Lending, Jay Powell, Oil, And EVs (Podcast)

lender to middle market pe owned company. So it's always a good chat with Tim to get a sense of what's going on with some of these small and mid cap companies out there as they deal with higher inflation, uh, the backside of a pandemic, potential recession. Uh. Tim gives us some good thoughts there. Tim, thanks so much for joining us here. And I'd love just to get kind of word of time of flux here. We've got rising inflation, we've got rising interest rates, we've got potential for a recession.

As you talk to some of these smaller and mid sized companies, what are they generally seeing, how are they adapting? Sure? Good morning, pauling creedy and pleasure to be here. So we have almost five hundred middle market portfolio companies, and what I'm hearing from them is that demand drivers remain favorable, Revenue growth is still quite strong, and while there's certainly some inflation concern, our borrowers have managed cost inflation with

price increases. The most significant challenge for these portfolio companies is navigating this tight, tight labor market. So it's kind of how do I retain my best people? Where do I find new talent? And this hiring issues impacting almost all industries and it's across all personnel levels. You made a key point. They're offsetting costs with price increases, and to your point, it has worked quite well, not just for middle market companies as you're focusing on, but I

would like to say broader sp companies as well. But I'm curious how long that can actually last. At what point do price increases become so dicky that it ends up leading to demand destruction. Sure, it's a very good question,

and I would say it's not sustainable. I mean, we've we've seen companies in our portfolio implement a ten percent price increase followed by a twelve percent price increase, and at some point there's going to be the customers are going to resist and just say I'm not willing to do that. But what's so interesting right now is the customers need the product, so because of all the supply chain disruption, they're willing to pay the extra price to get the product to then be able to meet the

demand from their customers. So what I love to just get your sense of a small mid market, MidCap kind of M and A activity the last few years. Much to my surprise, we're generally very strong despite the pandemic and challenges there. Um, what's the M and A activity this year? Sure, so we did experience a frenzy of activity, one with record deal volume. LBO volume is certainly down

this year. But notwithstanding this, what we've seen it's very strong add on acquisition activity in so our private equity sponsors are always looking for opportunities to grow their portfolio companies through new services or new product lines. And we really expect this strong add on acquisition activity to continue for the remainder of this year and and maybe into as well. But how is that financed? Exactly? How are they financed? Is we? So we and other lenders provide

that financing. So sponsor buys a company, Uh, the deal is capitalized with equity and debt, and when they have add on acquisitions, assuming the capital structure is right sized, will be able to provide a financing for those acquisition Sans if it's a really large acquisition, the sponsor may need to step up with additional equity as well. So talk to us about the private debt marketplace. It's been a area of good growth. That's where you guys play.

Talk to us about that market in terms of, uh, you know, the capital that's available, the rates that you'll lend, the liquidity in that marketplace. Gives a sense of overall health of that private debt market. Sure, Uh, there's good reason for private debt rapid growth. So the industry has demonstrated resiliency through numerous second economic cycles over the last twenty years. If you think about it, for the investor, private debt really offers more favorable risk adjusted returns than

many other asset classes. Importantly, right now, with the increasing interest grates, it offers an inflation hedge because our loans are floating rate instruments. So you ask, like, what would be a rate we've moved from library to sofa, so might be sofur plus five fifty so for plus six fifty um. And we don't really see the current economic

environment changing. Private debts appealed for investors. As a matter of fact, private debt assets under management are projected to grow at double digit rates over the next five years. Over the next five years double digit rates, well um, double digit rates per year. Yes, And so where where where does that capital come from? Is that coming from

pension funds, endowments, that types of thing exactly so? Uh, And it's from all around the world, right, So it's a lot of pensions, sovereign wealth funds and others looking for they need yield. So they need yield to be able to pay to their pensioneers on a current basis. And private debt offers that. Uh. It's an attractive product because you're investing in an instrument that provides a current yield and an attractive yield. So it's investors all around

the world, pension sovereign wealth funds, and dowments, etcetera. All right, Tim, great stuff, Always a fascinating discussion. Tim Line, CEO of in Terris Capital, get a good sense when we talked to Tim about the state of small you know, midsize, M and A out there, not just the big blockbuster deals that are on the Bloomberg terminal every day. We also get a good sense of the private debt market, which again is a a growing source of capital for UM.

You know, companies that are looking for growth capital, private equity firms that are looking for growth capital. You don't just need to go to your local bank. The S and P five hundreds still down almost fourteen percent on a year to day basis. And then I looked at the foot see one, d are good friends over in the UK It's up one point three pc. I did not know that, so I said, we need to check in with Tim craig. Hetty's a director of research, senior

European strategist for Bloomberg Intelligence and the Pride of Southwest Virginia. Tim, thanks for joining us. What do you guys get right over there that we're not doing. We're here's a pretty good relative performance for the foot see Paul, thanks for having me on. Look, I think there are a couple of things to consider. UM. One is the makeup of the foot see. Remember it doesn't have any tech which has gotten tumbled in the US, you know, notwithstanding the

bounce that we've had back over the last six weeks. Um, it's got a big chunk of it is is consumer global brands that are also benefiting from a week pound because they get to translate back strong dollars into the UK. And it's got a big chunk of energy with high energy prices, and a big chunk of financials with rising interest rates, and all this coalesces to a foot. See that's doing really well by trading water. Now. The caveat in the off set is it all depends on your

currency reference point. If you look at uh, the S and P five hundred in pounds where I'm sitting, Um, it's down a half a percentum. So you've got to keep that one in mind. Two, give us a sense to him just kind of I'd love to just get your thoughts of kind of what you're seeing and hearing

from companies over in Europe. How tough is it and from an economic perspective, and boy, how tough could it be when if you guys really are going to have this really challenging winter from an energy perspective, Yeah, well, fingers calls for a mild winter, that's for sure. And you know it's it's interesting because you know, inflation being the bug bear that it is for all markets right now,

it's different in different places in Europe. Um, the key issue is is energy um in terms of driving inflation, and it's also a key risk factor from the standpoint of economic growth. Um. You know our calculations are for rush it does cut off the gas and industry is what's going to be affected from the standpoint of potential shutdowns in terms of energy consumption. You've got to keep

people's houses warm. Um. You could see for example, the docks the main your the main German index with with consensus expectations cut by something on the order of from where we are right now for two thousand twenty three, so the profit impact could be quite significant relative to what baked in at this point. In Germany is definitely the poster child from the standpoint of where the most

impact is. And to your point, Tim, as we look at what the docks is doing in particular, the negative correlation between the docks and natural gas prices is just building is getting stronger and stronger. It really shows you that even on an inter day basis, you do start to see that reaction to the energy prices you're speaking about. I'm curious though about what changes it is the idea of a recession kind of this in ability that investors have to kind of get past to really be foolish

on Europe again. Um. Yeah, I think that's probably accurate, and frankly in ways I think it's true globally. Um, you know, evaluations are mawed down into the low teens. You're looking at the eurostocks fifty, which is kind of our equivalent of the dal Jones index, right, and it's now at eleven times forward earnings. You know, the SMP sitting it eighteen and change. So evaluation is such where a lot is already baked in from the standpoint of

the expectations of risk. Um. I think the biggest issue is when do we see peak inflation and you know, the peak in monetary policy tightening and the bad news is going to continue in terms of economic growth for a while. But when we when we sense that we're at that inflection that we don't see it yet, Um, that's when you can start to think ahead from the

standpoint of when valuation will be more important. Right now, we think earnings for the rest of the year are going to be the big thing, and we see earnings risk right now. So as sloppy market outlook. Tim Marcus Ashworth from Bloomberg Opinion based in London, we have him on pretty often. He is not afraid to show his disdain for the e c B UM and its approach. Here, what's the market feel like in terms of or what's the market discounting in terms of the ECB and its

ability to flight to fight inflation going forward? Yeah, it's it's it's a good question, Paul. And you know Marcus has some degree views central banks regardless of where they are there between a rock and hart rock and a hard place. They can't ease the energy crisis by um by supplying more oil um. The only thing they can do is accelerate or decelerate economic growth. And so it's the best an indirect um sworks tool. And you know, maybe they are late to the game. We can talk

about that all day long. But if they want to have an impact on what's going on with inflation, they're only option is to slow economic growth by raising interest rates. And lord knows whether they're late to it or not. That's where they're headed now, and they seem the beginning all that bus um, and certainly the b o E is and it's here in England, and obviously the FED is more here and more on this. As you guys said at Jackson Home, Tim, give us a sense. So

you've been in London now a long time. I mean you're born and raised in southwestern Virginia. But you in your career on Wall Street and at Bloomberg, you've been all over the world. You run business businesses for Bloomberg in Hong Kong and New York and now London. What's it like in in England these days? In the UK? How are consumers feeling? Um? You know? And I guess there's this I'm sure there's this tremendous concern about energy security,

come come this win. But how's the consumer over there in the UK and Europe? Um? You know, it's an interesting sort of juxtaposition. Um. If I go to the local restaurants, there's plenty of people there. There's still crowds in the pubs, you know, Lord knows. On the nice sunny afternoon, especially a Wednesday or Thursday, Thursday now being the new Friday, you know, the pubs are packed outside as you know we do here. Um. And if you go to the Regent Street, Um, there's plenty of activity. Um.

That said, UM, you know, that's only one element. And clearly there's an awful lot of press reports about especially those on lower income. They are really struggling. And so I think that there's a real dichotomy right now. But boots on the ground, actually things feel pretty normal. Retail sales look pretty good. Yep, yep, good stuff, all right. Tim craig Head always appreciate the euro perspective from Tim. Uh. Tim's based in London for Bloomberg Intelligence. He's a director

of Research, senior strategist over there. He's been on the Wall Street for well over thirty years. Goldman Sachs, Bloomberg Wealth of Experience. We appreciate getting some of his time from London later this week. Uh, some economic nerds are gonna get together Jackson Hall, Wyoming. I've been there. It's beautiful, you can do fly fishing, you can see all these crazy animals that you'd never see. Bison elk I mean,

I mean bison are huge. Um. Any who they're gonna get together, I'm not really sure what they're gonna do. But our next guest can help us figure that out. Janelle Marte, economics and Federal Reserve reporter for Bloomberg News. All right, Joannelle, we're sending out Michael McKee, Bloomberg's Economic School. We're gonna send out the surveillance team, Uh, Tom, John and Lisa out to Jackson Hole. Can you tell us and tell me and our listeners what is this Jackson

Hole get together? Who goes and what do they do and what's the purpose? So, as you said, it's a big deal, especially for economic nerds. Um. They go out to enjoy nature, but also to talk about what's happening in the economy, and not just here but globally. And it's often a chance or a good place for fat officials or fat presidents too. You know, they'll they usually use it like as a chance to unveil some big

policy change. Um. But this year, I think what people are looking for is any guidance from the Fed as to when they might slow rate increases or if they're planning to do so on any your term, you know, Janelle, I think it's so funny that Paul Sweeney creeps calling them nerds and clearly in school. But I mean they're the smart folks. That's put it that way. They are the smart folks, Janelle, I'm curious about how much of

this could be anticlimatic. To some extent, it almost seems like, at least this week for the markets, a lot of this is going to be in wait and see mode to see if indeed Chairman Powell and by ascension, the Federal Reserve is as hawkish as the market is expecting what happens if this becomes a huge nothing burger. I mean, listen anytime that power speaks, especially when he speaks at Jackson Hall, everyone is, everyone listens, right. Last year he made a big speech trying to defend the idea that

inflation was going to be transitory. Of course, he's since canceled that word and said, um, inflation is here, we need to get it, get it under control. So when he speaks on on Friday morning, everyone everyone's going to be listening to just to hear what he has to say, you know, especially given what he said last year. Um,

and yeah, maybe we won't get a big signal. I mean, he's not very likely to give us a hand as to what they're going to do exactly in September, for example, because he's already said they're moving away from that specific for guidance. They're not going to tell us they're going

to do it meeting by meeting. Um, However, you know if he if he's end the message that you know apparently you know from the from the July meeting, the takeaway that a lot of investors um grabbed was that the Fed what might soon slow down the pace of rat increases, and officials have really pushed back against that. So, UM, we'll see if he sends like a really clear message now, and you're right, he might not, but certainly that is what people are looking for. You know, based on your reporting,

what's the consensus here about recession? Are we in one? Are we going to get into one? If so this year, next year? How deep? What are you? What are you hearing and seeing? So I would say that there is no consensus. We're in a really unique and challenging time in that, you know, some economic data is pointing to a slow down, as we've seen the GDP numbers, but then we have some really strong indicators like what happened with jobs, for example, where we saw twice as many

jobs I did last month as anticipated. So you know, I think FED officials are looking at this trying to figure it out. There are some people saying that we might actually see GDP revised upward later and that that might help to close the gap. But really people are just waiting to see and figure it and figure it out. And I think that as we learn more that that's what's going to inform policymakers as to what the what the eventually end up doing with rates, Because you know,

economic data is not perfect. It is often revised. Some people have some officials have already blamed that as to why they were a little bit slow to respond into or twenty one rather as inflation continued to soar and so um. I think we'll just have to continue to look at the data and see how all the pieces fall into place, do you know, on the market scale. And one of the big conversations and markets has been that the FED is constantly behind the curve and has

been for years. I'm curious though, if they have actually caught up around the cusp of doing so, given that we've now had to seventy five bases point hikes and fifty and before that as well, So how much further do they have to go before they can say, well, the Fed is now on top of things. Really good point there. The Fed was behind the curve earlier. They've

said so themselves. But at this point, I mean, they've really aggressively raised interest rates and they're at a point now where the rates might be considered neutral, which is an area that people are not really sure where that is. But the point being that they've said they're not going to move into restrictive so continuing to increase rates to the point where that is intentionally meant to slow economic growth and cool demand and bring prices, bring price gains down,

bring inflation down. So they've said where they're going, you know where that endpoint is. It's hard to you know, they don't know themselves. They're trying to engauge clues or get clues from what happens with inflation and what happens with the economy. But we the level of tightening that we've seen in the past few months is really the highest that we've seen in decades from the FAD. So

um they're they're they're taking strong action. Uh they are, and will certainly pay attention to the news coming out of Jackson Hole later this week. Friday is kind of the big day. Uh. And again the surveillance team will have full coverage from Jackson Hole. Why. I'm sure they're gonna have a really cool set up out there, uh, in the middle of nowhere, but it is beautiful out there. Janelle Marte, Economics and Federal Reserve reporter from Blueberg News

joints us with some calls there. On the economy. You know, we've had oil really pulling back, you know, over the last several months. We hit one twenty on w T I crued several months back, and then we got down here below ninety. A little bit of a spike here today, a three percent. I want just to get a sense of kind of where the short term trends are. I'm really digging this. Blow four dollars or barrel or four

dollars a gallant gasoline. Um, We'll get a sense where the short term trends are and the longer term trends. To do that, we check the with the Fernando Valley, senior analyst for Bloomberg Intelligence. Fernando, I guess the news today is maybe OPEC will be cutting production what do you what do you make of the news seeing today and Paul, I think it's a very interesting indication of where they see the band over the next couple of months.

And uh, you know, our concern has always been that the FED tightening would lead to pain in the emerging markets, and I think that's something that we're starting to see a lot of emerging markets struggling with a strong dollar, with rising food and energy inflation and and low and behold. Uh, they're seeing some over supply, especially with China being slower

to buy some buy crude. And we talked about previously about how China I was having issues with lockdowns and how that could impact their purchasing and we're starting to see that. And you know, the physical market can be very different from the financial market, and they're starting to see some lag on the Asian side, even though on the on the U S side still zee, excuse me,

a very tight market, Fernando. One of the arguments that I believe is how the energy MR had made was that liquidity is an issue that there's so many people who had hopped into the commodities market. I mean, we talked about all the time oil as this big macro heade from investors who usually don't actually trade oil or trade commodities. I'm curious how much of that is skewing the numbers and skewing the price action. Absolutely, and that's

why we saw in biatigoing negative. It's a lot of financial UH speculators and the true definition of the word that they don't actually want to take the physical barrels, and they can skew that market. UH. The way that we tend to look at it is the difference between the crude grades themselves and Brent, Brent being the global benchmark, and when we see those differentials getting very narrow, it typically means that they are competing and there's less of

a UH. There's a lot less competition between the crude sellers and not so much between the crude buyers and the opposing is true. So while in the beginning of the summer you're seeing the differentials widely significantly, now there's they're starting to narrow, especially in Asia, again a sign that the activity there is is slower than expected. Fernando Gasoline, we're down below three dollars and ninety cents a gallon. Good news for the average consumer. It's like getting a

kind of a tax break, if you will. What's driving that is, is more refining capacity coming online, or is demand just kind of fading a little bit in the face of that some of that higher prices we saw earlier, what's the latter. For sure, we are both passed the peak demand for the northern hemisphere, so that helps. But we also saw weaker demand UH in two then we did in twenty one, and and even UH compared to were still below five to six percent below those levels.

But the other part that helps UH is that we're actually seeing a bifurcation between gasoline and diesel. Diesel margins are fifty seven dollars a barrel, while gasling is a thirty two, And because the refiners are chasing diesel, they're over supplying gasoline. So that's helping bring the gasoline margin down significantly, while diesel remains very high and we expect will continue to go higher, especially as we head towards winter. We'll stick to the subject of spreads in particular. Point

of this out earlier in the show. We're looking at front crewed with handle w t I with a nine three handle. That's a spread of about six dollars and change. What does that tell you six dollars if I'm not wrong, correct me if I am Fernando, it's historically high when

it comes to that spread, right, absolutely. Uh. It tells me that the spr releases are having that impact because you know, w T I is priced in Cushing and we're trying to we are continuing to sell more and more crude out of Cushing as opposed to Brent that is slightly more UM, so we're basically discounting it for

the transportation costs to take it to foreign markets. So it's basically showing us that we are exporting significant portions of that Cushing Uh, that Cushing release to oversee markets. How are things down into Permian? Those boys down they're still making money, they are. It's certainly and you know it's not just scrude. Natural gas liquids propane utane are are rising very significantly. Natural gas prices as well, very high,

so they are starting to make money. It's actually been allowed for what we call refracts, when you go back into an old well and you redo the fracking process so that you can get more production out of it. So we're starting to see are you rising in those refracts um to help produce producing, and that helps bypass one of the biggest issues, which is continuing to drill wells and continue to have to have the the the the the drilling rigs and the other portions that are

more supplied constraint. I think I'm going to go down in Texas, drill a couple of holes in the ground, put some wells in there, and see what I can do. I mean, they gotta oil just ripping here back above ninety. I think I could do that for now. Of Vale Senior Analyst or Bloomberg Intelligence, he does it for a living. He covers all things energy. He's been doing it for a couple of decades, and he is one of our go to voices when we get a sense of global oil,

global energy. All right, let's switch to I'm gonna talk electric vehicles because I actually drove an electric vehicle. I had a first couple of first month or so ago. I drove my first pickup truck ever and drove my first electric vehicle ever, the Ford F one fifty Lightning. Uh. They were kind enough to loan me for a few days and it was awesome. So I was really skeptical about that. Totally, totally, I mean everything. It was just an awesome vehicle and the electric uh, the EV technology

was pretty cool. Same of course, he's associate associate portfolio management Analysts at ARC Investment Management. That good folks ark they have some passing interest in the EV market here, Sam, I love to get your thoughts here on the EV market as it relates to the competitive landscape because our good friends at Tesla had had essentially had the market to themselves for a long time, and and wow, what an amazing job Elon Musk and the Tesla folks have

done and effectively creating and commercializing this market. But now you got the Ford f one fifty, you got Volkswagen go on all Electric, got porschego on Electric. Talk to us about how you guys think about this can petitive landscape for electric vehicles? Absolutely, And you know, I think, as you're saying f one fifty electric, I'm sure once you drive that you're not going back to the internal combustion engine. So I think really the first place to

start is what are the competitive dynamics. The competitive dynamics are that the internal combustion engine is losing out big time. So if you're just looking in the first half of two, internal combustion engine vehicles sales down eighteen point four, battery electric vehicles up. So the share games are tremendous for electric UH. And then when you look into the actual UH players, who are who are investing in this, you know,

that's where things we think start to get interesting. It's a growing pie, so they're not necessarily competing with one another, UM. But what we what we're looking at for the future is who's investing in battery capacity. That's very important UM and really looking to see who's putting the money where their mouth is. I think one of the the classic arguments we've heard over time were these large traditional automakers, when they decide to go electric, they're going to crush

any of the startups. But then when we when we look at you know, the actual cafex and what these companies are planning. You have forward planning seven to eight billion dollars a year in cafex UH, and that's combined for internal combustion and electric. You have GM in the nine billion range. Again that's a combination of traditional gas powered vehicles and electric. And then you have Tesla in there with seven to ten billion dollars and Cafex over

the next few years. So you have Tesla who's now competing with UH the incumbents, and we actually forecast that they're gonna outspend them by sgnificant degree and that's really going to allow them to keep market share going forward. What does that mean for the challenges when it comes to scaling and producing in bulk? How does the likes of Tesla Rivian deal with that? Yeah, scaling is it's

a very difficult problem. And I think the electric vehicle industry is in a great position as a whole where they do seem to be supply constrained. So it's good that they actually have the demand there and so looking to scale, um, you have the production side, which is

quite difficult UH. And this is actually where we think, you know, China has UH an advantage here when we look at the speed at which these Chinese companies are able to scale production and even Tesla in China right going from start of construction to a million vehicles produced in three and a half years is is pretty heard

of in the auto industry. And then when we look further down the line beyond just you know, the scale zero to one, you know, no cars produced to one car produced, uh, than getting up to the hundreds of thousands. We start to look into the raw materials UH. And this is I think where we've seen a lot of concern is saying, Okay, now that people are more convinced we're going to have an electric vehicle future, where do

we get all of the raw materials for this? And the good news is is that, ah, the raw materials exist right there, They're out there in the earth. UM. The challenging part is going to be the processing of these raw materials UH into what can be used in battery packs for electric vehicles. And we're seeing incredible investment on this front as well, and we're even seeing a shift in the bad mattery chemistry is being used to

help offset some of these bottlenecks. So a great example is if we went back, you know, three to four years, everyone was extremely concerned about cobalts and saying, you know, cobalt is incredibly difficult and there's you know, big human rights implications in cobalt mine. And the battery industry is shifted from using battery chemistry that was equal parts nickel magnese and cobalt to a new chemistry that had almost no cobalts in it. And then there was another constraint

on nickel. And you know you heard Elon Musk on the earnings call saying if you can, if you can mind, nickel will buy it. And now we're seeing a shift from batteries that are extremely nickel dense two batteries that have no nickel at all. So it's a combination of supply ramping up and the actual battery manufacturers and vehicle manufacturers shifting to different chemistries to avoid those bottlenecks. All right, Sam,

good stuff, good overview of the e V space there. Sam, course, he's associate portfolio manager and analyst at ARC Investment Management and ARC. Thanks for listening to the Bloomberg Markets podcast. You can subscribe and listen to interviews of Apple podcasts or whatever podcast platform you prefer. I'm Matt Miller. I'm on Twitter at Matt Miller three and on Ball Sweeney I'm on Twitter at pt Sweeney. Before the podcast, you can always catch us worldwide at Bloomberg Radio