Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisenthal and.
Speaker 2: I'm Tracy Alloway.
Speaker 1: Tracy, we just got back from California. We're at the
Speaker 1: future Proof Conference. I love going to southern California.
Speaker 3: I mean, you can't beat Huntington Beach. It was pretty sweet.
Speaker 1: It was so beautiful, it was really cool. We were
Speaker 1: out on the beach.
Speaker 2: We walked out to the pier, watch the.
Speaker 1: Perfect weather, watched the surfers, ate some really good food,
Speaker 1: and had some pretty good conversations about the state of
Speaker 1: financial markets.
Speaker 3: Yep, and we finally got to record an episode that
Speaker 3: we've been meaning to do for a while. We dived
Speaker 3: into not the ocean, but the credit market.
Speaker 1: I guess, like the credit market like comes up here
Speaker 1: or there in various aspects of our conversations. I guess
Speaker 1: typically when we talk about real estate, maybe a little
Speaker 1: bit about the FED. But the credit market is obviously
Speaker 1: so diverse and it's such a its own world that,
Speaker 1: like we really it had been too long since we
Speaker 1: talked about, Okay, what is happening in credit?
Speaker 4: Well.
Speaker 3: Also, I think there was this expectation that as interest
Speaker 3: rates went up, you were going to see lots of
Speaker 3: drama in the credit market, and even though we've seen
Speaker 3: bankruptcies rise a little bit, we haven't really seen the
Speaker 3: big fallout that a lot of people had been expecting.
Speaker 1: Right, And you know, look, the way people think about
Speaker 1: the FED is that it works by tightening credit conditions,
Speaker 1: right like in theory, like that's what like how the
Speaker 1: it's all's supposed to work, as you said, when interest
Speaker 1: rates go up. And yet we have got this rise
Speaker 1: in interest rates. For sure, we definitely see it on
Speaker 1: the mortgage side, like less housing activity, but the sort
Speaker 1: of like broader tightening of like business credit. We certainly
Speaker 1: haven't seen much of a widening in spreads at all.
Speaker 1: So it's a confusing time.
Speaker 3: Absolutely. So we really do have the perfect guest to
Speaker 3: talk about this.
Speaker 1: That's right, our guest. We spoke with Wayne Dall. He's
Speaker 1: a managing director, portfolio manager, an investment risk officer at
Speaker 1: oak Tree. We talk about all things credit. What do
Speaker 1: you see, Why did rates move so hard? Why are
Speaker 1: they still like pressed up against the ceiling.
Speaker 4: We went through a period so long where interest rates
Speaker 4: were very low and money was very easy, and unfortunately,
Speaker 4: during the period of COVID with some of the supply
Speaker 4: chain issues, with a lot of the stimulus that was
Speaker 4: put into the economy, both through the monetary channel and
Speaker 4: the fiscal channel, that really set up kind of the
Speaker 4: perfect storm for demand to go through the roof and
Speaker 4: supply to be diminished, and ultimately we ended up with
Speaker 4: this big inflation push, which, if you go back to
Speaker 4: the formula from the seventies and eighties, how do you
Speaker 4: cure inflation? You raise interest rates quickly, And I think
Speaker 4: that's the playbook that the central banks, not only in
Speaker 4: the US but really globally had no choice but to follow.
Speaker 3: What does risk actually mean to you an oak Tree
Speaker 3: and does it differ from maybe other financial firms definition
Speaker 3: of risk?
Speaker 4: Yeah, that is that is a great question, And anyone
Speaker 4: who's read our chairman Howard Marx's memos knows that he's
Speaker 4: very clear that risk is more than just the masure
Speaker 4: of volatility. I mean when typically at oak Tree, when
Speaker 4: we talk about risk, it is our number one investment philosophy,
Speaker 4: an investment tenant to keep risk under control. Really it's
Speaker 4: to avoid loss. And the tagline there for oak Tree
Speaker 4: is if you avoid the losers, the winners take care
Speaker 4: of themselves. So as credit investors, especially in a market
Speaker 4: like this where yields are high, you want to earn
Speaker 4: that yield and keep that yield and not give it
Speaker 4: back in the form of default. So to us, minimizing
Speaker 4: risk is largely related to kind of minimizing loss for investors.
Speaker 1: All right, let's dive deeper into credit. I mean, let's start, like,
Speaker 1: spreads are still pretty narrow, yeah, and credit is such
Speaker 1: a huge world, so I know we have to like
Speaker 1: go from like slice to slice and slides. But like
Speaker 1: big picture, people don't seem particularly concerned about like defaults.
Speaker 4: Yeah, I mean, look, I think one of the things
Speaker 4: with credit that has changed is largely related to the
Speaker 4: backdrop of interest rates. And to quote Howard again, our chairman.
Speaker 4: You know, he wrote a memo in December called a
Speaker 4: sea change, and in that memo he talked about this
Speaker 4: change in what was a low return world.
Speaker 5: To a high return world.
Speaker 4: And that has really I think shifted the dynamic and
Speaker 4: the expectations around credit. And you're right, have credit spreads
Speaker 4: moved maybe as wide as people thought, No, but the
Speaker 4: yields have become very attractive, and ultimately, I think if
Speaker 4: you look at credit this is something we did a
Speaker 4: lot last year. There's kind of three ways I would
Speaker 4: look at value in fixed income. Number one is what
Speaker 4: is the yield? Well, that was very attractive. Number two,
Speaker 4: what is the price? If I can buy fixed income
Speaker 4: at a discount, then I can you know, earn more
Speaker 4: than just the coupon. And number three what is the spread?
Speaker 4: The first two where it very attractive levels and spreads
Speaker 4: maybe kind of at median levels, but you know, two
Speaker 4: out of three makes a pretty good investment.
Speaker 2: Well, how are you thinking about default risk now?
Speaker 3: Because certainly there were a lot of people, I mean
Speaker 3: just last year in twenty twenty two, who were warning
Speaker 3: about we're going to get this big recession, there's going
Speaker 3: to be a big spike in defaults. We certainly haven't seen,
Speaker 3: you know, the bankruptcy rate has picked up a little bit,
Speaker 3: but we haven't seen this wave of failures that a
Speaker 3: lot of people were predicting.
Speaker 5: Yeah, that is definitely true.
Speaker 4: And I think for part of that, you have to
Speaker 4: think about what happened during COVID, And in a way
Speaker 4: you could almost say COVID was maybe recession part one,
Speaker 4: and we're on our way to recession part two. And
Speaker 4: the reason why I say that is because if you
Speaker 4: think back to the end of twenty nineteen, before COVID,
Speaker 4: the FED had stopped hiking rates in December twenty eighteen,
Speaker 4: and at that time actually had planned to continue to hike.
Speaker 4: Chairman Powell pivoted in early January twenty nineteen and ultimately
Speaker 4: ended the year by cutting rates three times. There were
Speaker 4: a lot of the similar signs of slow down in
Speaker 4: ism data, in industrial production data, a lot of your
Speaker 4: typical signs of a recession. So in a way, COVID
Speaker 4: potentially just accelerated us into a recession that was maybe
Speaker 4: on its way already. But what it also did is
Speaker 4: brought forth a number of defaults. You had, you know,
Speaker 4: default rates in the high yeld bond market, the broadly
Speaker 4: syndicated loan market anywhere from kind of four to six percent,
Speaker 4: And in a way that was kind of a cleansing
Speaker 4: event that prepared us for this time here in the
Speaker 4: high yield bond market. Because of that default rate, you
Speaker 4: cleared out a lot of the lowest rated companies that
Speaker 4: were under the most stress. Simultaneously, you had a number
Speaker 4: of downgrades, so triple B rated securities into double B
Speaker 4: or single b rated into.
Speaker 5: High yield, so you up the quality of.
Speaker 4: The high yeld bond market maximum triple b's, minimum triple c's,
Speaker 4: and kind of created this environment where everybody just refinanced
Speaker 4: at the lowest rates in history and they don't really
Speaker 4: have a cash flow problem or a maturity problem.
Speaker 1: So you anticipated my next question. And I appreciate that
Speaker 1: you brought the twenty nineteen experience because we don't really
Speaker 1: talk about twenty nineteen, but it's that much anymore. But
Speaker 1: of course that was an interesting year. And then so okay,
Speaker 1: so we have these defaults, then then the the pool
Speaker 1: of credit gets better, and then the big turming out
Speaker 1: of debt, so everyone refinances fixed.
Speaker 5: Rate ultra low.
Speaker 1: Talk to us about, like today in September twenty twenty three,
Speaker 1: how that turning out is playing into things now, and like,
Speaker 1: you know, people talk about the maturity wall.
Speaker 2: And no, Joe, you have to say looming maturity.
Speaker 1: That's the rule, the looming maturity wall. Talk to us
Speaker 1: about like the effects we're seeing today from that turning out.
Speaker 4: You're absolutely right, I mean, just to kind of put
Speaker 4: some numbers to that. In twenty twenty and twenty twenty one,
Speaker 4: the highy bond market in the US had gross issuance
Speaker 4: of about eight hundred billion dollars in a one point
Speaker 4: three trillion dollar market, so you had two thirds of
Speaker 4: the market refinance.
Speaker 5: Wow.
Speaker 4: Now today, you're right, we've obviously the the duration has
Speaker 4: shrunk in that market because refinancings have declined. But it
Speaker 4: does kind of become a twenty twenty six maturity, you know,
Speaker 4: kind of problem. Companies don't wait for the last minute
Speaker 4: to refinance their debt. That wouldn't be wise because what
Speaker 4: if the capital markets freeze up, So you kind of
Speaker 4: bring that forward maybe one to one and a half years.
Speaker 4: So I think as we get into twenty twenty four,
Speaker 4: you will start to see a situation where companies are
Speaker 4: going to have to come to the capital markets.
Speaker 5: Well it's not there yet.
Speaker 3: Well I was about to ask, though, because this month
Speaker 3: we have seen a pickup in new issue and so
Speaker 3: what's going on there? Like, why are companies deciding this
Speaker 3: is the moment to start selling new bonds?
Speaker 5: I mean there are certainly companies.
Speaker 4: I mean I can't remember the exact number, Maybe less
Speaker 4: than twenty percent of the market that comes due over
Speaker 4: the next eighteen months. So there is some amount of refinancing.
Speaker 4: There is some capital activity going on, and some of
Speaker 4: it I think is moving exposure from one market to
Speaker 4: another market. If you look at the broadly syndicated loan market,
Speaker 4: that market is made up of floating rate debt. I
Speaker 4: mean there is a market where people's interest cost has
Speaker 4: gone well, it's more than double in the last eighteen months,
Speaker 4: and the high yield market has seen some refinancing out
Speaker 4: of the loan market into secured bonds in the high
Speaker 4: yield market, So there has been some kind of new
Speaker 4: entrance in there as opposed to simply refinancing.
Speaker 1: Other sectors or types of borrowers who, in your view,
Speaker 1: are going to have a trickier time over the next
Speaker 1: eighteen twenty four months as some of these refinancings pick up.
Speaker 4: Well, Like I said, I mean you if you want
Speaker 4: to talk about the places in I'll say that non
Speaker 4: eventvement grade or speculative grade market that's going to have trouble.
Speaker 4: It will, I think potentially be some of these issuers
Speaker 4: in the loan market. And again the reason for that
Speaker 4: is they have seen their cost of financing really go
Speaker 4: up as their index to short rates, which are now
Speaker 4: five and a half percent what type.
Speaker 5: Of borrowers in the loan market.
Speaker 4: So you certainly get you know, exposure to many industries,
Speaker 4: but the loan market today has really shifted into the
Speaker 4: financing source of leverage buyouts. That is the majority of
Speaker 4: the issuance in that market. When you talk about a
Speaker 4: pick up an issuance in the loan market, you're typically expecting,
Speaker 4: you know, a pickup in m and A activity using
Speaker 4: loans to refinance. And one of the biggest areas that's
Speaker 4: seen a lot of m and A activity from private
Speaker 4: equity sponsors over the last few years is in some
Speaker 4: software and technology related business. So that is the largest
Speaker 4: single sector in the loan market today.
Speaker 3: Do you see froth in the leverage loan market, because
Speaker 3: this was an area of concern for I mean years,
Speaker 3: even before COVID, you saw a lot of financial regulators
Speaker 3: start to crack down on you know, capital requirements for
Speaker 3: leverage loans. You saw I should tell a story about
Speaker 3: I was in a bank one time, and I won't
Speaker 3: name the bank, but I was going to see their
Speaker 3: leverage loan bankers and they had a framed T shirt
Speaker 3: in their office that said I stole this shirt off
Speaker 3: my client's back, So that.
Speaker 2: Kind of encapsula I think it would have been.
Speaker 3: Like maybe twenty fifteen, twenty sixteen, it was definitely the
Speaker 3: height of the leverage loan boom.
Speaker 2: But is there froth?
Speaker 4: Look, I mean, there's definitely been frauth in that market,
Speaker 4: and maybe to define that a little more clear, to say,
Speaker 4: there are certainly borrowers that probably you are at risk
Speaker 4: of having extended their balance sheet too much, and in
Speaker 4: the face of borrowing costs or interest rates going so high,
Speaker 4: they've kind of put themselves in a tough situation. I
Speaker 4: think one of the things to remember in the loan
Speaker 4: market that has maybe masked some of the potential volatility
Speaker 4: over the years is the majority of buyers in that market,
Speaker 4: almost seventy percent, are coming from the CLO market or
Speaker 4: clateralized loan obligations, and those buyers are not active traders,
Speaker 4: so you don't see loans traded like you do some
Speaker 4: of the other investment grade bonds, high yield bonds, and
Speaker 4: in a way that can kind of mask some of
Speaker 4: that building volatility.
Speaker 3: Again, one of the stories pre pandemic was this idea
Speaker 3: that a lot of the power in the market had
Speaker 3: shifted from lenders to so the companies who are issuing
Speaker 3: debt or taking out a loan could dictate the terms
Speaker 3: of that deal, and so we saw a lot of
Speaker 3: cove light deals, maybe some sketchy leverage loans. Is that
Speaker 3: still the case or does it feel like the pendulum
Speaker 3: has swung a little bit as interest rates have risen.
Speaker 4: I think in the broadly syndicated loan market that's probably
Speaker 4: still largely the case. There is a lot of demand,
Speaker 4: and obviously over the last call it eighteen months, supply
Speaker 4: has been diminished. So you have people who want to
Speaker 4: buy loans. As institutions, you're competing against CLO's buying loans,
Speaker 4: so that demand has kept up. I think one of
Speaker 4: the places where maybe you have seen a little bit
Speaker 4: more of a shift there is in the private credit
Speaker 4: market that's issuing loans, where interesting you've seen kind of
Speaker 4: a pullback from some of the buyers that were very,
Speaker 4: very active in twenty twenty one, and the either the
Speaker 4: new buyers or continuing buyers have been able to be
Speaker 4: a little bit more strict with their demands for terms.
Speaker 5: Cove things like that, and those deals.
Speaker 1: When a private credit comes up all the time, and
Speaker 1: we probably should even do more on this, But it
Speaker 1: always seems like, for whatever reason, and I don't really
Speaker 1: understand it. I don't know much about the market. For
Speaker 1: whatever reason, it seems like it doesn't matter where the
Speaker 1: cycle is. It just seems like it just grows and
Speaker 1: grows private credit. What's the how does that happen?
Speaker 5: Well?
Speaker 4: I mean, who wouldn't want to put an asset in
Speaker 4: their portfolio that has no volatility and the price doesn't
Speaker 4: Is that.
Speaker 5: Really isn't really that simple? Is it?
Speaker 3: Like?
Speaker 1: Because people say that, I'm like, Oh, can't really be
Speaker 1: like that. They can't really be the story? But is
Speaker 1: that the story?
Speaker 4: I mean, Joe, to date, I think that largely has
Speaker 4: been the story. I mean, you're right, there has been
Speaker 4: a story can to the well, the time will come
Speaker 4: for the day of reckoning of you know, all this
Speaker 4: all this borrowing in this private credit market, all these
Speaker 4: marks that are staying at par are gonna are gonna
Speaker 4: come down, and you know, perhaps we are getting closer
Speaker 4: to that date, but you're right, that really still has
Speaker 4: not been tested, although I think people are preparing a
Speaker 4: little more, you know, for that day to come.
Speaker 1: Every time I hear about like pe or VC or
Speaker 1: private credit, and people are like, well, the biggest nice
Speaker 1: thing is like it doesn't move, and so I'm like,
Speaker 1: that can't be it.
Speaker 5: It can't be that.
Speaker 1: And yet maybe that is a big thing.
Speaker 5: I mean, it has kind of been that easy to date.
Speaker 4: But like I said, I think people are getting a
Speaker 4: little more concerned where you see. You know, I think
Speaker 4: some private credit managers deciding do I want to deploy
Speaker 4: this incremental capital that I can draw down or do
Speaker 4: I need to preserve this to potentially, you know, rescue
Speaker 4: some of the deals that are already in my portfolio.
Speaker 4: I think investors are getting a little more picky as
Speaker 4: well when looking at some of these legacy portfolios, going, hey,
Speaker 4: I like private credit and I like where it's priced today,
Speaker 4: But do I want to buy the portfolio that was
Speaker 4: built in twenty twenty one when money was free?
Speaker 3: Does the rise of private credit affect oat Tree at all?
Speaker 3: And what I mean by that is like, maybe there
Speaker 3: are certain opportunities that end up getting taken by private
Speaker 3: lenders versus publicly traded. You know, a company will decide
Speaker 3: I'm going to do a private deal. There's a lot
Speaker 3: of appetite, a lot of demand, rather than go down
Speaker 3: the publicly traded route.
Speaker 4: Maybe the caveat is it depends which group you talk to. Yeah,
Speaker 4: but no, I think the growth in private credit, especially
Speaker 4: over the last few months, has has been positive for
Speaker 4: oak Tree and has potential to be to be positive.
Speaker 5: For more areas.
Speaker 4: I mean, we are certainly active in these private credit
Speaker 4: markets seeking to you know, find value and really fill
Speaker 4: a gap that I think has grown over the last
Speaker 4: eighteen months where some of the larger players have you know,
Speaker 4: maybe step back and including some of the banks.
Speaker 3: Yeah.
Speaker 4: I think on the other hand, you know, oak Tree
Speaker 4: obviously we're known for our distressed as distressed debt business,
Speaker 4: which now is our global opportunities business. You know, here's
Speaker 4: an here's an opportunity for you know, a group like
Speaker 4: that to maybe you know, step in and support some
Speaker 4: of these deals if if things go south. So I
Speaker 4: think there's multiple ways where where we can see a
Speaker 4: benefit from from this growth.
Speaker 1: You mentioned, you know, maybe like some of these private
Speaker 1: credit managers and maybe they don't want to like to
Speaker 1: deploy that additional marginal capital for that risk. It made
Speaker 1: me wonder, just going back to the sort of the
Speaker 1: beginning of the conversation, like you can get a real
Speaker 1: return risk free these days, which you haven't been able
Speaker 1: to get in a long time, and you don't even
Speaker 1: have to take any like duration risk. You can like
Speaker 1: there's positive rates at the short end. Does that change
Speaker 1: risk ampetite or you see people was like, yeah, look
Speaker 1: I could make money and I don't have to take
Speaker 1: any risk. Does that change like how money gets deployed
Speaker 1: in your view?
Speaker 4: Yes, I definitely think it does. And really from our standpoint,
Speaker 4: it kind of shifts even where we take risk on
Speaker 4: the you know, on on the maybe the risk spectrum
Speaker 4: or the duration spectrum. I mean, it's rare that you
Speaker 4: have short rates being the highest part of the curve.
Speaker 5: So what's what's kind of.
Speaker 4: Resulted in that is securities that pay interest index to
Speaker 4: those short rates.
Speaker 5: Have become even more and more attractive.
Speaker 4: So just to again kind of put some numbers that
Speaker 4: if you look at the high yield market, a fixed
Speaker 4: rate market, sure their yields have gone up, but their
Speaker 4: income they generate has stayed, you know, right around low
Speaker 4: sixes despite the call it nine percent yields. Can you
Speaker 4: just explain that a little for what I mean is
Speaker 4: the coupon on a high yield bond is under six percent,
Speaker 4: their price is currently below par. So you take that
Speaker 4: coupon divided by the price, that's your current yield.
Speaker 5: That's going to be in the low sixes.
Speaker 4: Whereas, if I can buy a high quality floating rate
Speaker 4: security that might be a structured asset, that might be
Speaker 4: a broadly syndicated loan, I'm earning that near five and
Speaker 4: a half percent solfar rate plus a spread of call
Speaker 4: it four hundred basis points, now I'm earning nine and
Speaker 4: a half percent. So, yes, risk free is a you know,
Speaker 4: certainly a viable investment, but you know, so are a
Speaker 4: lot of other investments that are you know, reasonably safe,
Speaker 4: that have you know, an appropriate kind of spread for
Speaker 4: their risk.
Speaker 3: So we're talking about yields sort of enticing buyers at
Speaker 3: this moment in time. But there's something else that has
Speaker 3: happened since the pandemic, which is the Federal Reserve announced
Speaker 3: this massive corporate bond buying program that, in theory is
Speaker 3: now a permanent backstop for the market. Do you think
Speaker 3: that's affected investing behavior.
Speaker 4: There's no doubt that had a significant impact on investing
Speaker 4: behavior in twenty twenty. Just knowing that that backstop was there,
Speaker 4: I'm not sure how much today. I mean, I think
Speaker 4: in the case of say the hi Yo bond market,
Speaker 4: you have seen that market kind of shrink over the
Speaker 4: last eighteen months, shrink because deals of come do that
Speaker 4: haven't been refinanced. You've had actually more upgrades than downgrades
Speaker 4: in that market, which may be surprising given the you know,
Speaker 4: all the talk of recession and the need for spreads
Speaker 4: to be wider. So you know, you do kind of
Speaker 4: have this almost supply demand mismatch on the side of
Speaker 4: you know, maybe demand kind of pushing those those spreads tighter.
Speaker 4: But I think it's in the back of people's minds somewhere.
Speaker 1: How do you think about the Fed here Tracy mentioned
Speaker 1: the backstop, but in terms of like the sort of
Speaker 1: good old fashion where they are on the rate side.
Speaker 1: Obviously there's hope that maybe they could cut rates even
Speaker 1: in the absence of a recession.
Speaker 5: But is the FED like, are we clear?
Speaker 1: Is the Fed kinda like we got the inflation thing licked.
Speaker 4: I think that's a mistake that the market has made
Speaker 4: for the last year, that inflation would come down regardless
Speaker 4: of what the economic backdrop is, regardless of what happens
Speaker 4: to asset prices, the FED would turn around and cut rates.
Speaker 4: That was a big story in January of this year,
Speaker 4: when you had kind of everything rallied spreads, compressed rates,
Speaker 4: rallied high yield, rallied investment grade credit rally kind of
Speaker 4: everything rallied on this expectation that rates would come down
Speaker 4: before the end of the year, despite the fact that
Speaker 4: people called for a recession and that I think the
Speaker 4: market's kind of coming around to the fact that is
Speaker 4: probably maybe a little bit too much wishful thinking.
Speaker 1: My memory's gonna hit you. At some point, people were
Speaker 1: thinking that by like they would already be cutting by this.
Speaker 5: Point, yes, yeah, oh yeah in January. Well yeah.
Speaker 4: The other triggering event for the FED was in March.
Speaker 4: Right in March this year, when you had the Silicon
Speaker 4: Valley Bank signature bank, kind of regional bank flare up.
Speaker 4: The market really pivoted to expecting rates to be cut
Speaker 4: by about one hundred and fifty basis points.
Speaker 5: By the end of this year. That's completely reversed.
Speaker 1: And everyone said, like, oh, historically the FED hikes untilcilding
Speaker 1: breaks and then like a few weeks later it's still
Speaker 1: red hot.
Speaker 4: I think the Fed's kind of in an interesting spot
Speaker 4: right now. And you know, obviously you guys were at
Speaker 4: Jackson Hole, and you know, had a number of guests
Speaker 4: out at Jackson Hole. And I think looking at Chairman
Speaker 4: Powell's speech this year, maybe compared to the last two,
Speaker 4: I think he's got to be feeling pretty good about
Speaker 4: himself right now, because clearly last year he kind of
Speaker 4: had to give the market a bit of a scolding
Speaker 4: and say, hey, all you dreamer out there that think
Speaker 4: inflation is going to come down and we're going to
Speaker 4: immediately kind of ease financial conditions, you're wrong. We're in
Speaker 4: this for the long haul. And this year he was
Speaker 4: kind of able to stand up and say, thank you
Speaker 4: for listening to us. We're still in it for the
Speaker 4: long haul as long as the data dictates.
Speaker 3: Given your credit perspective, what do you think about the
Speaker 3: R star debate? So the idea that the neutral rate
Speaker 3: of interest might be higher than we once thought, or,
Speaker 3: to put it another way, the idea that maybe the
Speaker 3: economy is more interest rate resilient than it was previously.
Speaker 4: I will say, personally, I don't really have an opinion
Speaker 4: on what our star could be and should be, And
Speaker 4: I feel like I get a little cover from that
Speaker 4: because I believe Chairman Powell, he said the same thing,
Speaker 4: also said that. So, but I do think if you
Speaker 4: look at kind of where the market, you know, moved
Speaker 4: from a rate perspective, maybe leading into Jackson Hole, if
Speaker 4: you look at that kind of shift, maybe you know,
Speaker 4: call it like a shift in turn premium across the curve.
Speaker 4: I think there's no doubt that investors were probably thinking
Speaker 4: that there's a possibility that we may kind of have
Speaker 4: some form of higher rates for longer, and in order
Speaker 4: to compensate that.
Speaker 5: Let's let's lift the yield curve.
Speaker 1: Well, how much does the turning out of debt that
Speaker 1: we talked about a few minutes ago explain the lack
Speaker 1: of impact? They're the like, you know, we haven't had
Speaker 1: a recession, we have at a slow down. The rates
Speaker 1: have gone a lot higher than many people would have guessed,
Speaker 1: certainly in January, certainly in.
Speaker 5: March, et cetera.
Speaker 1: Like how much is it just the fact, you know,
Speaker 1: there are all these charts that people look at where
Speaker 1: it's like, yeah, rates are here, but actual net interest payments,
Speaker 1: share gdper whatever are still pretty low. How much is
Speaker 1: that just a function of Yeah, when so much fixed
Speaker 1: rate debt, these rate heis just don't wipe vent that quickly.
Speaker 4: I think that's definitely true in the corporate space, And
Speaker 4: don't forget. I mean a lot of corporates built up
Speaker 4: a lot of cash during the COVID period, So much
Speaker 4: was poured into the economy that yes they turned out
Speaker 4: that yes the rates were lower, but they also built
Speaker 4: cash and you know, saw leverage come down. But I
Speaker 4: think from an economy perspective, one of the keys to
Speaker 4: kind of why we haven't felt that interest rate push
Speaker 4: is in the residential housing market. Yeah, I mean that,
Speaker 4: to me is the real one of the real keys
Speaker 4: to why twenty twenty three from a consumer standpoint, from
Speaker 4: a spending standpoint, from a confidence standpoint, from a gross standpoint,
Speaker 4: has been a lot more robust than people would have expected.
Speaker 3: You mean the refinancing boom, basically putting money in a
Speaker 3: lot of people's pockets.
Speaker 4: Well, what I mean is if you look at the
Speaker 4: house prices since COVID, so from December twenty nineteen through
Speaker 4: you know twenty twenty one, house prices were up thirty percent,
Speaker 4: mortgage rates were three percent. If I told everyone in
Speaker 4: the room at that time. Hey, by the way, in
Speaker 4: the next eighteen months, the mortgage rate on a thirty
Speaker 4: year mortgage is going to go from three to seven
Speaker 4: and a half. How many would have said, oh great,
Speaker 4: I think house prices will go up another fifteen percent.
Speaker 4: I don't think anyone would have done that. But that's
Speaker 4: exactly what happened, because in this country, with our ability
Speaker 4: to lock in that financing like the companies for a
Speaker 4: long time, everyone just immediately said, well, great, honey, I'm sorry.
Speaker 4: That means we're not moving for the next ten years,
Speaker 4: and nobody has.
Speaker 1: We did an episode about a thirteen or fourteen months
Speaker 1: ago and our guest was like, house prices aren't going
Speaker 1: to fall and for this reason, And in the back
Speaker 1: of my head, I was like, man, this guy's saying,
Speaker 1: this guy's really going.
Speaker 5: Out on a limb.
Speaker 1: But I'm glad it is, like he gets it.
Speaker 5: He was right.
Speaker 4: Yeah, But I mean, think about think about what makes
Speaker 4: people happy they see the equity in their home. I mean,
Speaker 4: that is a big part of I think consumers kind
Speaker 4: of propensity to spend, maybe spend down some more of
Speaker 4: that access savings.
Speaker 5: It's a real driver.
Speaker 4: I think of just kind of overall kind of balance
Speaker 4: sheet stability and from a consumer standpoint, for sure.
Speaker 3: The last time interest rates were really high would have
Speaker 3: been the nineteen seventies, and.
Speaker 5: I think time we all remember fondly obviously.
Speaker 2: Well so, I think a lot of people remember the.
Speaker 3: Nineteen seventies for inflation, you know, the oil crisis, things
Speaker 3: like that. Not many people except maybe me, remember it
Speaker 3: as the birth of the junk bond market.
Speaker 2: And there are a lot of people who.
Speaker 3: Made their names in that environment, Mike Milkin being one.
Speaker 3: Howard Marx I think got his start then as well.
Speaker 3: Do you see the opportunity in the current environment of
Speaker 3: higher rates, maybe more volatility around bonds, things like that
Speaker 3: for a similar dynamic, could you see something brand new
Speaker 3: enter the market?
Speaker 5: Oh? Good question. Yeah, that is a great question.
Speaker 4: I mean, look, you're right that the junk bond market,
Speaker 4: the high yield market did really kind of benefit from
Speaker 4: that that kind of peak and rates. And you're right,
Speaker 4: Howard Marx did start one of the first kind of
Speaker 4: public high yield bond funds back in the late seventies.
Speaker 4: You know, I think the one difference maybe then versus
Speaker 4: today is rates were you know, fifteen to twenty percent,
Speaker 4: and you know, fixed income just.
Speaker 5: Rode that wave for forty years.
Speaker 4: And Howard mentioned this in his memo you Know More
Speaker 4: most recently that one thing he's certain is rates probably
Speaker 4: won't fall two thousand basis points again over a twenty
Speaker 4: year period. So I don't know if you get that
Speaker 4: same dynamic and fixed income, but the market seems to
Speaker 4: always find a way to to, you know, find a
Speaker 4: new way to solve an old problem.
Speaker 1: I'm buying a house right now, and one of the
Speaker 1: things people will tell me, like, oh, well to buy
Speaker 1: a house to They're like, oh, well, it's okay.
Speaker 5: That like paying cash, that's.
Speaker 1: A long story.
Speaker 5: That's funny. You should say that. No, I'm not.
Speaker 1: But one of the things people say is like, oh,
Speaker 1: it's yeah, it's all right, you just refined a few years.
Speaker 1: And what that tells me is like everyone is a
Speaker 1: bunch of people at least like are like of this
Speaker 1: generation locked into like a sort of assert mentality where
Speaker 1: it's like seven percent mortgages like super high, right, and
Speaker 1: so it's like this is abnormal, and the Fed's gonna
Speaker 1: and then they're gonna cut and just kind of what
Speaker 1: we were talking about before. But like, could it go
Speaker 1: in the other direction? Could we have like I mean,
Speaker 1: it just seems so unfathomable that like FED funds rates
Speaker 1: wherever like above ten. But it's like, is there some
Speaker 1: natural limit? Could we go like much higher on rates
Speaker 1: like that? None of us are thinking about.
Speaker 4: Look, that debate has certainly come up more often in
Speaker 4: the last twelve months, and it certainly did in the
Speaker 4: previous ten years. You mentioned kind of that belief about mortgages,
Speaker 4: and I think that's true. I can tell you with
Speaker 4: somebody who refinanced a mortgage in twenty twenty one that
Speaker 4: wasn't a thirty year and thought, okay, I have seven
Speaker 4: to ten years. Rates will probably come down again or
Speaker 4: won't stay high. But I think the big wild card
Speaker 4: in that is really just the cost of public debt.
Speaker 4: And I know you guys have spoken about this with
Speaker 4: other guests, but I mean that burden on the on
Speaker 4: the you know, our our budget annually to see rates
Speaker 4: at that level to refinance what's now you know, thirty
Speaker 4: two trillion dollars of debt. No, that's that's not a
Speaker 4: good story in the long And I don't know how
Speaker 4: you have a kind of viable economy with persistent rates
Speaker 4: that high.
Speaker 3: So we've been talking about inflation and rates and yields
Speaker 3: and default risk.
Speaker 2: But I'm curious.
Speaker 3: Even before COVID, there was a massive discussion around how
Speaker 3: bonds and credit are actually traded, and a lot of
Speaker 3: people talked about liquidity issues. They talked about the rise
Speaker 3: of exchange traded funds as a mechanism for maybe trading
Speaker 3: more liquid assets. And I'm curious, in twenty twenty three,
Speaker 3: in the current environment, has the way we traded we
Speaker 3: trade bonds changed even further.
Speaker 4: Not being a definite expert to answer the question, but
Speaker 4: but I think one thing that's happened for sure is
Speaker 4: that these exchange traded funds have increased liquidity in certain
Speaker 4: pockets of the markets. I speak a lot about the
Speaker 4: high yield market and not surprising, that's where you know,
Speaker 4: non investment great credit is kind of where where oak
Speaker 4: Tree makes its name and we focus a lot, but
Speaker 4: you know that is a market to where today, if
Speaker 4: you wanted to trade a lot of double B rated bonds,
Speaker 4: there's probably more liquidity because that's where the ETFs are
Speaker 4: going to be buyers. But if you still want to
Speaker 4: trade that, maybe you know, smaller maybe slightly sketchyr issue
Speaker 4: single B minus or triple C. You know, you're still
Speaker 4: going to have some challenges from a liquidity standpoint, So
Speaker 4: I guess it kind of depends exactly what you're buying.
Speaker 4: It certainly hasn't been you know, equally distributed across all
Speaker 4: of these different segments of the market.
Speaker 1: I want to go back to real estate for a second.
Speaker 1: You know, we talked about the residential component. One area
Speaker 1: where there's like obvious weakness is certainly like large swaths
Speaker 1: of the commercial real estate market. And I understand that
Speaker 1: it's not the entire market, and the commercial real estate
Speaker 1: is diverse, but offices in a lot of cities aren't
Speaker 1: doing great.
Speaker 5: Has that been felt like.
Speaker 1: Other people and other like further shoes to drop in
Speaker 1: commercial real estate?
Speaker 5: What's your view on that? You mean beyond like the
Speaker 5: challenge in the office.
Speaker 1: So right, so we've seen like these big jobs in office,
Speaker 1: and but then there's.
Speaker 2: Questions where will office get worse.
Speaker 1: Have they likes will get worse, or have have the
Speaker 1: holders of these assets really taken their marks yet or
Speaker 1: are they still living in some sort of fantasy where
Speaker 1: next year everyone comes back to the office and vacancy
Speaker 1: rates drop and everything, there's still like chapters to the
Speaker 1: series story.
Speaker 4: Yeah, I mean, look, there's no doubt that office has
Speaker 4: has its challenges, and I'm sure we have certainly not
Speaker 4: heard the end of it. One of the things in
Speaker 4: commercial real estate maybe unlike some of the corporate markets,
Speaker 4: when you have a maturity in a bond, you've either
Speaker 4: paid the bond or you've defaulted from a because the
Speaker 4: maturities dictated that. In commercial real estate you don't quite
Speaker 4: have that same dynamic. There's extensions you don't have to
Speaker 4: you know, in the case of securitizations, you can go
Speaker 4: into real estate owned, so you're effectively defaulted, but the
Speaker 4: asset maybe didn't change hands. A mezzanine buyer can step in,
Speaker 4: so there's a lot of ways to kind of you know,
Speaker 4: I'll honestly like kick the can down the road, and
Speaker 4: to some degree, so I don't think we've seen the end.
Speaker 4: But to your other point is there is a lot
Speaker 4: of dispersion and what is perceived today as the quality
Speaker 4: parts of the commercial real estate market certainly don't trade
Speaker 4: like stress is around the corner, and I'm not sure
Speaker 4: it is. We've had this debate at work a few
Speaker 4: times of hey, are we going to get a chance
Speaker 4: to buy this high quality industrial asset at a fifteen
Speaker 4: percent yield?
Speaker 5: And so far that answer has been no real estate owned.
Speaker 3: Is a blast from the sort of like two thousand
Speaker 3: and eight, two thousand and nine passed.
Speaker 2: Well, your job.
Speaker 3: Is to think about risk on a day to day basis.
Speaker 3: So I'm going to ask the very obvious, lazy journalistic question,
Speaker 3: which is what do you worry about the most?
Speaker 5: Wow in today's environment?
Speaker 4: Yeah, I think one of the things that's really challenging
Speaker 4: right now is it's very hard to define I think
Speaker 4: what is normal and a lot of people look at
Speaker 4: you know, different kind of masures of what they perceive
Speaker 4: to be normal. Oh, look at the jobs market. We're
Speaker 4: seeing an uptick in part time jobs. We're seeing an
Speaker 4: uptick in or a downdraft in full time jobs. Oh no,
Speaker 4: that's a sign that the labor market's weakening. We're going
Speaker 4: to fall into a receession. But really, in reality, we're
Speaker 4: kind of getting back to what we the labor market
Speaker 4: look like pre twenty twenty. You know, with inflation, is
Speaker 4: inflation going to remain sticky? A lot of that has
Speaker 4: to do with shelter price is how quickly will those
Speaker 4: feed through? I think to me there's just a big
Speaker 4: kind of unknown in how to interpret some of these
Speaker 4: kind of traditional economic measures that you know historically were
Speaker 4: our kind of benchmarker indicator for how much risk and
Speaker 4: in this case, maybe a risk of recession was building.
Speaker 4: And I think this year is an example for how
Speaker 4: hard that's been because, and I think you mentioned this earlier, Joe,
Speaker 4: the market went from thinking we were near an imminent
Speaker 4: recession twelve months ago to now thinking we might not
Speaker 4: have a recession at all.
Speaker 5: Yeah.
Speaker 1: Wayne Dahl, thank you so much for doing the live
Speaker 1: podcast here as a real treat, great perspective, and appreciate
Speaker 1: you coming on.
Speaker 5: Thank you very much for having me. It's my pleasure.
Speaker 1: That was our conversation with Wayne Dull, Managing Director, assistant
Speaker 1: portfolio manager and investment risk officer at oak Tree, recorded
Speaker 1: live at the future Proof Conference in Huntington Beach, California.
Speaker 2: I'm Tracy Alloway.
Speaker 3: You can follow me at Tracy Alloway.
Speaker 1: And I'm Joe Wisenthal. You can follow me at the Stalwart.
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Speaker 1: Bennett at dashbot and Moses Adnan and for all of
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