Jeffrey Sherman: Throw Away the Post-GFC Playbook | Insightful Investor Podcast

[music] Welcome to the Insightful Investor podcast, a weekly series that seeks to share industry, investment, and market insights. Learn more about our show at insightfulinvestor.org. [music] I'm excited to have Jeffrey Sherman joining us today live in our podcast studio in Los Angeles. Jeffrey is the deputy CIO of Doubleline Capital, which manages about $97 billion as of the end of June. Jeff, thanks for joining us today. >> Yeah, great to be here in a beautiful office and congratulations on the new move. >> Uh before we jump into Outlook, I want to ask you just a few questions about background to set the stage. What experiences most influenced the framework you use to today to evaluate risk and opportunity? I think it's an extremely important question because it's I think it's an ever evolving landscape when you think about it and and one of the addages in the investment business is that history doesn't repeat but it often rhymes and you hear that through you know historians in general um but I think that's the right lens to to go with and so when I think about the returning risk framework I think what one needs to do is throw away the playbook that we had in the post GFC era so I'll call that from 2010 10, let's call it, right after things started to kind of stabilize. Um, there's still a lot of pain, but we'll call it the stabilization all the way to 2020. And why I say that is this was evident of a world of financial repression. That was a phrase that was that coined and used a lot. Uh, there was massive coordination globally through central rate policies, uh, through trade policies. Right? You see where I'm going with this, right? The world's different. Um and I think when you look at markets they were managed and I mean what I mean by that specifically the bond market yields were not free to trade on supply and demand and outlook and fundamentals because there was the meddling of the central banks for a decade. Um and those policies I mentioned were coordinated. The central banks in the developed world all really had the same policies. You could argue Japan was on its own island. Uh it still is. We we'll talk I'm sure we'll talk about Japan a bit but coming back to it is that we may have had higher interest rates in 18. We kind of led people we led people to the cuts during the GFC. We led them out of it. We had similar behavior throughout it and we were kind of the leading model. Um but that all changed during the pandemic. And I think what changed is that one is it was the supply of money that came into the market and a lot of pundits will focus on the US but this was a global phenomenon. um inflation was a global phenomenon and some of the output of that obviously the supply chains changed a lot of it but we're still a wash with a lot of that money right it got invested it got put into the economies around the world and simultaneously we went into what I'll call disruption right and I think if if I if I want to think about what the administration does in in this sense is that they disrupt the orthodoxy right meaning that they want change. They want things to be different. And what this resembles to me is the market I kind of grew up in and call it the odds, right? In the early 2000s, like, you know, again, we had this debt binge, a lot of us in the housing market. Um, those markets traded on their own. Inflation was a number that had a three handle, a lot of cases, a four handle on it. We had nominal growth 7% or so, and we're able to grow our way through some of this. I think that's closer to the playbook than what we had in that post GFC era, meaning that there's still inflation here today. Um, it's not going away. Uh, economists call it the last mile of inflation. Not really sure where that phrase comes from. I should probably look that one up. Um, but I I hear that referred to. And it's very hard to get that last kind of leg of inflation down. And that's what we're seeing today. But inflation at 3% versus 2%, is it a big deal? Yes. But in general, it all goes into nominal GDP because GDP is real GDP plus inflation. And I think that's important to think through because as we talk about the economy and we talk about how things are growing, we need to grow our way out of some of this debt these debt issues, right? There's no doubt. And the good news is is getting a nominal GDP of six 7% gives you a chance, right? Remember the rule of seven, it's how you double and things like that. So the idea that I'm coming back to in the framework is that I think it may not rhyme with that ought period I'm talking about in terms of the inflation uh around growth rates there was a massive economic boom expansion there was a capex expansion there just happened to be in construction and housing but we there's a lot of similarities there but it looks nothing like that postGFC um kind of prepandemic era simply because we don't have coordination We have disruption of orthodoxy. We have disruption of the supply chains. We have disruption of trade. Um we have disruption of politics, right? And so I think when you start to think about it, I I may not be right that the most similar thing is that 2000 experience. And look, there's some semblance to the late 90s of tech buildout, of course, but I I'm pretty sure we're not going back to that era, which my my boss has coined it the fixed income dungeon, you know, where you've got 1 and a half 2% yields and there's just not much you can do as a bond investor. This market looks much more like the market from 20 plus years ago. And I think that's the framework people should be looking at both from an equity and a fixed income perspective. Uh, one thing that has changed is if you if you zoom out even further and you go back to the early 80s, you basically had falling interest rates for 30 years and then you had zero interest rates until 2122. And it feels like we're in an environment of higher rates for longer and part of that is you had a environment of low and stable inflation for an extended period and that seems to have changed as well. So, how does all that play into how you think about investing, but also what Fed policy might be, which may be less predictable as well? >> Well, here we go on a on a long diet tribe, so I'll try to make it concise so we can be a little more interactive. But, um, so, first of all, I agree that we had this disinflationary environment, declined inflation rates for roughly 30 years, but it wasn't a straight line. You know, there was periods in the '9s where we had these kind of head fakes of double dip recessions in the mid '9s. Um, you had inflation take off again those periods. And by the way, the correlation between stocks and bonds was positive back then, right? Very similar to some of the things you saw back in 22. Why? It was an inflation problem, right? It was unexpected inflation that kind of that showed itself. And so you're correct that we had this declining rate and then when we hit that zero lower bound and you know god forbid some of the world went negative. I mean that was just bizarre, right? You had to throw out all your all your textbooks and you know we start with risk premium it never went negative right and you're supposed to not buy it. But the point being in that low period is that it was just managed and it was that we didn't want to ever have a recession. We did not want the business cycle to play out. And I argue that because the pain we would have suffered in a true recession and the GFC was abysmal. Let's not let's not, you know, doctor this up with with flattering words, but the pain that would have transpired without some of these efforts would have been even more widespread and more rampant. >> We learned those lessons from the Great Depression. >> Correct. And that's Bernani is a student of the Great Depression as well as the Japanese experience. And so the behavior that he used was one that one he believed in quantitative uh easing. He believed that again by getting rates low QE made sense. There is an economic argument to that. But you're suppressing things. It's like it's like coiling a spring. It's you're building up more kinetic energy, right? Or I guess it's potential. It's kinetic when it moves. I wasn't a good physicist. That's why I go into finance. Um but the point is is you're building that up. And so at some point that wants to explode. And anytime it wanted to explode a little bit, the central bankers came to the rescue. And so rescue being more QE, more more negative yields, pushing people out the risk spectrum. And so when we talk about the environment now, yes, there's a higher inflation rate. It is unstable. Inflation usually is a bit unstable because it cycles. And so I think that's what has changed is that we're accepting part of the business cycle and like during the pandemic companies defaulted. We don't talk a lot about it. There were a lot of defaults in 2020. You know why? There were bad companies. And again, maybe you ran a good company and something bad happened to you. I get that the good things happen to bad companies which you get lucky on and bad things happen to good companies which you get unlucky on. But I bring that up because now we're at this point in the business cycle where we extended a lot of debt at low rates. We extend a lot of floating rate debt. We've raised rates with the Fed. The point of that is to try to slow things down. I think right now the problem is is that the Fed can't slow things down. What they can do is help signal policy. And what is one of, you know, the pet peeves of the chairperson is Kevin War says he doesn't want to provide forward guidance. that's not very helpful in a market that needs to see that. So, if you're not going to provide it uh through verbiage, right? Or, you know, remember Mario Draghy really started this when he said, I think it was 2013, early 14 when he said, "We'll do whatever it takes." And that placated the market. I I think what Kevin Worsh is trying to do is a positive. He's trying to say, "Look, we don't need to hold your hand. You all are professionals. You know, there is some retail in there, but in general, the market is a professional mechanism. You figure it out. We're here to kind of control the supply and demand side. But the problem, as I say, with the Fed, you could write hike rates next week, 100 basis points, and it's not going to choke off AI hyperscaler demand. Why? If you charge Apple, you know, Apple's a bad example. You charge Alphabet, you charge Meta another 100 basis points, they're still doing the project. Why? They believe the ROI is massive. There's there's a rationale for it. they could raise rates 200 and it probably wouldn't change a lot of that outlook. So the question is is how do you hit the knock-on effects of the other parts of the economy. I think that's where the Fed needs to have some action. And so sitting here today, we don't have the inflation report yet. It comes Friday. I I think you know everybody's eyes are on that. Um simultaneously we have intervention from the Treasury Secretary got announced today. Um we've had the intervention on the yen from the US Treasury Secretary. You've got Kevin Worsh who is, you know, trying to plate the president and White House while simultaneously trying to continue to establish credibility. Sure sounds like they could use a little intervention, right? Sounds like they could use some coordination, but we've alienated a lot of these partners along the way. So, what that means is we have to trade on our own. We have to resolve this on our own. And right now, the bond market's speaking volumes. The bond market's telling you rate should be higher. Why? It sees the inflation data. It knows that we had some transitory downward pressure because of the owner's equivalent rent. The lack of collection of data back in October led to some of this. We know there's going to be some revisions coming that's going to hit more PCE than CPI. So I I think what you see at this stage in the cycle that that's different. You have those declining rates, but irrespective of the direction of rates right now, bond yields are positive in a real sense. If if you believe inflation's going to 4%, the Treasury curve outside of, you know, anything inside of 6 months gives you roughly 4%. You can get break even, you can make money, you can outstrip inflation. And by the way, we think inflation still continues to print with three handles. Is that horrible? No. But you know what? If I can go by lower risk credit or sorry, higher quality credit, kind of what I deem to be low risk, not low quality, and you can start to put this stuff together, you can easily start on the front of the curve, yield five, right? You can go in the belly of the curve, yield 5 1/2, 5 and 3/4. And if you want to take more credit risk, you can get six, six and a quarter in a diversified portfolio. So all those numbers from a bond investor because that's the lens I'm using here still make sense even if rates are pushing up a little bit. Um even if we have some more inflation we have some cushion there right and as long as the economy is still humming along um earnings are strong you'll hear that from every investor right now um unfortunately profit margins tend to mean revert over some period of time you're in a good spot in the bond market. So I I think what it is is that outside the inflation argument, I just have to think about from the perspective of what can I get today? What kind of risk do I need to take that and am I being paid for it? And I'll say that if we have a let's call it 3 and 12% inflation. Let's just say that's the number of the next 12 months. But I can build you a portfolio that I don't know duration of a couple years throws off five, five and a quarter, right? Even if inflation goes to four, that's still 125 basis points real yield. that's positive. That's not what we were getting in the as I'm sorry, in the teens. We weren't getting that in a lot of periods. It was hard to get those real yields. It was hard to build a portfolio that was a few hundred basis points over inflation. So, I think the difference now in the market is that because of how you described it, unstable inflation, that means we should get more of an inflation premium, which says we call it higher for longer. That's that's the mantra. I would just say back to where we were 20 years ago. What's interesting is it seems like the market is placing a lot of faith in the Fed's ability to bring inflation back down closer to two when you look at long-term break even inflation rates despite the fact that uh inflation has been above target for over 5 years. What do you make of that? >> I'm going to offend the younger folk out there because I'm going to say I'm going to call it rookie traders. I'm going to call it and why I say rookie it could be 10 years experience and if you grew up let's say you came in the market you know 15 years ago right 2011 all you know is a 2% inflation target all you know is the Fed is adamantly committed to it all you know is that the ECB does it the entire developed world seems a target is outside Japan okay so that gets uh burned into the psyche right and so it's not that that people aren't thinking about it. It's the framework. Once again, the framework is you're a function of your own experiences and then we all try to learn history to try to learn from it. Uh we try to use spreadsheets and pretend we can live through those draw downs and all that even though we can't. >> But it's easy to overweight your personal experience. >> Uh it's what most people do. And I that's what I I always take a pet peeve at the the concept that there's smart money, dumb money, retail money. I mean, look, institutional PE committees are made up of people. They're smart people, too. By the way, some of them don't have finance experience. They come from the business they're in. And so, they have emotions, too. And so, all of this emotional behavior is very powerful. But coming back to it, the 2% break evens, you know, look, I I looked at the swaps curb this morning because obviously the oil was going on, seeing the new $100 price on on Brent. Um, we looked at zero Q1 swabs this morning and it's like the the range between like three and a half to four years out to 30 years is like 2.51 to 2.57. Let's call it 250 basis points. The market is just trained to that. And so we saw this too, Alex, during 22 when inflation was exploding that you really didn't get like 10 year break evens. They didn't even get to three, right? Even with a 9% inflation rate, right? compounding that out because you start extrapolating 2 two two22 that's how you get back to it. So, I think the market when I look at break evens, I look at tips, they've started to price in a little bit more inflation than we saw pre- pandemic. And I'll call that 30 basis pointsish kind of spread. Um, which seems light, you know, it seems light and it's been good to be betting on shorter term tips versus those longer term for this reason. And you get some roll effects. And so, um, for tips, we do like them in shorter duration accounts. They don't make sense in intermediate accounts to us. We just don't think that that pressure comes to the back end. And by the way, if we get some short-lived inflation, specifically in commodity prices, which is very difficult to time. Uh if you get that that leads to kind of slower economy. So it's one that you can be right very short term on the tips and then ultimately it becomes um you know a detriment to you because the duration hurts you eventually. But I I think when I I think about the inflationary environment, the challenge is is that we just have it everywhere. It's not a commodity store. It's part of it. Um, it's tariffs. I when you look at the manufacturing input costs this year and you look in the first half of this year, they're up roughly 15 16%. It's essentially the weighted average tariff of steel, copper, and aluminum. Not very hard to discern that that's going to go through eventually. Um, you look at services, the ISM services. People always look at the headline number, but the price is paid inside of that. You have more than 70% of respondents saying costs are going up. Well, what are costs to a service company? Some it's inputs, you know, and goods and things, but it's also labor. So, all of these things are saying that that last mile of inflation, it just doesn't look attainable in the near term. And so, does the Fed hiking 25 basis points change that dynamic if they do that next week? No. But the difference is by hiking you signal that you're serious. You're not jawboning. And what I've seen obviously the admin >> a credibility game in some sense >> they need to and I think if the let's say inflation doesn't cool on Friday let's say it's kind of on the upper end of the range and and call it add estimate to slightly above it and then the Fed pauses I think you can see the long bonds sell off 10 basis points because it says you're not serious about it. All Kevin has told or Kevin Walsh has told us thus far I shouldn't call him on the first name base. I don't know him. Uh, he probably doesn't want to know me either, but all we've heard from him thus far is they're going to get inflation down. What day of the week is it? We're going to get inflation down. What color is your shirt? We're going to get inflation down. We're going to two. He messed up in the first press conference and said he only looks left of the decimal. So, a bond trader is like, "Is that 2.0 and 2.99?" So, Kevin War said he only looks left of the decimal point. And so, he only cares if it says a two. So, is it 2.00? Is it 2.99? The same. >> No. and the bond market kind of scratched his head. Then at this next press conference, he was adamant. No, two is two within a not even within a whisker or whim. He said some kind of archaic thing. And so he's he's trying to establish credibility, but he didn't do anything. Then Jackson Hole, you know, he was pretty hawkish there, saying, "We're going to tackle this. We're going to do this. Obviously, there's no behavior there. It's time to show me the money, right?" [snorts] And I think that's what the bond market's looking for right now. It's looking for the credibility. So, does the 25 change it? No. But it tells the market that the direction of path of rates is not down. It's sideways to up and we are serious. And that is the most important thing I think Kevin Walsh can do. And he can make it a 5minute press conference. They're going to probably have some SCPs. This may be the last, you know, estimates we get out of that. He won't care. He could come in and just say that we told you we're serious. We're tackling it. If we need to, we'll hike again. We're going to make it data dependent. Also, the easiest answer, and this, Mr. Worsh, I am telling you this is what the market would like to hear. You can hike and you can say, "We're doing this to reverse the risk management cuts from last year. We gave you three. We think it's prudent to peel one of those back. We may need to peel another one back. We'll make that decision." How simple is that? Because Jay Powell set that up perfectly for that. And you don't hire the well, you're going to hire the president. I thought it was clever that on the day we get one of the best jobs reports we've had in like six months, president, oh, time to cut rates. It's kind of the other way around. But the point here is that you haven't seen the thing is is it's jawbon. And this is what Kevin's done thus far. It's what Scott's doing, Mr. Bessant. Um, you this whole intervention concept. I am the house was the headline from last night that he gave a speech in Texas where he said don't bet against me. Okay, show me. Right. And at some point, if you're going to intervene in the Treasury market, 6 billion isn't going to do it, Mr. Bessant. That's not going to happen when you have a $30 billion auction coming. You need net negative supply to do so. And the only way you do that is you buy it somehow. So, they have a problem. And this talking isn't going to get there. It's going to have to be actions. And I think it starts with the Fed chairperson. And we don't need to see coordinated efforts between Fed and Treasury because it's going to feel collusive. It's going to feel like they're trying to do interest rate curve management and curve control and just rate control. And we know how that kind of lasted last time. It'll build up some excesses. things will look okay in the short term, but I think the bond market ultimately pukes on that because it leads to higher inflation. And by the way, Alex, have you heard about this capback cycle we're in? It's massive. That's more supply coming. That's just more stuff that needs to be financed. As I tell people, if you want to have the estimates are like between 900 billion and 1.5 trillion next year alone. That's the spend estimate. Obviously, it can vacasillate. Where's that come from? It's got to come from the bond market. It's got to come from corporate bonds. It's going to come from asset backs. It's going to come from commercial real estate bonds. Um, it's going to come from free cash flow. It's going to come from bank loans. It's going to come from a lending facility. Heck, you might have to sell some of the art out of here just to finance the AI trade. We are going to have to figure out how to do that. And so either we get acceleration on the economy, we we can turn these profits into reinvestments or the bond market's going to set terms and eventually the bond market will dictate how far the AI trade goes simply because it has to be financed. Is your sense that we've shifted from a world of globalization to deglobalization and other factors that are structural in nature that are more inflationary. So we kind of have a more inflationary backdrop that maybe keeps that inflation rate elevated for next standard period. How do you think about that? >> Yeah, definitely. Um I mean uh let's let's talk about kind of the things we're dealing with. Tariffs, they are inflationary short-term. They're kind of transitory inflation if you want to define it that way, but the price level stays high, right? That's part of what we're dealing with right now. When consumers complain about the inflation level, they're not complaining about the 3%. They're complaining about the cumulative 40% since the pandemic. That's the problem. Or it's about 35. And so that's where you're seeing issue. It's the price levels have never come back down. Now, think about the plan that the administration had coming in was that we're going to redefine US manufacturing. By the way, US manufacturing is booming. Kudos to the president and the team for getting that done. Um I think they were talking about building widgets and you know cars and stuff. Turns out it's data centers don't care it's good good jobs manufacturing is there as well but some of the manufacturing is redundant. If you have redundancy in the supply chain that's inherently inflationary right especially when you run a globalization you're looking for lowest cost provider. And part of the whole kind of I think breaking this del globalization and and that that developing was that we essentially pushed the labor cost in China to a level where it's not as competitive as it used to be. In most instances, it's cheaper to produce things in Mexico just because of the supply distance. And by the way, our number one trading partner of at least today, who knows what it is next week. Uh they they change pretty frequently, but it's cheaper to go with that kind of labor. And by the way, if we want these two hemispheres, which it seems like that's kind of Trump's accord, I don't really know what it is, but if you have that, that that's kind of the natural progression. So, at some point, the globalization does break, right? Um, and now you just have more polarization. It's a multipolar world when it comes to uh agendas. And, [clears throat] you know, I think what you've seen in this, you know, maybe 18 months ago, the concept was sell America. Oh, you know, if you really want to show the administration who's boss, sell the treasuries. I argued the whole time, if you really want to hurt us, sell our socks. You'll plummet the dollar. But the problem is, we've been the we've been the cash flow engine for the world. And so, until you see something like that, you won't see it. But those policies start to change behavior. Why did we see such an acceleration in gold prices last year? This was not institutional money. This was not retail money. This was central bank money. This is a ddollarization. It's the things that people talked about the hedgeimony of of the US currency for two decades. But it's the idea is that if you're going to have these policies, we're not going to coordinate. We don't have to play in your sandbox either. The main benefit we have, our sandbox has tech. Our sandbox has the innovation. We have the rule of law. And you know, like the the idea of investing in the US has always been great. So bringing it back to your question, I forgot it is that you know when I think about really where we are in the inflation environment that it's just completely different and you you really don't necessarily want to bring it down that much because we need nominal growth. And by the way, for as good as nominal GDP has been, it's essentially over the last 5 years equal to the deficit. Let that sit in. this growth rate we have. You could all you could you could offset and say it's all just been financed by the government, but it wasn't cuz there's private sector. It's how we're spending and reallocating resources. And so at some point, someone's got to sit down and say, you know what, here's what we can afford. Here's what we can't. And we've got to restructure it. And I'm not saying restructuring and default or anything, but the easiest thing to restructure is benefits, right? We've seen this with DB plans. It's your world, right? What have they done? They want to offload that risk at some point. And so what you do is you just say, "Look, retirement age goes up. >> You know what? All these previous presidents and administrators and congressional people lied to you. It's not your social security money. Your money paid people every time you had a paycheck coming in. That's not the system. You know what? You're going to have to wait till you're 70 to retire. These are not popular." You know, the other thing is paying taxes. You know, not popular. We've got to find ways to figure this out and it will happen one day when something breaks. And unfortunately, it will happen. Um the good news is it's probably not today. Although it feels 101° in Los Angeles, it it feels like the world's breaking right now. You know, walking two blocks over here to meet with you, it was it was >> it was it was really like a desert. You know, it's what LA is, I guess. But as I as I look through the inflation lens, why should it be lower? And that's the thing. And by the way, looking at goods inflation, which we talked about the trans components, you've seen goods inflation start to print positive again on the year-over-year basis. And over the last, call it 15 years, there's really been three episodes where we saw goods inflation be positive. Remember, it's deflationary. This was all globalization, the Amazon effect. Everything's cheap and getting cheaper. And there was some merit to that. 2018 when we got the first tariffs, we saw goods inflation go up. Okay. And like it was very microscopic and Scott Besson in his testimony said, "Well, tariffs don't cause inflation. Look, CPI was flat." I'm like, "Yeah, but the stuffy tariff went up." Um, but fine, you know, he's he's he's being intellectually honest. And we saw the supply chain issue where that was that was significant. It went away. And when we got the tariffs again, all of a sudden, you're seeing it over the last 7 to 8 months. And so all of these things come together. So it's the supply chain pressure. It's redundancy. It's also that we have these fiscal policies which were spending way too much money specifically as a percentage of GDP. These used to be recessionary levels when we spent this much. And we act like everything's great. And so I think that's where you see that this term premium should be there. The inflation premium should be there. And you know if anything the back end of the curve is what is overvalued the most. It's not really the front-end rates. Two-year Treasury, you know, it's it's like 75 basis points over Fed funds. It's repriced the risk management cuts, right? So, from my standpoint, I feel like there's not as much value on the back end. And that's going to be the mechanism that really drives policy changes. And I think that's why you've seen Scott Bessing come out recently and talk about wanting to have buybacks on the 30-year Treasury. I think he's a little disingenuous. It's up on person's point of view. We are skeptical, but he's disingenuous. I would argue because he's arguing liquidity for off the runs. He wants to take those out. It doesn't make any sense to me. You someone who owns this long duration treasury doesn't care about that that much. They care about can they buy the duration and so and 6 billion was the announcement this morning. I mean, it's a drop in the bucket even if you did it once a month cuz it's it's really only core with auctions. It's usually the secondary around it. And so what 70 billion a year? I mean, our deficit is like one and a half trillion. Maybe maybe it's two. No one knows because of the war cost, too. So, anyway, I bring all that up just because these are the things that it's a complicated world, but we distill it down to very few factors. It is inflation. What makes you think inflation's going up? What makes you think it's going down? I look at just input costs. I look at imports, exports. There's inflation. So, it's hard to get your mind around how that doesn't transcend. And by the way, when you have a profit margin boom, that just means corporations are taking advantage to pass through some of that to you. >> Yeah. And when you have massive deficits during good times, and we know it gets worse during bad times, and you have this growing debt burden, you need some inflation to work your way out of that. You can restructure, like you said, that's relatively painful. Long-term inflation is a less painful, maybe equally bad, but less painful and at least optically to work through those debt problems. So you could see a world where there's structural pushes towards higher inflation and there is probably a great need for more inflation. So you could see that playing out over the next decade or so. >> And the problem with that is it's all regressive. And what I [clears throat] mean by that is that it affects the lowest cohorts, whether it's income or wealth because they have the least amount of disposable income. They live paycheck to paycheck. So if you're going to have it, what do you do with these people who you are penalizing, right? And so it's nice if you're an investor and you can buy something that gives you an inflation plus premium. But for those who don't get to participate, they're left behind. And so that's part of the problem of the wealth polarization in this country. And this has been an issue for almost two decades now. And what you have is that if you were an asset owner in 2020, and yes, you had some pain in March and April, but let's say you're an investor. You own a building, you own a house, you've done very well. Who didn't benefit? Those who weren't in the market, those rent, they call it the rentier class. My French isn't good, but means rent renter class. Um, have been penalized and they've had most of the pastor and that tends to be lower cohorts as well. So, we've had this experience of these regressive policies and I think there's three major ones. One was the money printing which caused inflation. The second has been the tariff policy because at least short term it causes that pressure on prices and resets the level. And then third, I think the wars have just put another level of inflation in here. And I've been very neg well I'm always negative on war. I try to try to not promote war. I think that's a good place to start. >> We should have known when they renamed it the department of war that it was going to change the the dynamics. But the thing is is that the destruction that Iran has done to the local region in the first month or two was enough to take oil supply out for, you know, offline. We we lose about 10% of the oil supply. Luckily, China had stockpiled. That's coming down now. And by the way, that's why you're seeing oil prices back up and the war has really reflared. So, I've been in the camp that I do think that oil prices are trade around 100. Again, rightly or wrongly, it's going to bounce a lot about it. That's an input cost that's going to choke people off. I mean, if you look about stuff going into midterms, what's the the biggest complaint right now? It's not affordability housing. It's diesel, right? And diesel set a new record high this week, right? All time. And remember when you when you do some of the the uh when you build the or when you go in the cracker and you end up doing distlate, the other thing that comes out with with diesel is jet fuel. It's kerosene. And so those are the two things. Those are huge input costs for this country. So it's hard to see how these policies are helpful at this point. And I think this is some of the revolt you see the unhappiness, why the sentiment is so low. A lot of it's price levels. And I think people just aren't happy with anything. And by the way, this has been the good times, Alex. This is the boom, right? And we're miserable. May maybe that's just who we are these days. Welcome to a bond py wake up to the mind of a bond psyche or >> uh so we talked about monetary policy. I I know you you feel like fiscal policy is becoming a more dominant factor. Would you talk through that as well? >> Yeah, I mean this is what economists call fiscal dominance. And what fiscal dominance means is that all policies point to fiscal. And so when we talk about the Fed, the Fed is the monetary engine, right? So they set monetary policy. By the way, the Fed doesn't control long-term interest rates. The Fed controls overnight lending. It makes sure the economy is functioning. There's >> tried to with the narrative. >> They do. And they did it with QE, you know, but that's kind of the role of the Fed is to make sure the market's functioning, markets are clearing. um you know, debt markets are open, you need to borrow money, we're here for you, there's the home loan bay, there's all kinds of stuff. And so, um that's the Fed's job. But when you hear about fiscal dominance, you know what that means is that the monetary policy is not independent. What it's trying to do is make sure that no matter what we do as a policy, the fiscal is the most important. And that's essentially what the administration has conoted from the standpoint of we need rates down. We need rates down. Why? We want to borrow more money. Do you recall when they set the debt limit last summer? The idea was that it would go through this administration's tenure. We're going to hit it next spring. Like that's not even half the time they thought it was going to take. Or maybe it is roughly half. It's about it's about 18 months. And so when you start to go through this, it's that it's reckless at the end of it. And look, I understand free stuff is super popular. People will stand in line hours for free things. >> Well, there's a long-term cost. >> There is a long-term cost and there's opportunity cost and there's other costs out there. But at the end of it, we've got to figure out how to make it all work. And look, is communism answer? No. Is capitalism answer? Not completely either. There's some mix of things. Um, and I'm not trying to say one's better, you know, probably one is better than the other. The capitalist side works pretty well. But there has to be societal benefits, too. And speaking of that, maybe when we're done with this AI buildout, maybe what it turns out to be is one of the greatest social experiments that we've done in in over two decades. Maybe call it three. Um, and what it is is maybe we're doing is these mega companies, we're going to use them to build the infrastructure for everything and they're going to pay back society for those gains. They're going to make money potentially on the other side. But that's what happened in the telecom buildup, right? It was massive overinvestment. Um, we have the internet now. You've heard of it, right? Works out pretty well. But when it first came out, I love to tell the story of like when it first came out, we were just sending random emails to each other. You've got mail, right? Um, and then it got to where you can send a weird little image along with it. And this prevalence came around. But we had an overinvestment and the demand evaporated, right? And job losses, etc. >> And so did some of the companies. >> But then we got the internet. The next phase was what happened. The smartphone came, the uh e-commerce came. the the some rando I say some rando will pick you up on the curb outside your office and take you to a a place you rented from some other rando you know um and we think it's okay we don't know what we're going to do completely with AI and I did read the headline from the anthropic guy this morning I hope it doesn't kill us if it does this podcast isn't going to be very valuable to folks but the point being here is that I think none of us can fathom what AI is think we we kind of get I I'll use an anecdote for my nephew. He's 23 and he was looking at the Ring camera and how it could identify that, oh, it's a UPS versus a FedEx versus, oh, someone's holding a trash bag. He's like, oh yeah, it's it's just AI. And I'm like, well, it's image recogni. Like, and I tried to like go and he's like he's just looking at me like I'm a total nerd, which he does think that. Um, but I'm like, not everything is just AI, right? And so it's the evolution of it. So I just think that we're going to get there at some point, but you can't tell me the spin is disinflationary. And that's what the Fed chairman has tried to tell us. That's what Mr. Besson has tried to tell us is that, oh, it's going to come because we're going to have such productivity gains. Well, I'll tell you this, >> that might take a while. >> Have you used AI at all? You use it, right? >> Yes. >> Was there a learning curve? Well, yeah. Yeah. Right. So, that's not a productivity game. You'll get one, but you invested in it, right? And so, I question to the average person that productivity game. I think there will be specialized things, right? And like I'm not going out here and saying anything profound. Um, but if all we're doing is trying to do large language models and you're trying to have your better model than me of trying to analyze some text or some document, it's going to be a commodity. It's not very valuable. The discovery is the infrastructure is how do you monetize it? And that's going to be the question. I think that's the biggest question for the market. Now we talk about Fed, we talk about inflation, we got to talk about this rampant spending and there's not a lot of business cycles you can go to in the history of the US and you can see four or five. Every time there's a significant investment in a in one single sector that promises all this great technology, the answer is it tends to be a bad investment at some point in the cycle and then it becomes exactly what people dreamed and plenty more. We can talk about, you know, the invention in aviation, we can talk about railroads, uh we can talk about electricity, uh you the internet's a perfect example as well. Um, and we just think that it's just going to be this straight line and we know the human nature. We all get excited about it. What happens is is someone else has a new AI idea. It just compounds and we just keep spending and spending and somehow, you know, the demand collapses at some point. But again, when is that? Is it 27? Is it 28, 29? No one knows. Um but history does show this that during these cycles that we tend to to have that I I'll coin professor Shonus the irrational exuberance. >> Are there any major risks or opportunities you feel like investors are generally missing? >> I think that some people have gotten very comfortable with cash and I think that stepping out the curve a little bit is something that people should really be entertaining. as I sat in here and described a very high quality low duration portfolio can pick up 150 to cash >> because yields are near 20-year highs in general. >> Yeah. In cash, right? But, you know, so is the 2-year, right? I mean, so then that's kind of how we're looking at things. So, as you start to really dig through it, I think some of that opportunity cost people have gotten complacent with it because a three and a half's good enough, you know, but if you can get five, why not try, right? Um, that's one. I I think more importantly, I think there's there's kind of a doubling down of risk that people have ignored. Um, or let's just call it it's worked. Um, and I think it's the I own private credit. And this is hypothetical me. I I by the way, I do own some private credit. So, I'm not I'm not the quintessential hater. Private credit. Um, I own bank loans and I own CLOS's. You know why? They've all worked. You know why? They don't have duration. there a lot of floating rate and again there's enough yield to compensate >> and you have an economic downturn >> but those are all the same trade is my point they're different parts of capital structure there's different risk in them but it's lending and it's lending in a narrowish market a very well- definfined market and why we've seen such kind of low default rates in high yield and bank loan is that stuff moved to the private market the really hairy stuff by the way Alex it should that's where it belongs when you go private there's a problem with your company. Usually, you don't just go, "Hey, I love this public company. I'm going to buy and go private. Maybe Michael Dell did it." There's not a lot of of of anecdotes out there, but there's usually a problem. There's a reason there's workout teams. There's a reason there's distressed investors. That's what they do. So, I don't have a problem with that. But I think there's layer in these risks that people think I have three line items. I have diversification. I think the other one that's a little missed today, but it's widely cited is the concentration risk in the US equity market. And there's again nothing profound. I'm not saying anything you don't know, but I like to tell people if you want to buy the S&P, instead of buying the S&P, why not just buy tech and buy something else with it? Segment that yourself to give yourself the mental accounting to realize this is my diversification. And I know that it's easy to have the lowcost index fund, whatever that may be, but you can do the lowcost tech thing and you can build something else to it. And we've seen this with some value values work this year. Value is always been a pain trade for 20 years. Um, but it's worked. Um, you've seen some mega midcap, I meant to say midcap, not mega cap, but midcap kind of really outperform and we've seen a little bit of the better quality small cap there. >> And non- US as well. >> Non US has been great. And so diversification once again um you know no one wants to hear it in a bull market um but the amount of concentration the top 10 names within the you know one sector dominating the market we're at all-time highs uh in the US and I I put together a chart showing this of what the largest sector is and I think Gunlock used on this webcast yesterday of showing that what's the largest sector weight and also what's tech and over the last 30 years it's almost always been tech right but we're at like 35% where during the the telecom boom including tech and telecom together I think it was like you know low 20s so it's a different world then I can play the other devil's advocate and say well if you buy Europe it's all financials you know it's very concentrate you go to South Korean stock market it's two stocks right it's SKHEX it's it's Samsung I guess there's LG in there too but that's really driving it um so other markets have that concentration >> what's interesting is when you look backwards it's all justified because that It's not just the prices have gone up, the earnings have accelerated significantly. So it's the question is is that all priced in looking forward? That's the that's the big question >> and that's the question. And look, right now it looks, you know, pees are coming down cuz estimates have been going growth has been super strong. So I'm not here to say the Mag 7 didn't deserve the moniker. The Mag 7 hasn't worked as well this year. Um, you know, I used I used to joke probably 15 years ago about Amazon. I'm like, why would you pay an 80p for Amazon? Oh, wait. it grows at the rate of the stock price. It's still an ADP, right? It just it it essentially the stock goes up by the earnings growth, right? Pretty good company, right? So, there's a reason that they've earned that. Um, and I think some of that consolidation, it's why the IPO market has been softer. It's why you've seen companies stay private longer is that there's been a benefit to size for the last decade. But these this rhymes with the late '9s. People talk about tech and telecom. there was a massive megga cap effect back then. I remember Walmart was like dominating as well. And if you didn't own mega mega, you underperformed in as a large cap manager. And so we've seen some of these things before. And look, maybe we we distilled this down and there's only seven companies in the world. In the history of the the world, we haven't ever got that. And usually there's some sort of regulation that comes in or there's destruction, wars, etc. But I I think that right now it's hard not to like the US stock market. I mean you can argue about the earnings. You can argue argue that their margins will come down a little bit but the end of it the pricing power has come through and the demand is for our technology. Yes, we need memory. Yes, we need compute. We need we need processors. We need storage. But guess what? We need that for everything. Everything has those components. And so it's a good time to to be an innovator and that's this is a place to innovate. So I'm not as negative. I like I don't love the multiple on the market, but until this trade gets disrupted, you've got to run with it. But what I like to say is just segment the risk. Understand that your S&P is not your S&P from 10 years ago. It's just different. It's more NASDAQ heavy. It's more tech heavy. It's AI heavy. And so you have to think through that. And I think that's another thing that's kind of missed. So we have this well not the oneline item you think is diversified isn't as diversified you think. You have three items you think are diversified but they're not really as much. And I think those are the things that that you you tease out. But my last comment on that is that during the pre- pandemic period, do you remember the rage was all factor analysis, right? And I know you guys do a lot of work on risk parity and that stuff. And as a mathematician, I love I love risk par by the way. I think the concept's great. Um, but the factor stuff has gone away. The only factor that anyone's liked in the last 5 years is momentum, right? And it's obviously had a bad year. But that kind of analysis needs to go through people's portfolio. Understand that, you know, you had this line item diversification, but what are the underlying risks there? And are you doubling down that? And I think that's where that complacency I talk about has seeped in because these trades have all worked. And the hardest thing to do as a portfolio manager, as an investor, is to sell the winning trade, right? You know, it's very hard to do. And sometimes you got to pair it. That's what we call just cut risk a little bit. That's that's the way of saying, you know, we're not we're not exiting, we're taking the gains. And I think that's some of the stuff needs to be revalued in this market right now. But look, if we get a hot IPO calendar, um it's going to transcend the economy. The the SpaceX IPO for what what happened and by the way, I've never seen a company come public and like within a week, week and a half, they have a debt offering. I I've never seen that in the public markets. And by the way, it wasn't very wellreceived. But SpaceX printed a lot of money for people. That goes to the economy. Anthropic is going to make the Bay Area rich. It's going to drive real estate to like 4,000 a square foot or something. it's going to be something insane. But these things have good knock-on effects, too. So, we can't um dismiss that either. And we'll see how it plays out. But for all these things I'm talking about building risk, these are kind of mid to late cycle stuff. It's not imminent. But there will be a hiccup somewhere and probably we won't see exactly what it was. And we'll all go back with, you know, Captain Hindsight and say, "Of course, that was happening." But the problem is we know the risk are building but it's hard not to participate in some of them. And I think that's the biggest challenge an investor has today. Um and that's part of being an investor. The the worst the worst trade tickets when it felt good to ride it. The best trade tickets a lot of times when you were nervous as heck to buy it. >> Yes. I I guess the the short answer is participate but be mindful of diversification so that you're not overly exposed. And and I think it's helpful to look at history and you see how leadership changes through time. You know, the winners don't stay the winners and that cycle always turns. You just it's hard to predict when that's going to happen. >> That's right. And look, the if I have the highest conviction about some is that, you know, we're we're we're negative on the dollar over the medium term. Um and it's hard to really hate the dollar against, you know, against kind of the Dixie, which is primarily euro and yen. um because you look at those, you know, okay, maybe the the yen needs to rally because the BOJ gets their act together. Um and there's there's too many players pushing that right now. But in general, it's hard to say why the euro should really strengthen against the dollar. Um so I think that that's a tough trade to want to own. I think owning, you know, defensive stocks in the European region, I think energy stock, that's very interesting as a European investor. Um so I can take that currency risk alone. If I'm going to buy it, I want to hedge it. I just want to own it. But the emerging world is a lot different. And I think what you've seen there is that, you know, they've been diversifying out. They're they've ddollarized a bit. You own commodity producers. There's banking system, media, tech, telecom is very big in these regions cuz they're diversifying too. >> It really is. And that's the part that we like the most. And even as a bond investor, you know, as a bond investor, I get paid for that trade. Whereas if I so if I buy treasuries today versus buying European denominated debt, I give up yield, right? I give up something between 100 to 150 basis points. So why do I want to do that trade? I have to think the currency is going to move and it's hard [clears throat] to hard to see that happening. But on the EM side, we can build a portfolio and this is what our our EM local currency book looks like today. um you know you're talking 7 and a quarter to 7 38 yield um on something with you know like a four and a half five year dur duration quasi investment grade there's probably 30% of that's below investment grade but I get paid to wait so while I'm hoping for that currency movement or or forecasting and going down and I I get to participate in a yield and also some of these banks have very high rates they can bring rates down so there's just there's a lot of ways It feels like winning there. Um it's not without risk. >> Plus the currency too, >> right? And there's the currency component. So while you're waiting for the currency, you get carry and then there's also just the bond price movements if you have all the fiscal and everything, you know, uh done. I I feel like our global sovereign EMF does a very good job there. And so from that standpoint, that's very interesting and that's something I think people just don't talk a lot about. And it was kind of popular to talk about last year and but that's especially late in the year and we started in a trade kind of around the late spring early summer and we've continued to add to it and you know we want to we want to double the position effectively like in credit books we're like 5%. you know, getting to 10 is no problem, right? But we're just trying to chip away at it, try to find some better entries as well, just based on the setup, the currency movements, the overvaluation of the dollar. I think that's the best way to express it. But it's not sexy. It's boring. You know, you're going to have a month like in March, you're down 6%. You're freaked out. You're like, why did I buy this stupid thing? Gave up all my yields for here, and it snaps back in a short period of time because of the dislocation of the war. So I I just think that for disciplined investors, you've got to rethink some of this stuff. The stuff that people didn't like EM, you know, spreads are tight in EM by the way, but they're not in the local currency sovereigns. They're tight in corporate credit. They're tight on the sovereign side. In fact, they're in the they're in the most expensive decile over the last decade in terms of spread levels. So it doesn't sound interesting, but when you look at the other cohort, you start to blend them together, now a 50/50 blend these two things looks pretty dang attractive. Now we're talking, you know, mid to high sixes, get more diversification, more investment grade, got some corporate credit. All of a sudden, I've just built a diversified book of emerging markets, right? And I think that's the hard thing to get is cuz someone's like, well, do you like South Africa? Do do you like India? Do you do you like, you know, and it's like, you know, you have to think about the package and unless you are a macro person, you have to outsource that. You've got to go to a manager that that spends their time day in day out. And um if you ever heard the the uh the the I was going to say diet tribes, but that that's an offensive word. If you've ever heard like our global sovereign team talk, they're always worried about everything. There's always a problem in the world. There's always geopolitical risk, but there's always an opportunity. And so that's it's just interesting to listen. And I I feel like it's that way in credit, too. There's always losers. There's there's some winners. As a bond investor, what you can't do is diversify yourself with a bunch of losers, right? the winners don't offset it. And that's the thing I remind people, you get diversification, but when you buy a single sector and you diversify on a bond portfolio, especially if they all trade at par, you have zero upside. The only thing you get is carry. You get the coupon. But if you have any losses, you eat that massively. In equity world, you can double, triple, quintuple, 10x, you know, in some of these names that have done in a year, right? completely offsets losers. Unless the bonds trade cheap on a dollar price, you don't get the diversification in a single sector. And that's something I've spent the last year reminding investors when I say, "Why are you think why are you so negative on this AI trade? I'm negative on it from a bond investor standpoint, on the speculative companies that have no history of doing this." >> Yeah. Because you don't get the upside. >> I don't get the upside. But you tell me all of them price at 40 and now I can start to price out yields. Excuse me. I got yields in the 1516 range. Plus I got some upside. Now we can talk. Right. So there's a different dynamic between the psyche of a bond investor and an equity investor. >> Uh well Jeeoff this was it's always fun having these conversations with you. I've enjoyed them over the years and uh this was another one of those. So I really appreciate you joining us. Well, thanks for hosting me and it's uh it's always great to talk to you and uh again for people out there any way any of us can help uh we're always happy to help. So, thanks for taking the time. [music] Important information. This podcast is provided forformational purposes only and should not be considered legal, tax, investment or business advice. It is not a solicitation recommendation or endorsement. All opinions expressed by participants are their own and do not necessarily reflect the views of the Evoke Advisors Division of MAI Capital Management LLC or Evoke, its affiliates or any companies mentioned. 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