Little Upside Left in U.S. Junk Bonds: Diamond Hill

be a boys for a big fall. The result this year so far has been a ten percent gain, the best return for the first six months of a year since two thousand and nine when we were climbing out of a financial crisis. Joining us to talk about this sector, Bill's Ox. He is chief investment Officer of fixed income at Diamond Hill Capital Management. Thank you so much for being with us today. I want to start with just a broad question. How much more upside is there left

in the US hild bond market right now? Yea, there's very little upside left. It's more about treading water right here and earning your coupon for the back half of the year. So all right, but we are again we're at least it suggested we've had a great run here in the high were ten plus years into this economic cycle. Are there any sectors that you're overweight or underweight given

where we are in the cycle here. Yeah. I mean one interesting sector that's still under a cloud, but a different cloud than the equity markets are focused on, would be pharma. In the high old space, the valuations are very much washed out. Yesterday's deal with Allergan could be a sign that that people are starting to take notice of those valuations. And is that simply because of the regulatory overhang of the sector? I think that's that's now.

The business has have been weak, but they're starting to bottom out. But the primary issue on valuation today is the political overhang for sure, although there are other challenges to im think of Tava, for example, the biggest generic maker UH and their bonds have been beaten up. There an incredibly leveraged company and they haven't really seen the same kind of pricing power that they had in the past,

and they faced a lot of headwinds. I mean, is that an area where you'd be willing to go or are you looking more toward US focused areas that have been hit by speculation about policy. No. I think that is one that that it makes sense to dip your toe in table. Yes, okay, really interesting to see that there is some opportunity there Are there any places that

you're selling right now? Well, I the of the U S high old market right now has a maturity greater than five years in a yield to worse below five percent. That part of the market gives people comfort and that the it's defensive, but the price is just too high. I think that's an area that you actually have to

be selling right now. You know, one of the areas that's just been a huge issue or has been kind of the greater communication space, you know a T and T, Comcast, things like that, and there's so much technology change going on. There's some uh M and a activity in this space.

How do you guys feel about the communications sector? Big issuers? Yeah, I mean in the high yield market, you're really talking about Sprint and T Mobile and whether that deal gets approved or not, Sprint will be under severe pressure of that deal does not get approved, Probably a very high probability that they file for bankruptcy and the investment grade space, there's a lot of pressure on A T and T

and Verizon. I mean that those businesses are are very mature right now, and they're they're tough, capital intensive businesses. So the picture that you're painting right now, which is security selection, treading water, coupon collecting for a firm that overseas twenty three billion dollars. And I'm looking right now at the inflows into the high yield sector. They have

been escalating, Uh significantly. Does that concern you given the fact that there just aren't that many opportunities out there to put that money to work in a way that you think might be prudent. Well, if we were too big and I had to put those inflows to work and in a relatively less liquid high old market, I would be concerned. But we're very disciplined in terms of our capacity, so that inflows have been steady but not

at all difficult for us to put the war. We're hearing more and more from economists, investors, strategists about rising odds of a recession mid next year's that's something you're

thinking about as you think about your portfolio. Well, I think the treasury market is is the best signal of that right now, And we're discounting three rate cuts between now and the end of the year, And to me, that's kind of on the precipice of that, that's probably still consistent with insurance against too low inflation, but anything more than that. And now the treasury market is discounting a much higher probability of recession. So we're we're close.

I'm close to being concerned about that, but not quite yet. Are you more concerned about the longer term for the high old bond market or the private depth markets right now? Yeah? I think that the private debt markets probably have grown much more rapidly that the high yield market. Although flows have been strong this year, it's actually down in size over the last three years or so, with the loan market and then the private debt market increasing in size.

So I think that investor expectations in the private loan market are probably more out of whack with reality than what you would see in the high yield market. And how significant is the risk that you see in say a recession, I mean, are we looking at just normal declines that are you know, not necessarily super painful but you know our declines. Are we talking about something that's more substantial than that? Yeah, I mean LDD Leverage finance

is extremely resilient. We saw that in the financial crisis. Spreads blue out in uh, you know, a year and then, but mostly in the three months after Lehman Brothers filed to over two thousand basis points, but high yield was back above its high water mark in the fall of two thousand nine. So it's a very resilient asset class. Each sector in leverage finance can pick up the other. So I don't think it's going to bring the economy down or anything like that. Bill Zocks, thanks so much

for being with us. Bill as a chief investment officer of fixed income for Diamond Hill Capital Management, about three billion dollars under management, is based in Columbus, Ohio the Ohio State University. I don't know why you guys say at the Ohio State, but it sounds good. We'll go

with it. Traders are preparing for the onset of G twenty talks, and as one guest on Billover Television said this morning, it really is b G two meeting because really we're looking at j and Ping and President Trump of China and the US getting together and coming to some sort of ceasefire. Maybe perhaps to set the stage from very pleased to say, we have Leland Miller with US, chief executive for Sir China beij Book International in New York.

He's joining us in our Bloomberg Interactive Broker Studios Leland Uh just to set the stage for these discussions between Presidents JJ and Ping and Trump. What is the economic backdrop in particular of China right now? Sure, so, people who have been very gloomy over the last several months, one because trade talks haven't gone well, but also you've had pieces of official data that have come in that

haven't made people very happy. And then there's rumors of trouble within the financial system, so a lot of pessimism out there. Are new Q two data, which was released this morning is actually more optimistic on that. So from a top line perspective, Q two improved over Q one, which I don't think many people expected. And then on the sectual perspective, manufacturing and retail were the two co leaders. So a lot of people probably assume manufacturing is under fire.

That's true because of the trade war, but there was evidence of very strong policy support, so manufacturers borrowed more and they borrowed the cheapest rates. This is the government stepping in. And Rita also did relatively well, so we Uh, there's some some worries on inventory, but the the key metrics for those two sectors in particular or upbeat. Hiring was upbeat, which means the trade war hasn't hit China word hurts yet. Uh. And overall, I think that there

was improvement the economy. How about the shadow banking situation that had been on the downside as China begun to de lever over the less several years. What's the status there. Well, when people heard the term deleveraging over the last several years, uh, they assumed that China was actually actively deleveraging. I mean the government was saying it was doing that. China was

never deleveraging. It was doing some aspects of financial uh, deleveraging, and in particular, they were cracking down on shadow finance. That's something that's crystal cleared our data. So for the past two to three years, we've seen shadow finance cracked down on a much lower share of overall borrowing over time and UH more to that borrowing going from off

balance sheet to on balance sheet. The borrowing wasn't there, wasn't less borrowing, but it was going from the shadows to the on balance on balance sheet where it could be was turning more transparent and more regulated. Well, that just reversed completely. This quarter we saw an explosion I think explosions right word for this of shadow banking and Q two it was the highest one quarter jump we've seen in shadow banking usage in the history of China

based book survey. So what clearly is happening here. Q one was a big credit quarter for China that made a decision that they were going to create a cushion for the economy in a worst case scenario for the trade war, prepare for the downside. And Q two was an expansion of that, almost as much borrowing overall, almost as aggressive, uh diminishment of of of rejection rates, et cetera,

but an expansion of shadow banking. So it's really amazing what the Chinese have done since the fourth quarter in the credit side. Leland, I want to just highlight this point once again because this seems to be a really big deal. You did just put out this early look brief of the Q two Chinese economy. The fact that shadow banking activity increased at the fastest pace quarter over quarter since China Beijing book began in two thousand and

ten seems significant. What is the potential risk here? I mean, how close are we to the consequences of this? Because it is a pretty closed economy, so some people say it's contained in terms of riskiness. Well, there's a reason that the Beijing leadership cracked down on shadow banking several years ago because they said, this is an enormous vulnerability. It operates outside of most rules. It operates in a

very out pake manner. Uh. There's important parts of shadow finance for the economy, but there's also Ponzi schemes, and there's no real way to to control this unless we shine a light on it. Now. They have been doing more and more and more to crack down on shadow finance for years, and what they're essentially doing right now is just throwing that all out. You know, the Trump trade war is such a priority to make sure you don't look weak in the face of that, and in

order to guard your downside if this goes wrong. Uh, they have essentially said we're gonna we're gonna forget about the long term consequences which could hit in the short term and medium term or long term. It's an unclear how long the a you know, taking fuse they have on this, but they decided that's not the priority. The priority is to make sure that we're getting credit to everybody that we have stronger growth numbers. And as a result, they've tossed out some of the good work they've done

over the past few years. All right, let's turn our attention to the G twenty. About an hour President Trump aboard Air Force one for Osaka. What is in your

mind a realistic expectation for the G two. Right, Markets have been much too barish on Osaka for weeks and weeks because after President Trump implemented terrorists back in May, there was this belief, due to the coverage UH that the two sides were hardening and that China was preparing for the long war and singing patriotic songs, and you know, the US was was led tariff man who wanted to lead the crusade against China, and you know, the two

you know, two sides had nowhere to go except farther apart. This was never true. Nothing has fundamentally changed since the terroriffs are raised, with the exception of some cracked some technology company crackdowns that are going to be used as trade fodder trade chips. In terms with President She so we are not at a deal yet, but the atmosphere for Osaka is one of the White House clearly wanting

a reset of talks. They're willing to punt the last tranche of tariffs and its entirety to make that happen. They're willing to give assurances on Huawei that will be

part of a final deal. All the music that she wants to hear, uh and in return that the Chinese have to say, we will return to the base text and we will work from that base text that was about nine note A Secretary of Nation said, So, assuming that the Chinese go along with this, the President wants to ride this out, and we're gonna see uh, quite

a quite a positive solution from a deal standpoint at Osaka. Really, so you think it's not just gonna be uh, the the uh, the fact that the trade tensions are going to escalate, but there actually will be a resolution. I don't think there's gonna be a resolution that there's not gonna be a final deal. They're not ready to do a final deal, but if they don't get along, you're gonna see UH tariffs on all five billion starting July one.

And that was a real possibility. As a matter of that, markets were rather scared a few weeks ago that this was a becoming more and more of a possibility. Look, that is not on the table right now. They have not been war gaming that possibility. Internally, they want to reset. So I think that the fact that this continues on may not be seen as as bullish because in some ways, you know, we're just getting tired of this entire tarade.

At the same time, this looked like it was going in the wrong direction and it was accelerating in the wrong direction. That wasn't true. But now markets are correcting themselves and they will realize that this has got that there is a clear glide path to a deal if the two sides decide they want to get there. We'll

see out that this week, hopefully some movement there. Leland Miller, CEO of the China Beige Book International, joining us in our Bloomberg eleven three oh studios today starts the two day extravaganza of democratic debates, including a twenty candidates to become uh the lead in the contest against President Trump.

Joining us now, Tim O'Brien, I'm so glad to say, executive editor for Bloomberg Opinion, joining us here in our interactive broker's studios, always with fresh perspective and all things politics and certainly President Trump. I'm just wondering, are we looking at a circular firing squad tonight. That's a great question, Lisa. I you know, we'll see what happens when all these folks get on stage. It's a lot of people, but I don't think the spirit of this is uh, they

want to try to assassinate each other. Uh. They clearly need to get Biden out of their ways. To some extent, Joe Biden hasn't had to put much effort into making public statements around things he's He's stepped in it a few times when he has, but he's clearly the front runner.

So I think the extent to which the people on stage tonight, which Biden won't be there tonight, he'll be there tomorrow, they needed to find themselves an opposition to Joe Biden and then I think the second step is an opposition to President Trump, and I think they don't really see a need to define themselves in opposition to

one another. So do you think that beginning tonight and through the all the the debates coming up, do you think the strategy will be for these candidates to focus on President Trump, attack President Trump, per se, or maybe step back and maybe try to differentiate themselves to find their own policies. And you know, Paul, I think I

think you know. I'm not a political consultant, but I think you know, in the media, we do know when things gain traction and when people start paying attention to things.

And I think each of these candidates gonna have to say, because we're gonna have a limited amount of time, what can I say that We'll get picked up after the debates are over and give me the kind of follow up where I can get asked on to other shows and I can begin to define myself in front of voters, because it's gonna be very hard with this many people for any of them to really stand out. And one question I have is how much to the left is

the Democratic Party swinging? And do we have a sense of just where what's gaining tractions so far and what that means about the direction of the party. Well, you know that I think the Democrats have as similar dynamic as the as the GOP does, where you've got you know that the left wing of the Democratic Party is pushing for bolder policy proposals in the same way that

the populist wing of of the GOP is. I think. UM, I think the Democrats have to figure out what they can put in front of a national block of voters and make palatable. And I think traditionally in national elections that's been the middle of the road kind of program. Uh. However, there's very you know, we're in an era where there's

a lot of wealth inequality. UM. I think the Trump presidency has brought intolerance and racial insensitivities to the frow and to the four and I think that that's going to Uh, those are issues that Democrats have to address. So, Tim, I've got a million things to talk about here, but let's shift gears to the Mueller hearings. Uh. It now looks like Mr Mueller is gonna appear before uh Senate,

um a car before Congress next month. How important do you think his appearance in his testimony is I think the theatrics of it really matter, Paul. I think most Americans haven't read the Mulla Report. It's a long, dense thing that that we in the media have consumed. Apparently the President hasn't read it um and I think the congressional hearings offer this easily digestible visual way for average Americans across the country to connect with what Muller believes

that report was about. And I think the second reason that's important is I think Bill barr Uh really was politically adept and and shrewd about trying to define it before the report even came out, and he had a lot of free air time as Attorney General to define the report in a way that I think wasn't accurate. I think it was designed to protect the president. I don't think bar was hiding the fact that that's what he was up to, but that doesn't mean it was

an accurate reflection of what the report said. And so this is a moment for that to happen. I guess that one question I have is there have been a number of surveys that show that the bulk of Americans are sick of the Mala report and aren't necessarily trained on it, and that basically they think that probably President Trump did some things that were wrong, but they kind

of just want to move on. And I'm wondering what the political risk is for Harping on this point, even if there is some credence to the view that there that there are aspects of this report that have not been highlighted well, because I think that there's more than politics at work here where a nation of laws, and I think one of the dangerous things that emerged here is that I think the president and his attorney general have defined him and the presidency is above the law.

And we live in a country which we believe no one is above the law. And I think that people on both sides of the political aisle should find common ground around that principle, even if it comes at a political cost. We've had other moments in our history where politicians have taken unpopular stands or taken stands on issues of photos don't care about, in order further the good uh the good, the good will and the well being

of the nation. So do you think the Democrats will use the Maldar testimony as perhaps a step towards impeachment. I have no idea. You know clearly Nancy Pelosi does not think impeachment is smart politically. I think there's law and order types and and other principle people in the in the party who think that it should happen regardless.

I'm wondering, considering the fact that you actually have read through this report, what are the areas that you think are going to get sort of highlighted as breaking the law, moments that could be exactly speaking to what you what you just said, Yeah, I've now read it twice, I'm sorry to say. And um, I think the second half

of the report on obstruction of justice is glaring. I think you can't read that report and not believe that there were very definable instances in which the president tried to disrupt the Mueller investigation and uh Jim Comey's investigation, that he tried to pull other people in his orbit to do this. It was very bald faced. I don't

think there's any doubt around it. I think the only reason Bob Mueller decided not to indict the president is because he believed that the Justice Department had a rule preventing him from doing so I think the language and the report clearly laid out that he believed it was up to the Congress to decide what to do next, but that he wasn't willing to exonerate the president from having committed no crimes. What would be a successful outcome for the Democrats with with this testimony? What are they

really looking for? Uh? You know, I think they're I think they're I don't know. I don't know there's a unified golder. I think there's some that would like to see it, as you asked earlier, Paul out is, you know, to make it a first step on the way towards impeachment. I think there's others that would be satisfied for it simply to raise doubts among the electorate about the president and his ethics and the way he operates. How much support is there from the Republicans to defend him regardless

of of what comes out. I think there's like one thousand percent support from the Republicans to get in the way of this. Yeah, I think that they I think he's already got you know, last night, Mark Meadows went on Fox and said that if Bob Mueller thinks he's going to come in here and uh not get cross examined by us. You know, he's got another thing coming as if you know Bob Mueller, as a veteran prosecutor, would really worry about a junior congressman's ability to cross

examine him in a public forum. I don't think Bob Mueller will break a sweat during that hearing. Uh, but clearly Mark Meadows, Jim Jordan, there's other people who have argued beyond the report, I think to defend the president. Tim O'Brien, thank you so much. He has a way of phrasing than Tim O'Brien is. Is really a word smith Beyond words Smith, he's fabulous. Thank you for joining us to my Brian executive at her Bloomberg Opinion, Joining

us on our Bloomberg Interactive Broker studio. If you look at home builder stocks, they have taken quite a fall, with the biggest to day decline in the subsector of the SMP five hundred since December. The question is how far have we gotten already in the slowdown in the housing market? Joining us now Logan Motor sham Me. He's senior loan officer at AMC Lending Group. Joining US from California, Logan, thank you so much for joining us. I want to

start there. How concerning is the slowing housing data that we're getting. How concerning is it to you? Well? Last year, towards the end of the new homesale market was flashing your recession, you know, uh, the builder's confidence index was collapsing, monthly supply spikes up to levels in and new home sales were trending negative. So I was, you know, calling for Hey, this is not a good data line. But back then I said, new home sales are still too low.

Don't call a peak yet. We should be able to get back, uh, get monthly supplied back down to below six and a half months. Now. We've done that this year, and new home sales are still being my estimates for the year. But we simply have too much supply of new homes for the builders to really start accelerating construction, especially on single family homes now. And I think that's the problem. And I think the market is starting to

get a get a whiff of this. That if if we are seven days away from really having the longest economic expansion ever with mortgage rates under five per cent since two thousand eleven, and we have a really hard time pushing housing starts to above one point four million on permits. There's a problem for the builders, not just now, but going out for maybe two or three more decades.

Can they really provide a product that would facilitate enough demand to keep monthly supply low enough for them to make money and to for for housing starts to keep on growing at an acceptable rate. And I've always argued this, they cannot compete with the bigger existing homesale marketplates. So look, I want to get a sense of kind of the new home sales market for versus existing how's that shaping

up right now? Even though existing home sales are down this year, which was my poecast sales are down a little bit, inventory up a little bit, it's still out performing as it has this entire cycle. New home sales basically had the worst demand curve ever in US history. So existing home sales is doing better. In my mind, new home sales has done one positive things. It brought monthly supply back down to below six and a half months.

UH sales trends are still running a positive But if we get above six and a half months again, a monthly supply. That is a red flag. And this is one of the reasons, and we talked about this last year on the show. Why housing starts in twenty nine is a question mark. We're still running negative year or year and housing starts, but comps on all housing datas are going to get a lot easier in the second half of the year, so things should look a little

bit better on the year of year averages. But simply there's not enough demand in the new home sales market to warrant more construction, and the builders are more cautious now than ever any time in the cycle. I'm trying to understand how this bleeds through to housing values going forward, because we have seen a decline in certain coastal cities due to the salt deductions and other issues that might have arisen, and just in general inflation and valuations there.

But what about throughout the nation, given the fact that market rates are so low and heading lower adjusting to inflation, home prices should be flattened. Some markets they are negative. There's there are homeowners that bought their homes last year and let's say early in spring that are down year over year. This to me is a very healthy saw of the housing market, the existing home sales market actually

performing this function. You know, a little bit demand weakness, a little bit supply increase in certain areas where the supply is actually more the rate of growth that's flowing down. In some cases, people are are down in your rear. I think that's perfectly fine. I think so many people are in this housing bubble two point oh mentality that they think that there's going to be just another crash

in prices. That's not how it works. You would need to really see a significant demand decrease from where sales are right now, even worse than the housing bubble and crash to get prices to really accelerate down on a national basis. So I think we're okay there. I think that's what's happening with in the home price market is positive in my mind. Uh that meeting sales prices for the new homesale market following is a lot of that has to do more with the makeshift of smaller homes

being part of the sales mix we have. We've seen some discounting by the builders, but nothing dramatic yet. I think that's where you, if you, if you really want housing, start to really kick up to provide more homes out there. You need. You simply just need a lot more new home sales now than any other time in this cycle. Look and are there any regions of the country that are surprising you with maybe with a little bit on

the downside in terms of weakness. No, because the coastal areas in the high price here is whenever mortgage rates get higher, uh, they see a demand hit. And I'm not a big fan of the salt deduction is really impacting the coastal areas that we just mortgage rates got up higher. This similar thing happened in actually uh and here in California, sales are a little bit higher than what they were in when when we saw the last

dip and there was no solved problem back then. Uh So right now, because mortgage rates are coming back down, it stopped the supply bleeding. You know, we're we're starting to see a little bit more demand pick up, take off a little bit of a supply. But again, these coastal areas, whenever mortgage rates go up to about four and a half to five percent, they see an impact

on demand. And that should be the case for sometime now. Look, Multasha, thank you so much for joining us logan as a senior loan officer for the A m C Lending Group based in Irvine, California. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts or whatever podcast platform you prefer. I'm Paul Sweeney. I'm on Twitter at pt Sweeney. I'm Lisa abram Woit's I'm on Twitter at Lisa abram Woits

one before the podcast. You can always catch us worldwide. I'm Bloomberg Radio.