High Yield, EM Most Vulnerable To Asset Collapse: TCW's Rivelle

prepare is preparing to fail. Tad Ravel is the chief investment Officer for fixed income for TCW, helping to manage more than a hundred and eighty billion dollars based in Los Angeles. Tad Ravel, thank you very much for spending time with us. What do you mean by this that failing to prepare is preparing to fail. Well, what we're speaking to is that there is an asset price cycle. There is a credit cycle. Unless this is the first

one that isn't actually going to be a cycle. We should expect that the relatively placid environment of the last seven or eight years is ultimately going to have its come up in and that it's imperative that investors understand that strategies that focused on risk taking and yield emphasis will probably have very disappointing results if in fact we are in the late stages of the asset price cycle,

which we do view ourselves as being. So how do you respond to people that point to the sort of I guess you would call it the disintegration of a connection between asset prices and growth in GDP. Right, Well, you know that is probably the most consequential place that people ought to be looking in terms of understanding where

you are in the cycle. As we would put it, the disconnect that what you alluded to, the disconnect in which asset prices are so robust against the backdrop where GDP has been growing at very muted rates for a very long period of time, suggests that there is in fact that disconnect, as you say, between asset prices and income. If you disaggregate asset prices into their constituent pieces, obviously what you have is equities, real estate, bonds, et cetera.

And when you have this large disparity between asset prices and GDP, which you're really saying is that one or all of the following are true. Pe ratios are being stretched. Cap rates in real estate are very low, or bond yields and bond spreads are also quite quite compressed. What it also means, of course, and just thinking about it in an equity formulation, if asset prices are high, if asset multiples are or pe multiples are high, ordinarily as

enterprise multiples left, so do debt multiples. If debt multiples are lifting at the same time that income and GDP is muted, sooner or later, you're going to have a debt servicing problem. Well, then speak about this debt servicing problem in the context of low discount rates that were available at one time but may not be available in the future. Right so to to a very great degree, maybe this also speaks to another kind of disconnect I'll

call it the central bankers disconnect. Is that traditionally you think of capitalism this way that when your labor and capital are efficiently configured in your economy, your profits are going to be growing, your wages are going to be growing, your GDP is going to be growing. That's just another way of saying that prosperity should naturally lift asset prices. Instead. What the central banks in effect have done over the course of this cycle is they short circuited the process.

They forced rates lower through quantitative easing, through zero rates, negative rates in Europe and so forth, and by driving the discount rates down. Uh, the result has been a surge in asset prices. But the surgeon asset prices. It's not the case that high asset prices create the prosperity.

The causation is completely reversed. And so now we believe you're in a late cycle type of environment, and ultimately you're going to have to resolve this disparity, this wedge between high asset prices and low GDP growth against the backdrop of substantially expanded leverage in the system that was incentivized by these low discount rates that you allude to. Well, does resolving this disparity? Is that a diplomatic way of

saying that we are headed for some real problems? Yes, I guess you said it much more directly that there's only one of two possibilities, as as the Great Lord Kine's put it, Uh, if a trend is unsustainable, then at some point it will stop. This idea asset prices can permanently disconnect and continue it um or work in a in a dynamic that's completely disconnected from the income economy, the wealth economy. That is what I'm referencing. It's it's absurd.

So either we're going to get just a massive surge in GDP growth going forward to validate and justify the increase in asset prices, or in most most probably you're going to have to see a reduction in asset prices to uh correspond back to the GDP. And the mechanism by which you get there is probably already being laid out in front of us. It's the FED tightening, it's the quantitative tightening as well as the actual rise in

the overnight rate. So does that mean that tad Rivella is talking himself into a job of managing cash for a while? Well, that that's probably an unnecessary, um uh extreme step, although maintaining a proper level of liquidity is probably always a smart thing to do. But in a late cycle environment, what it really means is that you're supposed to recall what Benjamin Graham said a long time

ago that bond selecting is a negative art. Uh. It may not be a negative art in the early and mid stages of the cycle, when leverage is increasing and almost everything that you do. UM, everything that you do from a risk seeking point of view tends to do rather well in the late stages of the cycle. You have to be very careful about not selecting assets that we would deem breakable in the sense that they're going

to give you a permanent impairment of principle. And so that means that when you survey your allocations to things like high yield and in some of the more leveraged area of the corporate market, is be careful. There are ways to continue to capture yield premium even in a asset price come up and bear market. In in in risk there are plenty of things that work out, but there's a lot of things that may be very disappointing

in terms of where where they end up. Where do you believe you'd see the first indications of these problems. Would it be and let's say the leverage loan market, would it be in high yield debt? Well, the places that are probably most vulnerable UM would be in the part of the high yield market, particularly that part of the market that has been so overgrown with covenant light debt issuance. And although covenant light sounds like a sort

of a technical, almost obscure term. What it really comes down to is we're always supposed to remember that a corporate management has a fiducial obligation to its shareholders, but

a contractual one to its bondholders. So what that means is that a business can have uh good potential as a business, but without a properly constructed set of covenants for the bondholder, it's also possible for management to essentially uh spin those assets off the shareholders, pay sell assets, and pay special dividends, and essentially leave the bond holder holding the bag. So the fact that covenant light issuance is essentially off the charts, it's much greater than we've

ever ever seen it. It's a very um imprudent form of lending. So you should expect that when the Fed raises rates, it also strengthens the dollar and you start to see cracks develop in parts of the emerging market. We've seen that just in the last week with Argentina and to a slightly lesser degree, Turkey and maybe Indonesia as well. Thank you very much, tad Rivell joining us as the Chief Investment Officer for fixed Income at the tc W group helping to manage more than a hundred

and eighty billion dollars global value. What is a global value investing perspective? Here to help us understand this is Thomas Russo, managing member of a gardener Russo and Gardener, helping to manage more than ten billion dollars of customer assets. Based in Lancaster, Pennsylvania. He joins us here in our eleven three oh studios. Tom, it is a pleasure to see you. Thank you very much for coming in. I want to jump right into it and specifically start about

talking about tobacco stocks. Because tobacco stocks, let's leave aside for the moment. Uh, they're the products in terms of whether you are for or again smoking and the health concerns. Many people have invested in these stocks because they have looked forward to what are many consider rich dividends. Yes,

do you believe that that's still a valid thesis? Well, it certainly has been over the past four or five or six years as rates short end and the curve have been so low, and so people have sort of been pushed into equities and search for yield, and they've had the highest the highest levels of yield. Um. Uh, and it's in large measure because up until recently they've they've lacked the ability to reinvest a lot of money

in the business. UM historically, um UH, and and the dividend yields five percent plus for um Fillmore's International and roughly the same for all three have attractive capital historically. So do you think that they are still attractive for

people looking for dividends? No, I think the I think the search for yield actually has has already sort of begun to reverse because the two year treasury yields close to two point seven percent today, and that's fully more than many public companies have as as their dividends, and so it's adequate. It's adequate to keep people away from equities. They don't have to chase after equities just to get yield.

Two point whatever it is is close enough. The issues with them, the three areas that you site tobacco and beer and and UH and banking, is that, interestingly all three of them stumble and and struggle today because they're going through a remarkable period of transition. Those are traditional old businesses. You can't imagine anything quite as long standing

as tobacco, banking, and and UH and beer. Um, But each of the business is that we're involved with there have new elements that make the future seem more cloudy than than the past. Okay, but just final question on tobacco stocks and then what we can go on and talk about a by shares of Philip Mooreton International are down by more than a fifth. Yes, so far this year, as you say, they currently pay a five percent did end um? Is this a stock in your opinion whose

time has come and gone. No, No, it's a position still in my portfolios. Um, it's a it's a stock which evidence is the expression at this moment that no

good deed in life goes unpunished. It's Philip Morris says alone in the industry, over the past five years, directed over two and a half billion dollars of shareholder money to develop a reduced risk product, a cigarette substitute that satisfies adult consumers who wish to quit, which are effectively half the community of smokers in the world over, probably a hundred and fifty million people would love to quit,

and yet they haven't had something they worked. Philip Morris, after having spent invested two and a half billion dollars, has a product that works, and in fact, in Japan and other markets where it's rolled out, they now have

close to market share themselves. Uh. In In this in what was the tobacco industry is now split with combustible cigarettes and the product that Philip Morris invented called the icos, which is a non combustible cigarette, and everything's moving along swell up until a couple of weeks ago they had a stumble in the in the rollout of of a new device that's attached to this product, and that caused

some investor concerned. There was a slowdown in the cigarettes that go with that product, and the market became a bit uh disenchanted with the near term prospers. The long term process of completely unaffected by this UM as far as I can tell. And then on top of it,

it's it's a regulatory thing. The US FDA has resisted allowing this product into the market, despite the fact that it has helped nearly six million smokers around the world in the last two years alone quit forever cigarettes and so UM we believe that that relief from the FDA will have to come because the product being adopted by millions of people overseas, leaves of the US seeming a bit of isolationists as it relates to a product that

has effectively helped people for the first time ever quit Now, that's one thing then, and I think at five five percent yields at thirteen times that income in this marketplace. The investments are in Altria in Philip Morris are quite reasonably priced, especially as I do believe that the product that both of them will share and we'll finally get approved by the U s f D. A. Thank you very much, Tom Russo. I look forward to having you

in the future. You got to talk more about your value strategy and get your insight into what's going on in the beer industry because, as you say, going through lots of changes. Tom Russo is managing member of Gardner Russo and Gardner, helping to manage more than ten billion dollars based in Lancaster, Pennsylvania, joining us here in our

eleven three oh studios. Well, if you've been scouring the quarterly reports of companies such as Netflix, Microsoft, or Google's Alphabet or even Oracle looking for how much cash they have held overseas, good luck you won't find it. Brandon Couch Codin is a managing editor for Bloomberg News, and he joins us now to explain why, all right, Brandon, why aren't companies reporting how much money they have held overseas? Yeah,

I mean, the simple answer is they don't have to. Um. The the more complicated one is basically, um, with the tax law changes, Um, every company how to pay these this mandatorily? How to pay this tax? Already they can space it out over eight years, but they have to pay this tax on their fore and holdings. So cash anywhere in the world is basically fungible. Now. Yeah, but why wouldn't they want to report that they had, let's say, brought the money back to the United States, if indeed

they did so. And that's the question that tax experts we talked to are asking. Um, they're looking for, you know, changes in disclosure right now because they haven't gotten a lot of guidance from the I R S. All Right, So if the company doesn't bring back the cash from the United States, there's no way to know this now, at least not from their quarterly reports. We might see it, um through other filings, some of them are actually disclosing.

I mean, we have an example in there from Google I believe that they told us how much UM tax they paid, so from there you can kind of back end it and get a sense of how much they brought back. But it's up to them, I mean, otherwise we're not going to know. And what about other companies. I mean I mentioned Microsoft, Netflix, Alphabet the parent company of Google, as well as Oracle and Apple. They don't report this and in some cases I should just mention

that it isn't something that's just happened, correct exactly. So Apple stopped last year at the end of their I guess their fiscal first quarter whatever whatever it was. They're back in October UM and then you know, the same thing. I think Cisco stopped a little bit earlier. Otherwise we're seeing them stop at this first quarter recording after tax law went into effect. And what about other companies? Are other companies like Coca Cola, for example, are they still

reporting how much money they have? That's that's sort of the interesting part to us right now is seeing who's reporting and who is and so Coke and Pepsi both are, g Caterpillar both are um. Facebook is some of the interesting things to get to see now is someone like Facebook there you actually have more cash overseas now than they did before, so it's not quite having the effect

we thought it would. The question is whether how much it is just how much it matters now the new rule is at a one time rate of what like fifteen and a half percent for the cash and eight percent for non cash or illiquid assets exactly, And and they have that's on what they were holding. Um. They have eight years to pay that, though they can space it out, so there's sort of that um opacity right

now in terms of when they're paying it. And that's something we're all gonna care about because it's going to have an impact. So this would then make the actual cash amount that is listed in the quarterly report a total obviously for the entire company, and it would be treated the same as if it was in the United States. Yeah, exactly, So what they held overseas, that's what's going to get taxed at those rates for this one time sort of

um you know, repatriation holiday, we want to call it that, um. Otherwise,

now it's all being treated the same. The questions are becoming now, um around if if we're going to see, you know, what the global minimum rates going to be and if this is a permanent situation, or if companies are keeping it overseas just in case something changes, and and that there might be an advantage down the road because previously they had to pay what a thirty five percent tax if they wanted to bring the money back

into the United exactly. And so that was always the rationale for why I was saying, quote locked overseas um you know, like we see we see it in the article. We have tax experts that are that are saying, you know, look, we tried this before in two thousand four. We didn't see a ton come back. You know, we're doing it now, expected to be sort of tactical, and don't expect this all to all of a sudden, you know, come on

to us accounts. And one of the reasons why investors would look at the cash position of a company is that when you do a total valuation of the company's stock, you want to back out, or at least you want to make note of how much cash they have on their books, because that would then be something you could

deduct from the actual share price. Yeah, of course, all right, And any word from the Internal Revenue Service as to whether they're going to make this kind of filing, uh, you know, mandatory in the future in order to sort of see or check to see whether the law itself was was effective. Everyone we've talked to is said that there's you know, the problem right now is the lack of guidance from the I R S. So there hasn't been anything to that effect yet. All right, well, thanks

for the guidance. Appreciate it. Brandon Couch Cotton is managing editor for a Bloomberg News on the story that the Apple, along with a variety of other companies such as Netflix, Microsoft, as well as Oracle, uh not reporting how much money or cash they have on their books outside the United States, go public or get sold. Well, there may be an

advantage to being acquired. Sandy Miller is the general partner at Institutional Venture Partners i v P, based in San Francisco, and Sandy joins us now to explain what's going on in the world of technology and initial public offerings and mergers and acquisitions. Sandy, thank you very much for being with us. You know, one of the things and preparing for this, I was taking a look at Snap, which was a headline grabbing initial public offering. It came public

at seventeen. It currently trades around ten dollars a share. UH that's a decline of a little bit more than forty percent. On the other hand, mule Soft was acquired by Salesforce dot Com in March of this year for a price of five point six billion dollars. And also looking at the number of technology initial public offerings, I think they are about six that are currently trading year to date. Give us your overview of what is going on in the world of funding for a large technology

companies such as the Sandy sure Well's first. It's a very healthy environment. The i p O s for for you. I'm looking here at US technology companies have really been working well. The last three that have gone Carbon Black Smartsheet Docum sign all raised the range from the initial filing range, priced adder above the range and traded up an average of Actually the nets consistent. It's actually been fifteen US tech i p O so far this year, which is running well ahead of and they're up an

average of the most prominent one. The biggest name of the group was Dropbox. UH was an i VP portfolio company which has traded up over so deals are working Um it's not really that a surprise because there's a there's great companies as a backlog of great companies that are expecting to see more I p O s. UM. They're benefiting from obviously deals perform and money managers are looking to add to the these companies to their portfolio

to you know, as a form of alpha. And they're benefiting from a favorable regulatory environment because the Jobs Act, which wanted to affect several years ago, has been expanded to include larger tech companies. Uh and some of these new I p O s are pretty mature companies that that didn't meet the standards of the Emerging market UM

qualifications for the job back but now they too. All the all the companies, not just tech of course, but all the companies can can use the confidential filing and the test the waters features of the Jobs Act, which has been a great boon to the I p O market because it gives CEO is much more confidence that if they go through the process that it's going to be successful. UM. So I think it's a very healthy

environment for ips. But one of the things that I wanted to mention really was the M and A market. You mentioned the mule Soft acquisition happened to be one of our portfolio companies as well, the very very successful after going after a successful IPO. But many cases, companies are going to be acquired prior to going I P O.

And this isn't new. But I think, you know, people sometimes think the M and A market people buy when things or prices are low or whatever, that it's going to be counter cyclical to the I p O market, But just isn't true. It's been consistently the case that I p O s and M and A, certainly in the tech sector cycled together. Well, what ap app Dynamics, which was purchased by Cisco. Would that be an example, it's a particularly vivid example. Happened to be another IPP

portfolio company, the very successful one. They got to the they took it to the brink. They were required really almost at the eleventh hour and fifty nine minute by Cisco, even though they had market the road show was going to be clearly successful, very well received offering, but Cisco just made a bid that you know, you just couldn't say no to. I guess the but we'll see others.

There are you know, two I p O s I'm sorry to M and A transactions this past week both our companies that could have gone public and UH recruit bought glass Door, the online review for employees company, for one point two billion, and Walmart brought flip Guard, the big Indian e commerce giant, for well, they paid sixteen billion for seventy seven percent of the company that you

applies to twenty one billion dollar company value. Those are two companies could have gone public but are being acquired instead. And we'll see we'll see more of that once companies get on either on file or gearing up publicly on file, or are preparing for an IPO and have made a confidential filing. And sometimes companies announced that they've made a

confidential filing. You're actually allowed to do that. Um, the they become it kind of, it becomes a cattle for the big tech companies that probably have been tracking them for a while to move in and make an acquisition if it makes strategic sense for them. Do you see more untraditional types of money raising activity? And I'm thinking for example of Spotify, which went public but not in a traditional way. Yeah, of course it wasn't money raising

for Spotify because they did a so called direct listing. Uh, they didn't need the money, they didn't need the visibility of an IPO road show because the company was so well known has been you know, it's an eleven year old company that's very prominent, very certainly very extensive, you know, consumer base and the so they did a direct listing.

I don't think we'll see a lot of it, but I'm glad to see it because I'm all for alternatives for companies, and we just see the Hong Kong market is getting more lively, so obviously that's going to be more for the Chinese companies. But shallow be going public plans in UM in Hong Kong. So I think it's good to have alternatives. But the direct listing doesn't raise any money UM, but it does get you, get you public.

I don't think it's that biggest savings. You know. The reason why people want to do it is there's jealousy over who gets the gains from the first day pop of an I p O. That's really what it's all about. They're not so much looking to save the underwriting fees. They're looking to redirect the pop of the first day to their own share existing shareholders rather than a new set of hand picked investors from an investment bank, you know,

occurrying favor with their best clients. Want you to get specific if you can right now, because I know that you have a lot of well you've got a lot of history in the in the in the industry, but telematics and and the logistics industry, and what if you could just comment on what you see, what you see happening. Sure, well it's an area that I've personally been pretty involved in. We're back to uh, we're back three companies so far, one right, Fleet Maddox was one of them. Yes, I

was on the board of Fleet Maddics. We've backed at road Um, which you know was acquired very very successfully, the Fleet Maddics which went public and then was later required and most recently a company called keep truck and based here in San Francisco, which has sort of turned the business on its head. And it's a it's a rather than a system that's kind of imposed by the fleet owner, is actually a telematic system and uh, combined with a lot of other functionality that the truckers that

have adopted themselves. And then you know, much like most technology today, you know, it starts with the users, then the company picks up on it. So it's it's gotten very very broad positive acceptance from the actual truck driver community. I think it's an area really right. You know, this is a massive amount of our Our whole industry moves

by truck uh. It's a very old fashioned industry. The information and available is remarkably limited historically, and it's really right for you know, technology improvements and people like Keep Talking and others are providing that. Thanks very much for being with us. Sandy Miller's general partner for Institutional Venture Partners i v P, based in San Francisco, and you can follow them at i v P on Twitter. Thanks

for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud or whatever podcast platform you prefer. I'm pim Fox. I'm on Twitter at pim Fox. I'm on Twitter at Lisa Abramo. It's one before the podcast. You can always catch us worldwide on Bloomberg Radio.