WEBVTT - Fridson Sees High Yield Going Distressed in Recession 0:00:17.840 --> 0:00:20.360 Hello, and welcome to the Credit Edge, a weekly markets podcast. 0:00:20.440 --> 0:00:22.960 My name is James Crumbie. I'm a senior editor at Bloomberg. 0:00:23.239 --> 0:00:25.599 Hi, this is Spencer Cutter. I'm a senior credit analyst 0:00:25.600 --> 0:00:28.159 with Bloomberg Intelligence. And today we are thrilled to have 0:00:28.240 --> 0:00:31.320 with us a legitimate fixed income legend, mister Marty Fritzen. 0:00:31.440 --> 0:00:33.400 He's the youngest person ever to be inducted in the 0:00:33.440 --> 0:00:37.440 Fixed Income Society Hall of Fame. Marty's Wall Street fixed 0:00:37.479 --> 0:00:40.800 income background Drake dates back to the nineteen seventies and 0:00:40.800 --> 0:00:44.000 includes stints at such firms as Solomon Brothers, Morgan Stanley, 0:00:44.040 --> 0:00:47.159 and Merrill Lynch, where he was instrumental in the development 0:00:47.159 --> 0:00:50.159 of Merrill's highield bond Index. He's since gone out on 0:00:50.159 --> 0:00:52.600 his own and now runs fritz en Vision, which provides 0:00:52.640 --> 0:00:55.600 empirically based, value focused investment recommendations. 0:00:55.760 --> 0:00:58.880 Yes, Spencer, As you mentioned, global markets are being royal 0:00:58.960 --> 0:01:02.600 by trade wars and concerns about Federal Reserve independence. US 0:01:02.640 --> 0:01:05.559 equity markets and the dollar have both dropped. Bond yields 0:01:05.560 --> 0:01:07.480 are also higher this month. There's no safe haven bid 0:01:07.480 --> 0:01:10.119 for treasuries as there has been another periods of prior 0:01:10.280 --> 0:01:13.120 volatility and global investors are trying to find alternatives to 0:01:13.240 --> 0:01:17.280 US assets As the storm rages on, Analysts meanwhile slashing 0:01:17.319 --> 0:01:20.600 earnings estimates, fearing that a severe economic slowdown is coming 0:01:20.640 --> 0:01:23.400 as a result of tariffs, and the risk of stagflation, 0:01:23.520 --> 0:01:26.360 which would be very bad for corporate borrowers, is rising. 0:01:26.880 --> 0:01:29.280 Despite all of this, the credit market reaction has been 0:01:29.319 --> 0:01:33.840 relatively muted. So given a very troubling macro and geopolitical outlook, 0:01:33.880 --> 0:01:37.559 we do expect to see a repricing wider in credit, 0:01:37.680 --> 0:01:39.840 especially in high yeld bonds and loans. I do want 0:01:39.840 --> 0:01:42.160 to start there, Marty, because one of the data sets 0:01:42.200 --> 0:01:44.040 you are known for is a model of high yield 0:01:44.080 --> 0:01:47.080 bond fair value. What do all the data tell us 0:01:47.120 --> 0:01:50.240 about high yield bond fair value right now? 0:01:50.760 --> 0:01:56.640 Well, there's a lot wrapped up in that question. When 0:01:56.640 --> 0:01:59.960 you talk about fair value, you're not really that's sure 0:02:00.280 --> 0:02:05.560 making a market forecast. If the economy goes into recession, 0:02:05.640 --> 0:02:11.840 particularly in a way that's not anticipated for an advance, 0:02:13.120 --> 0:02:19.240 high old will perform poorly. It's and I think there 0:02:19.320 --> 0:02:23.000 is a kind of a false confidence about how far 0:02:23.240 --> 0:02:28.119 it can fall. Notion is that well, the credit mix, 0:02:28.200 --> 0:02:31.680 the ratings mix, of the High Old Index is close 0:02:31.720 --> 0:02:37.000 to the best it's ever been. That comparison really is 0:02:37.760 --> 0:02:42.120 fairly strong. If you look at the history of the 0:02:42.440 --> 0:02:46.080 High Old Index going back to nineteen eighty six, or 0:02:48.080 --> 0:02:51.600 where you get a more specific rating breakdown from nineteen 0:02:51.680 --> 0:02:55.240 ninety six onward, it hasn't changed all that much in 0:02:55.280 --> 0:03:00.120 the last decade. And we had a recession in twenty twenty. 0:03:00.600 --> 0:03:05.200 The spread on the High Old Index, and I use 0:03:05.280 --> 0:03:08.240 here the option adjusted spread on the ice B of 0:03:08.240 --> 0:03:13.480 a US High Old Index that did get to over 0:03:13.520 --> 0:03:17.080 one thousand, close to eleven hundred in that very brief 0:03:17.080 --> 0:03:23.440 recession of twenty twenty. The percentage of double b's is 0:03:23.480 --> 0:03:29.120 a little bit higher than it was there the inconveniently 0:03:29.200 --> 0:03:32.560 for those making such arguments, the triple C and lower 0:03:32.560 --> 0:03:35.840 component is also slightly higher than it was when you 0:03:35.960 --> 0:03:42.120 net it all out. If the spreads on the rating categories, 0:03:42.640 --> 0:03:47.840 which weighted by those their representation in the High Held Index, 0:03:48.800 --> 0:03:52.760 produce the spread on the index as a whole, you'll 0:03:52.760 --> 0:03:56.560 get to about the same actually a few basis points 0:03:56.640 --> 0:04:00.520 higher by my calculation than in the two So this 0:04:00.640 --> 0:04:03.560 idea that well, we've had this radical improvement in the 0:04:03.640 --> 0:04:06.120 quality of the index, and you can throw out all 0:04:06.240 --> 0:04:10.880 history as far as how far spreads can go. Now 0:04:10.920 --> 0:04:14.360 that is, does assume that a double bee of today 0:04:15.000 --> 0:04:17.640 is similar to a double bee of just five years ago. 0:04:17.680 --> 0:04:20.559 I mean, if you were to say, oh, well, let's 0:04:20.600 --> 0:04:23.560 compare it to double b's of twenty five years ago, 0:04:24.760 --> 0:04:26.520 I'm not sure there would be a big difference, but 0:04:26.800 --> 0:04:30.520 at least that might be a plausible argument. But certainly 0:04:30.560 --> 0:04:32.919 over the last five years there hasn't been some radical 0:04:33.040 --> 0:04:37.479 change in rating standards, so I think there is some 0:04:37.600 --> 0:04:42.120 false confidence out there. You mentioned the point about the 0:04:42.480 --> 0:04:48.960 private credit, which is very important. The supply of highial 0:04:49.080 --> 0:04:53.800 debt is no higher than it was ten years ago. 0:04:53.880 --> 0:04:57.480 If you look at the face amount of bonds in 0:04:57.520 --> 0:05:00.760 the that ic B of a us hilde so I mentioned, 0:05:01.000 --> 0:05:04.640 it's essentially flat from a decade ago. And you can 0:05:04.680 --> 0:05:11.719 assume that wealth has increased, investible funds allocations to the 0:05:11.760 --> 0:05:14.320 demand for high old debt has increased. So we went 0:05:14.360 --> 0:05:19.240 through quite a long period up until this recent sell 0:05:19.279 --> 0:05:25.680 off started on Liberation Day on April second, where the 0:05:25.720 --> 0:05:33.120 spreads were persistently too tight relative to fair value, which 0:05:33.200 --> 0:05:35.880 talked about how I get to that fair value estimate. 0:05:36.680 --> 0:05:41.800 That problem has been corrected by a substantial widening of 0:05:41.839 --> 0:05:47.279 the spread since then, so we're close to fair value now. 0:05:48.600 --> 0:05:51.800 But again, if you take the view within your shop 0:05:52.200 --> 0:05:55.240 that we're on the verge of recession, yeah, you can 0:05:55.320 --> 0:05:58.240 expect spreads to widen quite a bit from the four 0:05:58.240 --> 0:06:01.640 to five hundred to where they'll reach in at the 0:06:01.680 --> 0:06:03.200 maximum during the recession. 0:06:03.640 --> 0:06:07.640 Following up on your points of fair value and the 0:06:07.760 --> 0:06:10.839 credit rating metric, our standards haven't really changed, and a 0:06:10.880 --> 0:06:12.720 lot of the analysis is looking you know, as a 0:06:12.800 --> 0:06:16.080 very empirically based, so you know, looking at just the 0:06:16.160 --> 0:06:18.800 numbers where we are today versus where we've been. It 0:06:18.839 --> 0:06:21.599 feels like for many of us, you know, part of 0:06:21.600 --> 0:06:24.039 that is saying, well, this time it's not different, and 0:06:24.080 --> 0:06:26.200 maybe it's not. Maybe it is, but we're now in 0:06:26.240 --> 0:06:32.000 a position where global alliances are being reshuffled. The US 0:06:32.040 --> 0:06:34.920 dollars position is a safe haven is you know, still there. 0:06:34.920 --> 0:06:37.200 But it's being questioned. We saw the outflows of the 0:06:37.279 --> 0:06:42.560 United States altogether. How much does that impact the empirical 0:06:42.600 --> 0:06:46.080 analysis that that you're doing. Can you adjust for that 0:06:46.320 --> 0:06:48.320 or do you feel like this time is really not 0:06:48.400 --> 0:06:51.840 that different? It's different factors driving the volatility and sell 0:06:51.880 --> 0:06:55.360 off today versus twenty twenty when oil prices briefly went, 0:06:55.480 --> 0:06:59.000 you know, down to zero or negative. That was a 0:06:59.040 --> 0:07:02.680 different driver. But the market's still the market, and fair 0:07:02.760 --> 0:07:05.880 value is still fair value today versus five years ago. 0:07:06.279 --> 0:07:08.960 Yeah. Well, especially you can bring in all sorts of 0:07:09.680 --> 0:07:13.640 predictions of the future. Keep in mind that there's a 0:07:13.800 --> 0:07:17.920 ring of hell in Dante's Inferno reserved for fortune tellers. 0:07:18.440 --> 0:07:22.200 Predicting the future for pay is illegal in New York City. 0:07:22.640 --> 0:07:25.280 When the mayor finally starts to enforce that law, a 0:07:25.320 --> 0:07:27.120 lot of people are going to be in serious trouble. 0:07:28.160 --> 0:07:32.560 So I don't do that. I have views about all 0:07:32.600 --> 0:07:37.040 those things you've mentioned, and investors should certainly take that 0:07:37.160 --> 0:07:43.280 into account. But the as far as to say what 0:07:43.440 --> 0:07:49.840 has driven spreads over time, they are really four factors 0:07:49.880 --> 0:07:56.360 in my model that are not related or the views 0:07:56.400 --> 0:08:00.440 on those things are subsumed in them. So one is 0:08:01.040 --> 0:08:05.440 the most powerful factor is credit availability, and I use 0:08:05.520 --> 0:08:10.800 for that a survey that's done quarterly by the Federal 0:08:10.840 --> 0:08:14.480 Reserve of Senior Loan officers at banks and ask are 0:08:14.480 --> 0:08:18.680 you currently tightening or easing your standards for companies to 0:08:18.800 --> 0:08:21.720 qualify for loans, So it's not the rate that they're setting, 0:08:21.800 --> 0:08:25.760 but the standard to qualify. Now, one limitation of that 0:08:25.960 --> 0:08:29.360 is that it's done only once a quarter, and unfortunately 0:08:29.400 --> 0:08:34.640 we're currently close to getting a new update. It was 0:08:35.320 --> 0:08:39.920 mildly in the direction of net tightening a quarter ago 0:08:40.040 --> 0:08:43.200 when the last survey was done. You would think that 0:08:43.440 --> 0:08:45.880 if it's going to go in any direction from there, 0:08:45.920 --> 0:08:48.960 it's going to be more in the direction of tightening 0:08:49.040 --> 0:08:51.920 rather than easing in light of some of the factors 0:08:52.600 --> 0:08:57.160 you've stated, So that could result in the fair value 0:08:57.160 --> 0:09:01.000 spread going somewhat higher than it is and putting the 0:09:01.080 --> 0:09:05.440 current spread back not necessarily an extreme relative to the 0:09:05.480 --> 0:09:08.640 fair value that would cause you to make a significant 0:09:08.640 --> 0:09:14.240 asset reallocation, but toward the tight side relative to fair value. 0:09:14.440 --> 0:09:18.000 The other factors in the model, industrial production turns out 0:09:18.040 --> 0:09:21.880 to be the most useful economic indicator. People sometimes say 0:09:21.920 --> 0:09:25.400 to me, well, why not unemployment or GDP, and I say, 0:09:25.480 --> 0:09:28.120 this is not Marty Fritzen's subjective view of how the 0:09:28.120 --> 0:09:30.720 world ought to work. You know, basically, we take a 0:09:30.720 --> 0:09:32.520 lot of things and throw them against the wall and 0:09:32.559 --> 0:09:37.200 see what sticks. And capacity utilization and industrial production have 0:09:37.280 --> 0:09:41.520 consistently over the years been the best economic indicators for 0:09:41.640 --> 0:09:48.520 the high yield spreads. Specifically, the spread is also inversely 0:09:48.559 --> 0:09:53.040 correlated with the underlying yield. The five year yield is 0:09:53.080 --> 0:09:57.040 the closest to the average maturity for the high Yield index, 0:09:57.280 --> 0:10:01.400 So the lower the treasure yield, the fair value spread. 0:10:01.679 --> 0:10:04.480 And then I do bring in ratings mixed because over 0:10:04.480 --> 0:10:07.360 a very long term there have been significant changes in 0:10:07.400 --> 0:10:10.680 the breakdowns between double B single b's and triple C 0:10:10.800 --> 0:10:15.480 and lower. So the triple C percentage specifically is the 0:10:15.520 --> 0:10:19.840 best proxy for rating change. So that is taken into 0:10:19.840 --> 0:10:21.440 account in my fair value estimate. 0:10:21.600 --> 0:10:23.760 But last time I looked at the model, Marty. And 0:10:23.920 --> 0:10:26.960 also we should mention that the Bank of America indices 0:10:27.000 --> 0:10:30.240 that you mentioned on high Yield, you were instrumental in 0:10:30.280 --> 0:10:32.720 setting those up. You essentially created those. 0:10:33.400 --> 0:10:36.840 Well, no, I don't want to take unfair credit. I 0:10:36.880 --> 0:10:41.319 did have some role in setting up the industry breakdowns, 0:10:41.360 --> 0:10:46.600 and when payment and kind bonds and zero coupon bonds 0:10:46.640 --> 0:10:51.160 came along, I encouraged them to bring that in. Those 0:10:51.160 --> 0:10:53.880 bonds had not been included in the previous version of 0:10:53.920 --> 0:10:59.600 the index. But Phil Galdy, who ran that operation Preston 0:10:59.640 --> 0:11:05.040 Peacock along with him other ones. It's a tremendous, tremendous tool, 0:11:05.960 --> 0:11:08.040 and I don't want to take on Dreker, but thank 0:11:08.080 --> 0:11:10.400 you for mention. I did have some role. 0:11:10.320 --> 0:11:12.840 In it, a huge innovator. But going back to your model, 0:11:12.840 --> 0:11:14.720 the last time I looked at it, the CIR called 0:11:14.760 --> 0:11:18.040 fair value was let's say, I'm guessing about four twenty 0:11:18.040 --> 0:11:22.440 five basis points over treasuries. We kind of went above 0:11:22.440 --> 0:11:27.120 that in the volatility posts Tariff's announcements, but now we're back. 0:11:27.160 --> 0:11:29.440 I'm looking at our own Bloomberg indext but we're now 0:11:29.480 --> 0:11:31.960 back at three sixty, so, you know, closer to what 0:11:32.120 --> 0:11:36.360 I think you were previously calling overvalue, maybe not extremely overvalued. 0:11:36.400 --> 0:11:38.880 But it also seems to me things have only gotten 0:11:38.880 --> 0:11:40.679 a lot worse since I last looked at the model. 0:11:40.760 --> 0:11:42.880 So you know, to me, it would it would it 0:11:42.920 --> 0:11:45.080 would imply in my head that fair value must be 0:11:45.240 --> 0:11:46.920 a lot higher in terms of the high yield spread. 0:11:47.160 --> 0:11:50.960 Yeah, no, I think it's a valid point. The likelihood 0:11:51.040 --> 0:11:56.640 is divergence in both directions. The spread because of the 0:11:56.800 --> 0:12:00.800 credit availability measure, likely to go somewhat while and as 0:12:00.800 --> 0:12:05.720 you say, the spreads have come in after that initial reaction, 0:12:05.920 --> 0:12:09.800 and I think that that is related to the as 0:12:09.840 --> 0:12:16.720 I mentioned, the supply has not grown because the issuance 0:12:16.800 --> 0:12:20.680 has been diverted in large measure initially to the leverage 0:12:20.720 --> 0:12:25.079 loan market, and more recently the private credit market has 0:12:25.120 --> 0:12:30.520 been so successful that the lenders there who were previously 0:12:31.040 --> 0:12:35.560 focused on small and medium enterprises have graduated to being 0:12:35.600 --> 0:12:39.600 able to compete in the market for even the large 0:12:39.960 --> 0:12:43.880 issuers that have access to the public hig bond market. 0:12:44.200 --> 0:12:47.040 So we have a kind of a crowned shortage of supply. 0:12:47.280 --> 0:12:50.439 And you can look at that in two ways to say, well, 0:12:50.440 --> 0:12:54.760 that's a technical factor that supports and justifies spreads wherever 0:12:54.800 --> 0:12:57.400 they are, or you can say, well that's a vulnerability 0:12:57.440 --> 0:13:02.040 because it won't matter when a fault risk starts to 0:13:02.160 --> 0:13:08.120 escalate significantly and investors will really be concerned and looking 0:13:08.160 --> 0:13:10.040 to safety and not as an alternative to go into 0:13:10.080 --> 0:13:13.160 private credit, but to go into treasury bonds or even 0:13:13.200 --> 0:13:17.400 treasury bills if they're concerned enough about the outlook. 0:13:17.600 --> 0:13:19.240 But if you run the model today, what would it 0:13:19.280 --> 0:13:21.400 give you as a fair value spread behind yield? Where 0:13:21.440 --> 0:13:23.600 should we be based on all of the inputs you have. 0:13:24.000 --> 0:13:29.040 Well, it's a little hard to say. We're a little 0:13:29.040 --> 0:13:33.560 ways away from getting an update on the credit availability measure, 0:13:33.920 --> 0:13:37.480 so probably we're looking at moving somewhere upwards from four 0:13:37.559 --> 0:13:38.480 hundred and fifty or so. 0:13:38.800 --> 0:13:41.160 Quick follow up question on the supply point that you 0:13:41.200 --> 0:13:44.800 brought up, as mentioned earlier, I follow the energy sector, 0:13:45.040 --> 0:13:50.280 and I've clearly noticed that same trend within energy if 0:13:50.280 --> 0:13:53.560 you go back to twenty fifteen when we probably peaked 0:13:53.600 --> 0:13:56.080 in terms of high old energy supply, and then where 0:13:56.080 --> 0:13:59.599 we are today. I haven't done the analysis recently, but 0:13:59.640 --> 0:14:03.280 I looked at like high yield independent energy debt outstanding 0:14:03.320 --> 0:14:05.480 in the Bloomberg Index, and it's we're back down to 0:14:05.559 --> 0:14:07.839 kind of where we were, as you mentioned ten, if 0:14:07.840 --> 0:14:10.600 not fifteen years ago, from an energy standpoint. A lot 0:14:10.600 --> 0:14:13.959 of that was bankruptcies that you know, companies went bankrupt 0:14:13.960 --> 0:14:17.000 in twenty sixteen again twenty twenty, so those bonds disappeared 0:14:17.040 --> 0:14:19.120 and they wrote off, you know, billions and billions of 0:14:19.120 --> 0:14:20.480 dollars worth of debt, and then some of it was 0:14:20.520 --> 0:14:23.760 also credit rating upgrades. Since twenty twenty, a lot of 0:14:23.800 --> 0:14:26.440 the oil and gas companies, not just the producers, but 0:14:26.480 --> 0:14:29.480 even the midstream companies which were relatively safe havens within 0:14:29.600 --> 0:14:33.480 energy have been very focused on paying down debt, generating, 0:14:33.960 --> 0:14:36.680 focusing on free cash flow, and you've seen leverage metrics 0:14:36.760 --> 0:14:39.800 come down, and so a lot of companies like Apatche, 0:14:40.240 --> 0:14:44.160 Occidental and others have gone from high yield into investment grade. 0:14:44.200 --> 0:14:46.920 A lot of people, myself included, seem to think that 0:14:46.960 --> 0:14:49.200 if we're going to have another downturn and energy, that 0:14:49.200 --> 0:14:52.360 that least in the high yield side, provides some cushion. 0:14:52.960 --> 0:14:55.440 I'm curious from the supply side overall, how much from 0:14:55.520 --> 0:14:57.800 what you've seen, I've just following energy, but from the 0:14:57.840 --> 0:15:00.600 broader market, how much of the smaller or stagnant high 0:15:00.640 --> 0:15:03.720 yield supply is deals going to the private market or 0:15:03.760 --> 0:15:07.320 going to the leverage little market versus maybe upgrades other 0:15:07.360 --> 0:15:09.120 sector has been following the same trend, And does that 0:15:09.240 --> 0:15:12.080 help provide some cushion if there's a downturn, or as 0:15:12.080 --> 0:15:13.920 you said, is it just kind of doesn't really matter. 0:15:14.080 --> 0:15:18.200 Well, it's a good question. I never really got onto 0:15:18.640 --> 0:15:23.520 the analysis. Sam Deroza Farag, who was at Credit Swiss 0:15:23.840 --> 0:15:25.960 in the old days, used to do a very detailed 0:15:26.680 --> 0:15:31.720 analysis of exactly what you're describing. Where the supply came from, 0:15:31.760 --> 0:15:34.840 where it went, and so on. What I can tell 0:15:34.840 --> 0:15:38.360 you is that what I have looked at is you 0:15:38.440 --> 0:15:40.560 have a runoff of something on the order of twenty 0:15:40.680 --> 0:15:45.280 or twenty five percent per year in high yield outstandings, 0:15:45.720 --> 0:15:52.840 a combination of defaults, upgrades to investment grade retirements, including calls, 0:15:52.960 --> 0:15:56.320 and those bonds may or may not get replaced with 0:15:56.680 --> 0:15:59.360 high yield bonds, or may not get replaced at all. 0:15:59.760 --> 0:16:03.200 The company is reducing that, as you say, in the 0:16:03.320 --> 0:16:06.320 energy sector and batically, I think there's been some movement 0:16:06.400 --> 0:16:11.040 you know better than I companies saying well, maybe raising 0:16:11.040 --> 0:16:14.680 more money and investing at the when cruit is at 0:16:14.680 --> 0:16:17.400 one hundred dollars a barrel isn't really the best way 0:16:17.400 --> 0:16:21.840 to serve shareholders. Maybe we should return that capital to 0:16:22.680 --> 0:16:28.040 the shareholders and you know, invest when prices are at 0:16:28.160 --> 0:16:32.360 and more modest levels rather than peak levels, and not 0:16:32.640 --> 0:16:35.440 get into situations where we're going to be sort of 0:16:35.480 --> 0:16:40.640 exploiting very high cost reserves that won't ultimately be profitable. 0:16:40.920 --> 0:16:42.440 But as they say, there's about a you know, twenty 0:16:42.520 --> 0:16:46.200 or twenty five percent runoff in the outstanding amount, So 0:16:46.280 --> 0:16:50.520 you have to have new issuance each year just to 0:16:50.760 --> 0:16:54.720 stay even. And I think that's that's the real issue 0:16:55.000 --> 0:16:59.480 to me, you know, the specific breakdown of where it goes. Again, 0:16:59.520 --> 0:17:02.280 it's a combination of factors, but the key thing is 0:17:02.320 --> 0:17:05.080 you have to have the new issuance coming. And we 0:17:05.160 --> 0:17:08.160 haven't seen the growth in the new issue market that 0:17:08.200 --> 0:17:12.440 we had historically seen going way back to the really 0:17:12.480 --> 0:17:15.120 beginning in the late nineteen seventies, you had had a 0:17:15.240 --> 0:17:18.800 very steady growth, but it's kind of leveled off in 0:17:18.880 --> 0:17:19.880 more recent years. 0:17:20.320 --> 0:17:23.920 So sticking with energy, so my understanding is your view 0:17:23.960 --> 0:17:26.679 recently at least has been that energy is one of 0:17:26.720 --> 0:17:29.080 the sectors that might be cheap on a rating for 0:17:29.200 --> 0:17:32.439 rating basis. I'm just kind of curious given the volatility 0:17:32.480 --> 0:17:35.360 we've seen. I mean, I've seen some bonds widened by 0:17:35.720 --> 0:17:37.920 well over one hundred basis points in the last couple 0:17:37.920 --> 0:17:40.280 of weeks, and they've tightened by thirty or forty since then. 0:17:40.880 --> 0:17:42.960 What's your view on energy or any of the other 0:17:43.000 --> 0:17:46.320 industries right now that might be standouts as either relatively 0:17:46.680 --> 0:17:50.360 cheap to their peers or conversely overpriced. 0:17:50.840 --> 0:17:55.280 Yeah, well, energy stands out, as you mentioned, it widened 0:17:56.400 --> 0:18:02.040 recently and this was even before my gibvious update on 0:18:02.280 --> 0:18:07.080 the industry relative value. So in a period from the 0:18:07.160 --> 0:18:10.880 end of March through April twenty fourth, whereing the high 0:18:10.920 --> 0:18:16.119 Yield Index as a whole widened by just eighteen basis points, 0:18:16.240 --> 0:18:19.640 energy widened by seventy seven basis points. We also talk 0:18:19.680 --> 0:18:22.040 about paper if we have time, which was the other 0:18:22.680 --> 0:18:27.480 standout in that, But that was attributable, I believe to 0:18:28.119 --> 0:18:33.639 the expectation that with a contraction of global trade, commodity 0:18:33.640 --> 0:18:37.320 prices in general would come under pressure. Crude oil prices 0:18:38.000 --> 0:18:42.040 did decline in that period, and there was also a 0:18:42.080 --> 0:18:45.240 statement by Saudi Arabia that they were going to punish 0:18:45.240 --> 0:18:50.040 some of these cheaters in OPEC plus who had been 0:18:50.040 --> 0:18:54.639 exceeding their quotas by stepping up the Saudi production. So 0:18:54.680 --> 0:18:59.760 that puts some further downward pressure. So energy is one 0:19:00.040 --> 0:19:03.359 that's attractive, And let me describe what that means. You know, 0:19:03.440 --> 0:19:06.840 if you say industry X, which has a lot of 0:19:06.880 --> 0:19:10.440 triple c's, is that a wider spread than industry WHY, 0:19:10.600 --> 0:19:13.680 which is mostly double bees. It's kind of a meaningless 0:19:13.720 --> 0:19:16.919 statement because of course you're talking about the difference in 0:19:17.000 --> 0:19:21.040 ratings mix rather than how that industry is perceived. So 0:19:21.640 --> 0:19:25.240 with help of a research assistant, I do this very 0:19:25.320 --> 0:19:29.159 laborious process, going through bond by bond in each of 0:19:29.200 --> 0:19:33.240 the twenty largest industries represented in the High Old Index 0:19:33.760 --> 0:19:38.439 and normalize for that difference in ratings mix, so that 0:19:38.480 --> 0:19:40.159 we can say if they were if they all had 0:19:40.200 --> 0:19:44.880 the same ratings mix, given how double bees within Energy 0:19:45.240 --> 0:19:48.920 are trading compared to double b's in the peer group, 0:19:48.960 --> 0:19:52.320 how single bees are trading, and so forth, then you 0:19:52.320 --> 0:19:55.480 can see on a rating for rating basis, this industry 0:19:55.600 --> 0:19:58.680 is rich or cheap, and by construction, half of them 0:19:58.760 --> 0:20:01.520 are wider than the peer group and half of them 0:20:01.560 --> 0:20:06.040 are narrower. But I also look at a separate dimension, 0:20:06.160 --> 0:20:09.439 which is what do the rating agencies say about that 0:20:09.640 --> 0:20:16.240 industry's ratings prospects? Because they put out rating outlooks for 0:20:16.359 --> 0:20:19.400 every company in the speculative grade range that they rate, 0:20:19.480 --> 0:20:22.560 saying that the rating is likely to remain stable, or 0:20:22.560 --> 0:20:26.359 it's likely to decline or likely to improve, and they 0:20:26.359 --> 0:20:30.080 don't put a specific timeframe on that, but people generally 0:20:30.119 --> 0:20:33.159 feel about eighteen months or so is the horizon that 0:20:33.200 --> 0:20:37.080 they're looking at. Well, Energy is in this kind of 0:20:37.119 --> 0:20:43.120 anomalous position of being cheap relative to its ratings even 0:20:43.119 --> 0:20:45.639 though the rating agencies are telling you that those ratings 0:20:45.640 --> 0:20:49.080 are likely to improve. You'd expect the ones that are 0:20:49.520 --> 0:20:51.720 trading cheap to their ratings to be the ones where 0:20:51.760 --> 0:20:54.959 they say the ratings are likely to decline. That would 0:20:55.400 --> 0:20:57.480 make sense that they would then be cheap relative to 0:20:57.520 --> 0:21:03.840 the ratings. So energy is in that category and attractive again. 0:21:03.880 --> 0:21:05.520 You know, if you say to me, I have a 0:21:05.560 --> 0:21:08.240 crystal ball that says the crude oil price is going 0:21:08.320 --> 0:21:10.480 to drop another ten percent next week, I'd say, well, 0:21:10.520 --> 0:21:13.480 wait until another week before you buy them. But on 0:21:13.520 --> 0:21:17.480 a fundamental kind of value basis, it is one of 0:21:17.840 --> 0:21:23.960 five industries in that category currently. The others are diversified 0:21:24.000 --> 0:21:28.919 financial services that excludes banks, thrifts, insurance companies, but leasing 0:21:29.000 --> 0:21:35.320 companies and other other kinds of finance companies. Energy is one. Healthcare. 0:21:37.240 --> 0:21:40.840 The retailers that's not the food or drug retailers, but 0:21:41.240 --> 0:21:47.680 department stores, discounters, especialties stores, and utilities within high yield, 0:21:47.680 --> 0:21:52.520 those are not typically the usual regulated electric power companies, 0:21:52.560 --> 0:21:57.520 but more of the merchant power producers. But those five, 0:21:57.560 --> 0:22:00.000 and it's unusual they have as many as five. Sometimes 0:22:00.119 --> 0:22:03.240 you have only one out of the twenty that's in that. 0:22:03.800 --> 0:22:06.600 If you picture that as a diagram, it's in the 0:22:06.640 --> 0:22:13.080 northeast quadrant of the diagram, improving ratings and cheap relative 0:22:13.119 --> 0:22:13.600 to the rating. 0:22:14.000 --> 0:22:16.040 Yeah, I just a quick comment. I'll hand it back 0:22:16.080 --> 0:22:18.479 to James. I know he has a question, but for 0:22:18.520 --> 0:22:20.640 me following energy can't help but think some of the 0:22:20.680 --> 0:22:22.959 investors in the market are having sort of post traumatic 0:22:23.040 --> 0:22:27.200 flashbacks to twenty twenty in twenty fifteen sixteen, and assuming 0:22:27.280 --> 0:22:29.959 that that may play out again. As you mentioned, ratings 0:22:29.960 --> 0:22:33.280 trend has been positive within energy, there's a lot less 0:22:33.320 --> 0:22:36.359 debt within high heeled energy. Feels to me like you know, 0:22:36.480 --> 0:22:39.080 downturn would certainly be painful, but perhaps less painful than 0:22:39.119 --> 0:22:41.760 it was in twenty twenty. But wondering if that's knee 0:22:41.840 --> 0:22:43.040 jerk reaction from the market. 0:22:43.240 --> 0:22:46.000 No, not at all. I mean, take a step back. 0:22:46.119 --> 0:22:48.000 I'm very proud of the fact that in all the 0:22:48.080 --> 0:22:50.879 years that I worked on Wall Street, the phrase our 0:22:50.960 --> 0:22:54.920 chief economist says never once appeared in my research. And 0:22:55.000 --> 0:22:57.320 it wasn't that I didn't have respect for them, but 0:22:57.440 --> 0:23:00.800 my feeling was that for the people received our research, 0:23:01.280 --> 0:23:05.159 half agreed with our chief economists and half disagreed, and 0:23:05.320 --> 0:23:08.320 hence the market was where it was at. I mean, 0:23:08.320 --> 0:23:11.960 that's the equilibrium that separation of opinion occurs. I didn't 0:23:11.960 --> 0:23:14.399 want my research to be useful only to half of 0:23:14.440 --> 0:23:18.359 the audience, so that's why I emphasize things like the 0:23:18.400 --> 0:23:22.080 fair value analysis. And it's quite appropriate to have an 0:23:22.080 --> 0:23:26.879 overlay of a house view about the direction of oil 0:23:26.960 --> 0:23:31.040 prices or the direction of interest rates, whatever it might be. 0:23:32.080 --> 0:23:35.040 And I think the combination of those two is the 0:23:35.080 --> 0:23:40.360 way you get to, you hope, superior risk adjusted returns 0:23:40.359 --> 0:23:43.639 over time. So I'm not at all discounting any of 0:23:43.680 --> 0:23:47.800 those factors you say. But by the same time, by definition, 0:23:48.200 --> 0:23:52.360 half of the market is more optimistic than the view 0:23:52.400 --> 0:23:56.320 you've described. Hence we're at the oil price and the 0:23:56.400 --> 0:23:59.440 spread on energy index that we're currently at. 0:24:00.080 --> 0:24:04.120 Looking of PTSD, which Spencer just built up. My PTSD 0:24:04.200 --> 0:24:06.200 is more about to two thousand and eight, in which 0:24:06.440 --> 0:24:09.800 the rating agency has just got coot wrong too slow. 0:24:10.200 --> 0:24:12.199 Is there any chance in any of this analysis that 0:24:12.200 --> 0:24:15.160 the rating agencies just aren't fast enough to act and 0:24:15.240 --> 0:24:17.800 you know, on a broad scale, or is that just 0:24:17.880 --> 0:24:19.439 not going to happen? 0:24:19.720 --> 0:24:23.520 Well, it's a big question. I've written quite a bit 0:24:23.560 --> 0:24:26.760 about the rating agencies, not because I have a brief 0:24:27.080 --> 0:24:31.880 to defend them or anything, but people sometimes lose sides 0:24:31.920 --> 0:24:37.080 the fact that the rating agency say explicitly that ratings 0:24:37.160 --> 0:24:43.119 are not investment recommendations, they're not price recommendations. Within a 0:24:43.240 --> 0:24:46.680 rating category, you have quite a wide range and overlap 0:24:46.720 --> 0:24:51.200 among the rating agencies, and that sometimes interprets me, oh, well, 0:24:51.240 --> 0:24:57.639 they're wrong. Well, you know, what the ratings address is 0:24:58.160 --> 0:25:03.160 probability of default and expected recovery in the event of default, 0:25:03.440 --> 0:25:06.320 and to some extent, covenants are reflected in the ratings 0:25:06.359 --> 0:25:12.800 as well. They don't address the liquidity of the issue, 0:25:12.840 --> 0:25:16.560 which can be quite important at times, and they certainly 0:25:16.560 --> 0:25:20.760