know Pimco, I mean you must know Pimco. But
Speaker 1: PIMCO has something like two trillion dollars worth of assets
Speaker 1: under management, so making these tough decisions about out the
Speaker 1: macro outlook and where to actually invest every day. So Dan,
Speaker 1: thank you so much for coming on all thoughts. Well,
Speaker 1: thank you Tracy and Joe. It's very excited to be
Speaker 1: here today. So you sit on Pimcoe's investment committee, I'm
Speaker 1: really curious what's top of mind for the people who
Speaker 1: have to do something with two trillion dollars worth of
Speaker 1: assets every day? You know, what are you guys talking
Speaker 1: about and what's what's um on the on the top
Speaker 1: of the agenda for you at the moment. Sure, well,
Speaker 1: you know, inflation is is certainly a topic. As you
Speaker 1: mentioned this has been an incredibly challenging time from economic
Speaker 1: forecasting perspective, First the global pandemic, than an unprecedented amount
Speaker 1: of fiscal stimulus, and now an inflation problem that at
Speaker 1: least is partially related to those two prior points. So
Speaker 1: increasingly we're spending a lot of time talking about this
Speaker 1: inflation dynamic. Of course, um, how policy makers are going
Speaker 1: to you'll look to look to you know, get inflation
Speaker 1: back towards their targets. And now increasingly markets are seeing
Speaker 1: what has you know, historically been um, a fairly obvious
Speaker 1: trade off, and that's you know, growth employment, uh, and
Speaker 1: this inflation problem and how will that be balanced over time?
Speaker 1: In addition to that, of course, we're not you know,
Speaker 1: operating in a normal environment. We have war in Europe,
Speaker 1: lots of uncertainty, and ongoing global tension between the United States,
Speaker 1: you know, other Western countries in China. So there's just
Speaker 1: a lot of uncertainty, UM, a lot of risk, and
Speaker 1: we're trying to gain sufficiently broad perspectives to see where
Speaker 1: we may have an edge. And I think it's important
Speaker 1: in an environment as highly uncertain as this one to
Speaker 1: realize when you know, at a particular point in time,
Speaker 1: you don't have an edge and where um your entering
Speaker 1: markets that represent a lot of risk, a lot of volatility,
Speaker 1: and I think there's a risk management piece here as well. Um,
Speaker 1: there's enough volatility where we should be able to zero
Speaker 1: in on areas where we do have an edge, where
Speaker 1: we can't add value while looking to shelter the portfolio
Speaker 1: from a lot of the unwanted volatility that we're seeing
Speaker 1: elsewhere in markets. Um So, So that's one key theme.
Speaker 1: The second, of course, is a lot of real time
Speaker 1: discussions around this volatility that we witnessed beneath the surface.
Speaker 1: A lot of dispersion across equity markets, in fixed INCA markets,
Speaker 1: a lot of you know, localized overshooting. Given markets aren't
Speaker 1: super liquid, um, they don't feel distressed, but certainly a
Speaker 1: type of environment where there's you know, you using a
Speaker 1: baseball analogy, a lot of singles, um, you know to
Speaker 1: hit while you gotta be careful, you know, swinging for
Speaker 1: a home run given this radical uncertainty and the fact
Speaker 1: that you can get you know, caught off sides pretty
Speaker 1: quickly in this type of market. So what do you
Speaker 1: talk a little bit more about, you know, you said
Speaker 1: identifying your own sources of edge, like what are they?
Speaker 1: You know, And I want to get to the actual
Speaker 1: market environment you're outlook for inflation and bonds and all that.
Speaker 1: But when you think about, like where sources of edge
Speaker 1: come from an environment like this, Like what's the answer
Speaker 1: to that? Well, I think think one lates to UM.
Speaker 1: You know, markets that are are less liquid than they've
Speaker 1: been in the past, UM, and and opportunities to take
Speaker 1: advantage of some overshooting UM. Perhaps a good example is
Speaker 1: more recently over the last few weeks, or or maybe
Speaker 1: going back several weeks, where UM equities work quite weak.
Speaker 1: UM credit spreads were widening and widening fairly significantly, big
Speaker 1: upticks in the various volatility markets UM, you know volatility.
Speaker 1: Volatility market could be an agency mortgage, but it could
Speaker 1: also be more technical you know volatility markets. And you know,
Speaker 1: we've seen even over the course of this summer, various
Speaker 1: UM levered players you know, other other you know, specially
Speaker 1: type styles get a bit over their skis for risk
Speaker 1: perspective and part of the stack back that we witnessed
Speaker 1: over the last several weeks and you know, pretty powerful
Speaker 1: recovery into what appeared to be you know, bad fundamental
Speaker 1: news is tied to you know a little bit of
Speaker 1: this UM this this positioning that was a bit off sides.
Speaker 1: So you mentioned how unusual the economic environment has been,
Speaker 1: and I feel like this is the source of tensions
Speaker 1: or problems for a lot of investors at the moment.
Speaker 1: Like we're used to thinking about a normal economic cycle.
Speaker 1: You know, it starts and then at some point it stops.
Speaker 1: But it feels like what we've seen post pandemic is
Speaker 1: is not a normal economic cycle at all. How would
Speaker 1: you characterize it, Like, how are you thinking about it?
Speaker 1: Is this late cycle? Is it early cycle? It seems
Speaker 1: very confusing at the moment, A cycle outside the cycle? Yeah,
Speaker 1: is it even a cycle? Who knows? Yeah? I think
Speaker 1: the multiple cycles or or at least significant cross currents UM.
Speaker 1: I think when you look at cycles, I think it's
Speaker 1: important to make the distinction between a lot of the
Speaker 1: Western economies and what's going on in China right now,
Speaker 1: UM get to a lot of us UM COVID is
Speaker 1: mostly behind us, and where in the midst of a
Speaker 1: pretty significant COVID related reopening process, very strong demand for
Speaker 1: travel services shift away in in in many economies from
Speaker 1: UM COVID related goods consumption towards you know, a more
Speaker 1: normalized um. You know, focus on areas associated with a
Speaker 1: more more traditional and open economy. Over in China now
Speaker 1: they're dealing with COVID. Other Asian countries are to a
Speaker 1: lesser degree, and they're in the midst of an environment,
Speaker 1: you know, where economic growth is slow and slowing uh,
Speaker 1: and inflation isn't a material problem. And then back to
Speaker 1: you know, even the US economy very very different or
Speaker 1: difficult to understand in the sense that we do have
Speaker 1: significant momentum and a lot of sectors. Yet we're quickly
Speaker 1: beginning to see the impact of prior policy tightening on
Speaker 1: some carry key areas of the economy as well. So
Speaker 1: you know, the level of complexity is is there. But again,
Speaker 1: you know, when you have an inflation problem and you
Speaker 1: have policymakers looking at tighten policy, you're going to get
Speaker 1: into a situation where it's almost certain that you're gonna
Speaker 1: see some economic weakness. And then of course the channel
Speaker 1: so then becomes, you know, how does this economic weakness
Speaker 1: impact inflation? UH? Is there a chance of a soft
Speaker 1: landing or do we have a situation where probabilities are
Speaker 1: growing and growing fairly rapidly, that we end up in
Speaker 1: a recessionary environment. Of course, those different scenarios have very
Speaker 1: different implications on what segments of the opportunities set are
Speaker 1: going to perform well, both an absolute and relative terms. Well,
Speaker 1: let's just get right into that. And of course there's
Speaker 1: an econ debate. You have folks like Larry Summers and
Speaker 1: Olivia Blanchard saying like, look, it is, it is unrealistic.
Speaker 1: It's wishful thinking to say that we can really get
Speaker 1: inflation back down to any reasonable level without having a
Speaker 1: meaningful rise, a significant rise in the unemployment rate. Do
Speaker 1: you buy that or do you think? I mean, because
Speaker 1: I think this is the multi trillion dollar question right now.
Speaker 1: Can the Fed get back to target without a painful recession? Yeah? So,
Speaker 1: I I think histories on their side. Uh, you don't
Speaker 1: see a lot of breads Summers and Blanched for sure,
Speaker 1: But there's certainly a chance that we that we um
Speaker 1: see what will feel like a somewhat soft landing. Now.
Speaker 1: You know, here at PIMCO, we still think core CPI
Speaker 1: at the end of this year is gonna remain elevated
Speaker 1: up near that five and a half percent type range
Speaker 1: even out you know, towards the end of twenty three,
Speaker 1: and I take that forecast with it with a great assault,
Speaker 1: given extreme uncertainty, But we don't see inflation getting back
Speaker 1: below three and a half percent, you know, all the
Speaker 1: way out to three. So we do think that the
Speaker 1: likelihood is the FEDS going to need to tighten, and
Speaker 1: tighten fairly significantly from here. But we do think there's
Speaker 1: at least a shot of a somewhat soft landing. We think,
Speaker 1: you know, officially, you know, we're gonna have a recession.
Speaker 1: It could be a prolonged but fairly mild recession. But
Speaker 1: but again, um, one of the bright spots, if if
Speaker 1: there is a bright spot here, is that you know,
Speaker 1: over the last few cycles, there appears to be a
Speaker 1: strong and increasingly strong relationship between the financial economy and
Speaker 1: the real economy. And you've already seen in response to
Speaker 1: moderate tightening thus far, a pretty significant impact on financial conditions.
Speaker 1: Now they've loosened over the course of the last several weeks,
Speaker 1: but that transmission mechanism appears to be working and working
Speaker 1: fairly quickly. So again, we have an economy with very
Speaker 1: strong momentum, particularly on the wage of the employment side. Uh,
Speaker 1: and a FED in other central banks that have tightened
Speaker 1: and it appears that they're having an impact on recent
Speaker 1: economic activity. Um. So there is a path that I
Speaker 1: would define as a moderate slowdown, in a slowdown that
Speaker 1: doesn't have a material impact on overall credit fundamentals and
Speaker 1: would probably put a twenty or thirty percent type probability
Speaker 1: to that type of scenario. Again, UM, you know, anytime
Speaker 1: you have headline inflation up in the nine percent type range, unprecedented, UM,
Speaker 1: at least for you know, several decades in a lot
Speaker 1: of geopolitical risk, including war in Europe, which could deteriorate
Speaker 1: very very quickly. Uh, you have to position yourself, you know,
Speaker 1: for at least a meaningful probability of war, material economic
Speaker 1: slowdown and what that means. Of course, under that state
Speaker 1: of the world, you have a lot more widening to
Speaker 1: go across most credit sectors. You probably have significant earnings
Speaker 1: UM deterioration from this point forward, which will likely lead
Speaker 1: to weakness and equity markets as well. So you know again, UM,
Speaker 1: you know, our general view is that we have a
Speaker 1: fairly mild but sustained recession. That's why we continue to
Speaker 1: be fairly cautious regarding the more credited sensitive sectors of
Speaker 1: the market. But again that's one of a handful of
Speaker 1: credible scenarios. And and again you have to prepare for
Speaker 1: the worst as an investor, um and that means, you know,
Speaker 1: thinking about preserving capital given the radical uncertainty as much
Speaker 1: it does, you know, aggressively positioning to you know, generate
Speaker 1: total return, particularly in those riskier segments of the market.
Speaker 1: You know, Joe mentioned at the beginning of this conversation
Speaker 1: that a lot of people got it wrong on inflation.
Speaker 1: And I'm not just talking about the FED, of course, um,
Speaker 1: which you know doubled down on the transitory idea a
Speaker 1: number of times. But I'm thinking also just of the
Speaker 1: broader market. You know, you look at break evens and
Speaker 1: those were continuously expecting inflation to peak within a few months,
Speaker 1: um and that hasn't really come to pass. What do
Speaker 1: you think people got wrong about the inflation outlook? What
Speaker 1: was it that the market seemed to miss? Yeah, I
Speaker 1: think a lot of participants, you know, we're looking at
Speaker 1: an inflationary process and traditional sense. I think the pandemic
Speaker 1: itself was quite confusing, and of course had direct supply
Speaker 1: side impacts on the global economy. And UH, even more importantly, UM,
Speaker 1: the policy response on the fiscal side was massive, UM,
Speaker 1: and and and and massive, sufficiently massive that again, we
Speaker 1: haven't had a lot of good case studies in history
Speaker 1: and dealing what's with such a significant demand side boost
Speaker 1: at a time where you already had significant COVID related
Speaker 1: supply constraints. So you know, it's an unprecedented situation. We
Speaker 1: talked earlier about you know, these cross currents, you know,
Speaker 1: impacting economies, making an even harder to forecast. And I
Speaker 1: think you know, in some sense, you know, we all
Speaker 1: or many of us were you know, using you know,
Speaker 1: prior frameworks at least initially to think about it into
Speaker 1: forecast this inflationary process. Now your points are you know,
Speaker 1: a good one. UM. You know, even even you know
Speaker 1: market pricing UM didn't envision you know, this level of
Speaker 1: inflation or how sustained this inflation would be. But at
Speaker 1: the same time, when you look today at longer term
Speaker 1: measures of inflationary risk within markets, UH, they too are
Speaker 1: fairly complacent. And if markets proved to be right, UM,
Speaker 1: then in fact, UM, this inflationary event may prove to
Speaker 1: be fairly temporary. So it is remarkable if you said,
Speaker 1: you know, inflation would be you know up at nine percent,
Speaker 1: people would be talking about a FED you know, well
Speaker 1: behind the curve and you would have a ten year
Speaker 1: break even inflation rate below two and a half percent.
Speaker 1: Or looking at a popular rate, we look at a
Speaker 1: forward rate, like a five year forward five year rate, uh,
Speaker 1: well below two and a half percent, or yield curve
Speaker 1: for that matter, today that is fairly flat um or
Speaker 1: you know, slightly inverted at levels below three percent. So
Speaker 1: you know, in some sense, um, although policymakers and investors
Speaker 1: were late, uh, you wouldn't have made a tremendous amount
Speaker 1: of money through a significant bet on inflation unless you
Speaker 1: happen to be in some of those commodity markets, and
Speaker 1: particularly the commodity markets that have been impacted as much
Speaker 1: by the conflict in Ukraine as they were you know,
Speaker 1: tied to this inflationary trend that we've been discussing. So again,
Speaker 1: markets still may be wrong. There's still plenty of uncertainty
Speaker 1: around this inflation dynamic on a go forward basis, but
Speaker 1: it is um, you know, quite interesting that um, although
Speaker 1: you know, people were late, markets are suggesting that perhaps
Speaker 1: things can be just fine um with with a bit
Speaker 1: more policy Titan. Yeah, some of these medium term break
Speaker 1: even measures or five year five year forward break evens
Speaker 1: never really got two out of hand and are kind
Speaker 1: of a normal range. That Big said. The other phenomenon
Speaker 1: this year is I don't want to say the FED
Speaker 1: has been behind the curve per se, because that's a
Speaker 1: little bit of a cliche and I'm never even totally
Speaker 1: sure what it means. But I would say that it
Speaker 1: does seem as though at each meeting they're sort of
Speaker 1: expressing some hope or optimism that Okay, we think we're
Speaker 1: getting closer to air, we're uh in a neutral range,
Speaker 1: we're not going to go as hard. And then some
Speaker 1: other data point comes out and it's like, whoop's time
Speaker 1: to increase, uh, time to go faster again. And so
Speaker 1: we got that seventy five. Maybe those hope was going
Speaker 1: to go down another seventy five. Uh Still we're sort of,
Speaker 1: you know, uh than police believes that policy is close
Speaker 1: to neutral. Are we at a place where maybe the
Speaker 1: FED UH is in a comfortable spot, or do you think,
Speaker 1: as you said, you think there's going to still be
Speaker 1: significant tightening from here that once again the FED might
Speaker 1: have to go a little harder than it hopes in
Speaker 1: the short term, at least in order to constrain inflation. Yeah,
Speaker 1: you know, first of all, you know, policy bakers tend
Speaker 1: to you know, you know, they'll, they'll, they'll, they'll tend
Speaker 1: to have an optimistic spin on things. But you know,
Speaker 1: certainly the price action of late suggests that what central
Speaker 1: banks have done so far are beginning to have an
Speaker 1: impact on economic growth. And um, it's not um a
Speaker 1: you know, a view that hard landings around the corner.
Speaker 1: Um credit spreads tightened over a hundred basis points, you know,
Speaker 1: using you know, using high yield as as a proxy.
Speaker 1: We've seen a significant you know, bouncing in equity valuations
Speaker 1: in the midst of moderate deterioration and a lot of
Speaker 1: the forward economic indicators. So relative to where we were
Speaker 1: several weeks ago, the FET has to be reasonably pleased
Speaker 1: with the impact of their policy decisions thus far. And
Speaker 1: I think although Powell may have um, you know, slipped
Speaker 1: up a touch in suggesting, you know, with a high
Speaker 1: degree of confidence that we're we're implied degree of confidence
Speaker 1: that we're in your neutral right now, I think the
Speaker 1: key point was that, UM, we can begin to focus
Speaker 1: a bit more on the data. UM, you have seen
Speaker 1: the beginning of some you know, material signs of economic
Speaker 1: slowing in a world with massive uncertainty of geopolitical variety
Speaker 1: or traditional economic variety. So I think they're they're they're
Speaker 1: they're comfortable in the sense that they've have gotten to
Speaker 1: a point where they seem to have calm markets over
Speaker 1: the short term. This could change very very quickly. And
Speaker 1: when we look at you know, nine percent headline inflation rate,
Speaker 1: which is likely at least the near term peak, they
Speaker 1: have a lot of work to do UM, and we
Speaker 1: do think that they likely will need to tighten a
Speaker 1: bit more than what's currently embedded in the front end
Speaker 1: of yield curves. We don't think they were wildly far away.
Speaker 1: We still have thought that you know, three and a
Speaker 1: half or four percent type funds rate combined with material
Speaker 1: balance sheet reduction will likely be enough UM to UM
Speaker 1: slow the economy and get inflation back towards their target.
Speaker 1: Another hundred and fifty basis points of tightening more or
Speaker 1: less is what you see that would be right, Yeah,
Speaker 1: one fifty, But you know, again, even under that base
Speaker 1: case scenario. You know, we're not back to core CPI
Speaker 1: levels UM that you know, UM within most central bank
Speaker 1: target zones until you know, probably out into and there
Speaker 1: can be a lot of shocks of the interim, some
Speaker 1: that may be helpful, UM you take to getting inflation
Speaker 1: back down towards target, several events that may not be helpful.
Speaker 1: And again I think humility has got to be the
Speaker 1: key point here. But we think about inflation, when we
Speaker 1: think about inflations impact on the developed markets, UM, you
Speaker 1: have to be a meteorologist as well. UM. You know
Speaker 1: you're going to go into a period UM in Europe
Speaker 1: in particular, temperatures get cold, with massive uncertainty around energy
Speaker 1: supplies and with Russia UM holding the cards at least
Speaker 1: for the time being. So there there are a lot
Speaker 1: of events that can derail UM the more positive scenarios
Speaker 1: that we've described and have been embedded in market pricing. Again,
Speaker 1: one of the reasons when we add up all of
Speaker 1: these sources of uncertainty, we see, you know, the type
Speaker 1: of rally that we've gotten across financial markets over the
Speaker 1: last several weeks, and we're inclined, you know, to take
Speaker 1: a few chips off the table um get get get away,
Speaker 1: or reduce exposure to the economically sensitive areas of the market.
Speaker 1: Not because our base case view UM is so dire.
Speaker 1: It's just that this extreme uncertainty is such um that
Speaker 1: that investors should just be careful in some of those
Speaker 1: more credit sensitive investments where you know, essentially there are
Speaker 1: forms of of of of a short volatility type trade,
Speaker 1: and given that extreme uncertainty, we just don't think, you know,
Speaker 1: you're getting paid enough just yet at these levels to
Speaker 1: be overly aggressive in the those more economically sensitive areas
Speaker 1: are higher yielding areas of the opportunity set. It's a generalization.
Speaker 1: There's there's a certainly you know, things you can do,
Speaker 1: you know, on the margin, but that's our general thinking.
Speaker 1: You know, given where we are today, can you talk
Speaker 1: a little bit more about how you see the credit
Speaker 1: market at the moment, because I feel like, obviously, whenever
Speaker 1: there's concern about a recession, a lot of those worries
Speaker 1: are going to seep into corporate bonds um, which are
Speaker 1: economically sensitive, as you mentioned. But then secondly, even before
Speaker 1: the pandemic, I think there was quite a lot of
Speaker 1: concern about froth in various portions of the credit market
Speaker 1: things being overvalued and potentially a liquid when the time
Speaker 1: came to sell. So how are you viewing that space
Speaker 1: at the moment? Where are their opportunities and what's most vulnerable? Sure, so,
Speaker 1: you know, just just at a very high level, and
Speaker 1: I think there's a lot, a lot of interesting things
Speaker 1: going on, you know, within the credit markets. Um, you know,
Speaker 1: we were adding some credit um you know, back you
Speaker 1: know several weeks ago, when you know, how yal corporate
Speaker 1: bond spreads you know, had gotten out to the north
Speaker 1: of six hundred basis points. We thought they're you know,
Speaker 1: looking at historical analysis and and thinking about embedded our
Speaker 1: recession probabilities and those spreads the credit markets were, um,
Speaker 1: you know, forecasting a very high probability of at least
Speaker 1: a moderate recession. After the rally. Now, over the course
Speaker 1: of the last several weeks, um spreads look less interesting
Speaker 1: to us. Uh, the embedded probability and in credit spreads
Speaker 1: currently of a more moderate recession is dropped, you know,
Speaker 1: down towards you know somewhere in that you know type areas.
Speaker 1: So a little bit less interesting today. But back in
Speaker 1: terms of thinking about the credit market and the structure
Speaker 1: of the credit market. You know, a few thoughts here,
Speaker 1: UM One, Since the Global Financial Crisis, you've had massive
Speaker 1: regulation impacting the real estate areas of the credit markets,
Speaker 1: asset back markets, UM, the market. The financial sector, as
Speaker 1: we know, is heavily regulated today. UH not coincidentally, these
Speaker 1: are all the areas that caused all the problems during
Speaker 1: the GFC. UH. Non financial corporate credit growth in terms
Speaker 1: of issuance has been significant, both public and private markets,
Speaker 1: and that's where you know, even you know, before COVID,
Speaker 1: we did see a meaningful deterioration in underwriting standards, more
Speaker 1: corporate leverage, more aggressive rating agency framework around UM, you know,
Speaker 1: putting their ratings on certain types of risk, far fewer covenants,
Speaker 1: and when there were covenants, not particularly strong covenants. We
Speaker 1: also saw a significant build out our growth in the
Speaker 1: private markets, which are inherently lower quality lending markets. So
Speaker 1: this is where we think there's the weak link this time.
Speaker 1: If we were to get into a broad economic slowdown. UH.
Speaker 1: Public markets have repriced, and they've repriced quite significantly in
Speaker 1: certain sectors and segments of the market. Private credit markets,
Speaker 1: that always move a lot more slowly, have lagged and
Speaker 1: lagged considerably. That dynamic is true within the real estate
Speaker 1: credit markets as well. If you look at what type
Speaker 1: of spread you can obtain for like risk in a
Speaker 1: public CMBs security versus you know where lending is going
Speaker 1: on currently in the private space. So I think point
Speaker 1: number one, um, it's the corporate credit sectors where there's
Speaker 1: the most excess. It's nowhere near the type of excess
Speaker 1: we saw uh in the mortgage credit markets leading up
Speaker 1: to the global financial crisis. So don't want to set
Speaker 1: over the alarming, but this is probably the weakest link
Speaker 1: in the credit chain and where there will be some
Speaker 1: interesting opportunities for fresh balance sheets, fresh band dates to
Speaker 1: take advantage of what will likely be a moderate default
Speaker 1: cycle over the course of the next few years. And
Speaker 1: then again, if you have you know, a public band
Speaker 1: date that's repriced quite significantly versus other private markets, it
Speaker 1: makes sense to take advantage of those opportunities because over
Speaker 1: time there's going to need to be convergence. It can
Speaker 1: converge with public markets recovering. More likely it will converge
Speaker 1: by gradual deterioration in marks in a widening of spread
Speaker 1: levels in the private sector as well, and then the
Speaker 1: last point, I'll make all those areas I mentioned earlier
Speaker 1: that have been heavily regulated since the global financial crisis,
Speaker 1: we think present tremendous opportunity for investors. People still get
Speaker 1: nervous today about housing related risk. Banks continue to trade
Speaker 1: in a very volatile fashion. Um. They are well capitalized,
Speaker 1: and the mortgage credit market is near pristine um in
Speaker 1: terms of you know, the borrower qualifications necessary to get
Speaker 1: a loan over you know, the last decade or so.
Speaker 1: So and those are some high level thoughts, um. And
Speaker 1: again consistent with the way we're positioned across portfolios. Of course, UM,
Speaker 1: you know there's a difference you know, and where when
Speaker 1: we're operating in mutual fund space versus your longer locked
Speaker 1: up alternative vehicles. But those say general principles are the
Speaker 1: principles we're adhering to at this stage in the economic cycle.
Speaker 1: So my next question is completely out of self interest,
Speaker 1: but I I bought a house in in February of
Speaker 1: this year. Did I top tick the market? And then secondly, secondly,
Speaker 1: you know, you mentioned taking on some housing exposure or
Speaker 1: real estate exposure, and I'm curious what the opportunity is
Speaker 1: there exactly because We have seen a lot of people
Speaker 1: worry about the fact that house prices shot up post pandemic,
Speaker 1: secondly the fact that mortgage rates have shot up. And
Speaker 1: then thirdly there's been some sort of market structure weirdness
Speaker 1: within the arena of mortgage backed securities um where things.
Speaker 1: You know, for a while it looked like the market
Speaker 1: was sort of like creaking a little bit at the
Speaker 1: edges as rates went up very very quickly. So how
Speaker 1: are you balancing that? Can you just dig into housing
Speaker 1: a little bit more for us? Sure? So you may
Speaker 1: have top ticked the market if you set all the
Speaker 1: details to our Our mortgage team you know, will run
Speaker 1: some numbers and let you know just how much you're
Speaker 1: top ticked by. But that's a good actually offering that
Speaker 1: service to that's a really nice service. Trace you gotta
Speaker 1: take them up of that. Ye tell me how wrong
Speaker 1: I was. Yeah, it is a little frightening how much
Speaker 1: mortgage data of a highly granular fashion is out there nowadays.
Speaker 1: But um but now in terms of housing, um so,
Speaker 1: so you know, we do think housing is going to
Speaker 1: slow and slow significantly. We think on a national basis,
Speaker 1: housing is likely to decline in real terms or inflation
Speaker 1: adjusted terms over the worse of the next few years.
Speaker 1: Our base case view is that home prices UM stabilized
Speaker 1: near zero growth or you know, very very low single
Speaker 1: digit type growth rates, but it would not be surprising
Speaker 1: and it wouldn't necessarily have to be overly alarming if
Speaker 1: you saw, if you see home prices decline on a
Speaker 1: national basis now similar to the comments I earlier, you know,
Speaker 1: on on on the complicated you know, economic environment. Housing
Speaker 1: markets are complicated as well. UM. As we know, there's
Speaker 1: been a massive shift in preferences since the COVID pandemic,
Speaker 1: desire to live further from the office. Certain vacation and
Speaker 1: resort communities UM have gone up in price quite significantly.
Speaker 1: In some areas there's more land scarcity than others. So
Speaker 1: they are gonna be pockets UM where you saw a
Speaker 1: big increase in demand, where they're gonna be outright price declines. UM.
Speaker 1: You're gonna hear over the course of the next several
Speaker 1: months more headlines around price reductions, price declineings. UM. A
Speaker 1: lot of stories in that regard, And I think if
Speaker 1: you're underwriting a new pool of mortgages, particularly higher risk
Speaker 1: type investments, you have to be very very granular and
Speaker 1: very very careful in how you under write that risk.
Speaker 1: But from a macro perspective, there's still too few homes
Speaker 1: in this country and other Western nations relative to the
Speaker 1: number of households that have been formed over the last
Speaker 1: several years. UM, So again that supplied demand dynamic is important.
Speaker 1: Rents remain elevated, so when you think about the buy
Speaker 1: to rent decision, although the cost to own a home
Speaker 1: has gone up, UM, rental rates are going up as well,
Speaker 1: so that switch is less obvious. And then when you
Speaker 1: step back and look at price to incomes, priced to rents,
Speaker 1: the amount of borrower equity that exists, and again you
Speaker 1: have a tremendous about borrower equity today after um several
Speaker 1: years of significant home price growth, and I mentioned earlier
Speaker 1: a near pristine mortgage market. From a credit quality perspective,
Speaker 1: we just don't see a major risk of significant declines
Speaker 1: in housing on a national level. UM. We do expect though,
Speaker 1: and you're already seeing this a rise in inventories, a
Speaker 1: reduction and housing related activity, which is the transmission mechanism
Speaker 1: or one of the transmission mechanisms that's going to help
Speaker 1: slow the economy and eventually bring inflation back down towards
Speaker 1: towards more reasonable levels. The last, but not least, from
Speaker 1: an investment perspective, in housing related areas of the market, UM,
Speaker 1: those investments in many cases aren't tied to um what
Speaker 1: goes on in home prices from here because they've delivered
Speaker 1: so much. So the typical housing related investment you can
Speaker 1: buy today is backed by pools of mortgages that were
Speaker 1: issued again ten or fifteen years ago. UH embedded loan
Speaker 1: of value ratios in those types of investments today have
Speaker 1: fallen from a dent back during the global financial crisis
Speaker 1: down to in most cases today, borrow with sixty points
Speaker 1: of equity and their property even you know, facing moderate
Speaker 1: declines in their current home price are not a big
Speaker 1: default risk. And even if they are, that's the type
Speaker 1: of load where you anticipate a full recovery. So a
Speaker 1: lot of what we like in the market today is
Speaker 1: season type risk that benefits from the multi years of
Speaker 1: home price appreciation and therefor is much less sensitive to
Speaker 1: what goes on from this point forward. Let me go
Speaker 1: to the other side of things. I mean, just trying
Speaker 1: to think of your overall view, it seems like not
Speaker 1: particularly pessimistic. Your outlook isn't particularly dire, but clearly risks
Speaker 1: abound and opportunities to derail or return to a soft landing,
Speaker 1: all kinds of risks out there. I'm curious, though, like
Speaker 1: what is your view right now on if and what
Speaker 1: role treasury should have in people's portfolio, because and I've
Speaker 1: asked versions of this question too many people. It's like,
Speaker 1: for years it was just such a great trade to
Speaker 1: own a slug of tenure treasuries, and they went up
Speaker 1: in the principle appreciated in value, they were a great
Speaker 1: diversifier to risk assets. They usually went up when the
Speaker 1: stock market went down in the short term. And now
Speaker 1: those conditions are obviously changing to some extent. Sixty forty
Speaker 1: type portfolios got club that coupon that you're getting each
Speaker 1: year is getting swallowed up big time by inflation. Is
Speaker 1: there a role for what is the role for treasury ownership? Yeah,
Speaker 1: that that's a great question. And uh, of course, you
Speaker 1: know what you're getting out is a correlation argument. Um,
Speaker 1: you know, are we gonna have are we are we
Speaker 1: gonna get back? Can we get back? Then you'll uh
Speaker 1: to to a degree and I think you're you're you're
Speaker 1: witnessing this um now with the recent rally that we've
Speaker 1: seen in government bond markets, elevated geopolitical risk um, you know,
Speaker 1: both both in Europe and in the China cityation signs
Speaker 1: of deteriorating economy and elevated risks of recession, and now
Speaker 1: government bonds are beginning to rally, um, you know on
Speaker 1: that type of news. Now, you know, we think you
Speaker 1: get better protection, you know, up when a ten year
Speaker 1: treasury is at three and a half percent versus you
Speaker 1: closer to two and a half percent. But we do
Speaker 1: still think high quality bonds at these higher yield levels
Speaker 1: will provide some insurance benefit now locally and by locally,
Speaker 1: I mean you know, during you know, small moves and markets.
Speaker 1: We don't think you know, you're gonna you know, we
Speaker 1: we we think correlation is going to be much lower
Speaker 1: than they've been in the past. I think that's gonna
Speaker 1: be the case as long as inflation remains a key
Speaker 1: risk facing financial markets. But if inflation begins to trend
Speaker 1: lower towards central bank ranges, so again, exiting this this
Speaker 1: post COVID period of elevated inflation, we do think you
Speaker 1: can revert back to more traditional correlations and high quality
Speaker 1: bond can you know, provide stronger protections or stronger diversifying
Speaker 1: benefits for UM a multi asset type portfolio. But for
Speaker 1: the time being, and by the time being, I mean
Speaker 1: the next several quarters, those correlation is going to be
Speaker 1: highly unstable. We think an extreme flight to quality situations
Speaker 1: signs of a major hard landing in in the global economy,
Speaker 1: signs of you know, UM deteriorating um UM, a deteriorating
Speaker 1: situation with the war in Europe, or heightened conflict you
Speaker 1: know with China as another example. We think those are
Speaker 1: scenarios that likely lead to lower treasury yields. So the
Speaker 1: bottom line is we wouldn't give up on bonds here.
Speaker 1: I think investors just need to understand that UM, those
Speaker 1: traditional relationships that were fairly strong have weakened and there's
Speaker 1: just more in certainty, at least over the short term.
Speaker 1: In terms of these overall trading relationships. How are you
Speaker 1: hedging volatility nowadays? And who is selling it? Because it
Speaker 1: feels like everyone wants vlatility protection And I can remember,
Speaker 1: you know, once upon a time, not so long ago,
Speaker 1: PIMCO is a big seller of fall protection. But I'm
Speaker 1: assuming you guys aren't doing much of that now. Well,
Speaker 1: we sell a little bit of we sell a little
Speaker 1: bit of volatility explicitly, Um, we didn't talk about agency mortgages. Um.
Speaker 1: You know, these these are are are are interesting investments.
Speaker 1: They benefit from a direct government guarantee or a strong
Speaker 1: agency guarantee, which is always nice. You know, given heightened
Speaker 1: risk of a more material economic slowdown, and they've widen
Speaker 1: and spread a lot. Um they're not quite as cheap
Speaker 1: as they were in the first quarter of but they
Speaker 1: are quite attractive on an option adjusted spread basis relative
Speaker 1: to where they've been historically. So we have been adding
Speaker 1: back some agency mortgage backed securities. In an agency mortgage
Speaker 1: backed security represents a form of a volatility sale. We've
Speaker 1: also on a targeted basis, have have have taken advantage
Speaker 1: of some volatility sales in the option markets. That's one
Speaker 1: of the areas I mentioned earlier where you know, a
Speaker 1: lot of the hedge funds other specialist managers have been
Speaker 1: caught offside given the significant moves and realize volatility, and
Speaker 1: there has been a few opportunities to provide liquidity UM
Speaker 1: and and and and take on some of that risk
Speaker 1: at what we think are attractive levels. But the way
Speaker 1: that we're we're dealing with volatility uncertainty now is is
Speaker 1: really staying up in quality in terms of our investments.
Speaker 1: And you know, I mentioned that we've been reluctant to
Speaker 1: aggressively add to the weaker areas of the credit markets
Speaker 1: where your short volatility from a more implicit perspective um
Speaker 1: so across a lot of our portfolios today, we've been
Speaker 1: taking advantage of the widening in areas of the market
Speaker 1: that represents spread risk, not material risk of permanent capital impairment.
Speaker 1: And I mentioned agency mortgages in that category. I mentioned
Speaker 1: the non agency of the non government guaranteed mortgages. I
Speaker 1: mentioned the banks where we have high degree of conviction
Speaker 1: that although those spreads will remain volatile, most banks, particularly
Speaker 1: US banks a bit more isolated from the European uncertainty,
Speaker 1: are tremendously well capitalized and not taking um significant risks
Speaker 1: at the moment. And then there's a whole slew of
Speaker 1: other triple A and double A type risk high quality
Speaker 1: municipal bonds, other areas of the acid back sectors. We
Speaker 1: have a lot of hard collateral and additional subordination. These
Speaker 1: are all areas that should be resilient in a period
Speaker 1: of heightened volatility and which in some cases of widening
Speaker 1: sympathy with these other markets that are much more sensitive
Speaker 1: the credit fundamentals. Where are the areas that you see
Speaker 1: are particularly sensitive to credit fundamentals that you want to
Speaker 1: avoid because you don't want to deal with actual impairment.
Speaker 1: I mentioned the private markets, um, you know, and I
Speaker 1: again you need to differentiate there what we're referring to
Speaker 1: there would be more traditional direct lending mid market companies
Speaker 1: that tend to struggle in a recessionary environment, you know,
Speaker 1: more so than larger cap names. The other issues within
Speaker 1: the private markets which have which have significantly lagged public
Speaker 1: markets or the senior secured bank loan market as an example,
Speaker 1: is that you have floating great debt, so borrowers within
Speaker 1: that space are seeing a direct impact from FED policy
Speaker 1: in the form of higher debt service costs. Now, some
Speaker 1: of those companies will hedge in the cap markets, but
Speaker 1: typically it's a partial hedge. Several companies won't hedge, and
Speaker 1: it's not easy to tell which companies are hedging and
Speaker 1: which ones aren't. So you know, that's an area of
Speaker 1: the market that's going to be more sensitive to rate
Speaker 1: policy from here. In fact, we anticipate that if the
Speaker 1: FED had to tighten policy materially more than a terminal
Speaker 1: funds rate of three and a half percent, you know,
Speaker 1: you'll begin to see a decent amount of stress on
Speaker 1: that segment of the market. If that higher rate policy
Speaker 1: coincides with EBA dot or earnings deterioration, you can even see,
Speaker 1: you know, more problems from a downgrade perspective in that
Speaker 1: segment of the market. So again, I don't want to sound,
Speaker 1: you know, overly alarmist here, but in terms of looking
Speaker 1: for weaker links in the marketplace, that's where we would focus,
Speaker 1: and that's where we're being most defensive right now in
Speaker 1: terms of overall credit position. So I think you've outlined
Speaker 1: a pretty um sort of cautiously optimistic approach here, or
Speaker 1: maybe cautiously opportunistic where you're sort of selecting quality credits
Speaker 1: and things like that. What would make you feel comfortable
Speaker 1: about taking on either more credit or more interest rate
Speaker 1: risk in general? Like, is there a particular thing if
Speaker 1: you saw that happen in economic data point or something
Speaker 1: in the market where you would just jump right in. Yea.
Speaker 1: So so you know from where we top down perspective
Speaker 1: better valuations as a start, you know, you know, stating
Speaker 1: stating the obvious, Um, you know, if we got up
Speaker 1: to a point where you saw some of these riskier
Speaker 1: segments of the market embed a much higher probability of
Speaker 1: an outright recession, you know we would we would get
Speaker 1: more comfortable. Now you know that that's likely up at
Speaker 1: levels you know, you know, around seven d basis points.
Speaker 1: You know, you know, within the high yield space. Now again,
Speaker 1: you think about high yield in a full blown recession
Speaker 1: and you can get to a thousand basis point type
Speaker 1: spreads quite easily. But as as you approach that level
Speaker 1: um and you embed you know, you know, more risk
Speaker 1: of harder landings. You know, we would begin to add
Speaker 1: to that space a bit more aggressively in terms of
Speaker 1: the fundamental picture, um, you know, really focusing on this
Speaker 1: inflation every process we think headline is is hard to
Speaker 1: forecast and is I'm certainly going to come down based
Speaker 1: on what we're seeing commodity prices today, but other areas
Speaker 1: represented in course cp I are going to bear watching
Speaker 1: as well. One is housing or owner's equivalent rent, it's
Speaker 1: been quite elevated. Another is wages that have been running,
Speaker 1: you know, at levels that are that are making central
Speaker 1: banks uncomfortable. Even related to labor, focus on the labor
Speaker 1: for and seeing you know, what percent of the labor
Speaker 1: force returns to the market, providing some cushion and increasing
Speaker 1: the probabilities that the FED can bring job openings lower
Speaker 1: without a meaningful hit to unemployment. So it's it's really
Speaker 1: the details embedded in a lot of these higher frequency
Speaker 1: economic indicators that we're monitoring more closely. Of course, on
Speaker 1: on the geopolitical side, any type of sign of UM
Speaker 1: a stalemate or an improvement UM in the relationship between
Speaker 1: Russia and Europe, the situation on the ground in Ukraine,
Speaker 1: it would take a considerable risk off the table as well.
Speaker 1: So I just a lot of focus on the higher
Speaker 1: frequency type numbers. But again, even if we don't get
Speaker 1: resolution there, we are going to respond to, you know,
Speaker 1: better valuations, you know, like we did a did a
Speaker 1: bit you know, several weeks ago, you know, at at
Speaker 1: higher yields and materially wider spreads all right down, We're
Speaker 1: going to have to leave it there. Thank you so
Speaker 1: much for coming on Odd Lots. Really great to have
Speaker 1: you on the show. And I'll be sending over my
Speaker 1: my mortgage data to your department so you can tell
Speaker 1: me exactly how bad my timing was on on real
Speaker 1: estate purchases. Well, yeah, well we'll do that. They have
Speaker 1: some pretty pictures too, yeah, they they look real good.
Speaker 1: So Joe, I've really enjoyed that conversation. There were, I
Speaker 1: mean a number of things that stick out, um number
Speaker 1: one to call on real estate, but secondly, when he
Speaker 1: was talking about floating rate loans and the idea of
Speaker 1: some of those companies who had borrowed money in floating
Speaker 1: rate increments like actually becoming a credit risk as interest
Speaker 1: rates go up. That's interesting to me because you'll remember
Speaker 1: that floating rate loans were supposed to be the big
Speaker 1: hedge for higher interest rates, right, Like, those were the
Speaker 1: things you were supposed to buy if inflation was going
Speaker 1: to go up and rates were going to go up.
Speaker 1: And now it's like, well they've gone up too much
Speaker 1: and it might actually be a risk. Right, So if
Speaker 1: you're an owner of those notes, yes you get higher
Speaker 1: monthly coupons, which is nice in a period of higher inflation,
Speaker 1: but the cohort of companies that may have issued that
Speaker 1: the company might go bankrupt are not necessarily the more
Speaker 1: the most credit worthy ones, which raises the risk that
Speaker 1: if we actually get like a real recession, that your
Speaker 1: inflation hedge suddenly you start to worry about loss of
Speaker 1: loss of principle exactly, you know, just in general, I
Speaker 1: thought it was interesting, sort of and basically to the
Speaker 1: point that you just made. You know, we we tend
Speaker 1: to think very broadly about like rate and credit, but
Speaker 1: it was interesting hearing him, you know, sort of speaking
Speaker 1: from the perspective of a of a fixed income investor.
Speaker 1: That's like, you know, credit is just way too broad
Speaker 1: a category, and so you mentioned floating rate it. But
Speaker 1: also some of his point about like highly seasoned reads
Speaker 1: was interesting, this idea that, again, how do you avoid
Speaker 1: credit risk, How do you get some of the how
Speaker 1: do you get some of the upside but avoid the
Speaker 1: credit risk and a downturn. Well, one answer might be
Speaker 1: reads in which the owners are the payers of those
Speaker 1: mortgages have built up significant equities such that you're not
Speaker 1: likely to experience significant defaults. These are all just sort
Speaker 1: of things that are like a little more in depth
Speaker 1: and insightful than sort of a typical like headline credit conversation. Yeah,
Speaker 1: I totally agree, And it sounds like PIMCO. I mean,
Speaker 1: you would assume PIMCO would be very good at doing this,
Speaker 1: but it sounds like PIMCO is sort of they're not
Speaker 1: They're cautious in the market, they're not adding a ton
Speaker 1: of risk, but they are sort of tweaking their portfolio
Speaker 1: for the uncertainties that we just discussed well. And I
Speaker 1: think also, you know, it's is a this is an
Speaker 1: environment with lots of lots of I don't know, land
Speaker 1: mines out there, so to speak, in which you know
Speaker 1: it would be easy to or you know, stepping on
Speaker 1: a rake right and hitting your face, And so this
Speaker 1: idea that like you can be sort of optimistic. You
Speaker 1: think maybe the FED it's possible that it's turned the
Speaker 1: corner or getting ready to make a pivot, that maybe
Speaker 1: we're going to soon see lower CPI readings. We'll have
Speaker 1: some confidence that the line is going down. But there's
Speaker 1: just so many little things that could go wrong. There's politics,
Speaker 1: there's geopolitics, Uh, there's the virus. There's other aspects of
Speaker 1: the supply chain that like it all sort of keeps
Speaker 1: you guessing. Actually recording these interns and outros kind of
Speaker 1: makes me nervous nowadays, because there's so much that could
Speaker 1: happen between the time that we record and when we release. Yeah,
Speaker 1: all right, shall we leave it there? Let's leave it
Speaker 1: there alright. This has been another episode of the All
Speaker 1: Thoughts podcast. I'm Tracy Allowhite. You can follow me on
Speaker 1: Twitter at Tracy Allowhite and I'm Joey Isn't All. You
Speaker 1: can follow me on Twitter at the Stalwart, follow our
Speaker 1: producer Kerman Rodriguez at Carmen Armand, and check out all
Speaker 1: of our podcasts Bloomberg under the handle at podcasts. Thanks
Speaker 1: for listening