Low-Rated Junk Bonds Not Properly Pricing Risk: TCW's Rivelle

extraordinary day in markets. Stocks dropped about three and a half percent, but gold was down and so were treasuries. Treasury yields rose priced down, which was unusual and it's only happened twice since March eleventh and March eighteen. This according to Bank of America Global Analysts, the question is our treasury is no longer a hedge against equity volatility. Joining us to answer that question, Tad Revel, chief Investment Officer for Fixing come at TCW with two five billion

dollars of assets under management. Tad, what's your view on that? Well, there's a lot of incoherence in the capital markets, and I think pointing out the anomaly of gold and bonds versus equity, and the breakdown of some of the traditional relationships between those asset classes is one of the manifestations

of this, Uh, how do I call it? Let's call it a massic economy in the sense that there's a massive policy response that's still working its way through the underlying economy and getting price into the capital markets, and that's very much at odds with the actual reality that we're facing in front of us. There is so much opacity as it relates to the ongoing withdrawal of stimulus

that's taking place over time. The question that overhangs will some of this be renewed or potentially enhanced with the elections. There's issues related to the vaccines. So I don't know that there's much that you can judge on the basis of historical relationships in order to make judgments about how

assets are going to be correlating with one. In other that said, there is so much suppression of rates and volatility on the part of the FED um the FED is not in a in a sense allowing the capital markets to speak up and express what they perceive to be this underlying level of uncertainty, and so it does call into question whether owning treasuries at these very low, historically low, galactically low interest rates actually is going to

correlate or provide any hedge against anything on an ongoing basis. All right, So tad obvious. It seems clear, particularly after hearing from Madame Leguard this morning of the e c B, that we are in a world of lower rates for longer. What is a person like you, I manage your fund manager like you, what do you do in terms of perhaps looking for some incremental yield in a in a

world where it's lower for longer. Yeah. So, in a sense, you have to take the gift that's being offered by the central banks to the extent to which they're so to speak, allowing you to rely on borrowed funds in order to make your bones um. One of the ways you can do that is by accessing the t B

a agency mortgage back market. There are exceedingly low um rates, lower than the rates that you can earn by being long the agency mortgage that are implied in the financing and so relying essentially on the gift that's being given by the by the agency mortgage market courtesy of the central banks is one thing that can be done. The other thing that I think that can be done is

to remind yourself that we ain't through this yet. I mean, there is a uh it's it's rather clear, at least from our vantage point, that there's an ongoing economic transformation. It's a bit glib to put it this way, but the economy of so to speak, is being fast forwarded practically into the present day. And what that means, of course, is that there are a lot of business models and a lot of assets that are going to be rendered

obsolete or unprofitable. So wait, you can see this being expressed through delinquency rates on commercial loans in the hotel space. We don't need to talk a whole lot about what's been happening, the devastation in so much of the industries that are vulnerable to social distancing. And we have this huge question. We ran this amazing experiment in which we took many millions of professional working professionals and move them out of the office environment and put them in a

work from home type situation. So big question I guess that overhangs is how much commercial real estate do we

need going forward? If you hold back, I suspect that there's going to be lots of opportunities as these asset classes were priced right now, we're living in a world where the sellers in general in so many of these related asset classes are looking for last year's prices, and the buyers obviously aren't stepping up to to validate that, which is the reason Tad why there's been paralysis in certain commercial real estate markets, because there just hasn't been

a meeting of minds in terms of what of value is I want to go to a more liquid market just to gauge the appetite for risk and to get your sense of whether people are perhaps getting a little ahead of themselves in terms of how much of a backstop the FED is going to provide. I'm looking at triple C rated junk bonds. This is the lowest rated

debt that is the closest to default. And yes, yields recently have ticked up a little bit, prices down, but still the yields are now sub ten percent versus a high this year of nearly twenty at the peak of the disruption in March. Are people pricing in the type of insolvencies or struggles that you're talking about that are inevitable, regardless of all of the FED support and regardless of

any fist glade. I mean, the short answer is that as we localize the conversation to that part of the high yield market, that the triple C area, the highly leveraged and in many cases high operating leverage married to high financial leverage, there are there is not a sufficient degree of of appreciation for the defaults that are going to be coming in those in those sectors, and nor, as you alluded to, I think, is there sufficient appreciation of the defaults that are going to be coming into

the commercial real estate market as well. So it's it's very interesting. I mean, the FED can liquefy markets, but at the end of the day, are they going to make good operating losses to the bondholders or to essentially allow obsolete businesses to sustain themselves in a zombified way

on an ongoing basis. So it creates this huge tiering in which double B spreads or I don't know about three hundred and fifty basis points over treasuries and triple C s, which, as you pointed out, they have actually been an outstanding performer um from the point of view of where we were in March, and yet the level of credit risk associated with that part of the market is probably not properly priced at all in many cases

ataches real quickly seconds in the corporate credit market. Any areas of opportun a new for you right here, There's been a number of them. Actually, um the but but the short take on it essentially is that you want to stick with the sectors that are most that are least at risk of disruption by the the ongoing changes transformations that are occurring in the underlying economy. So basically, uh, in some cases, just we're really sticking with mostly higher

quality investment grade type type issuers. Tad, thanks as always for joining us. We always appreciate getting your thoughts on all things fixed income. Tad Revel, chief investment officer of TCW. That's Trust Company of the West, one of the big big money managers out there, two thirty five billion dollars firm wide. It was a must stop for me back in my analyst days while on the West Coast. You had to go see the good folks at TCW. Getting

his thoughts on the credit markets. Fixed income markets here really an issue here as we kind of go into another love of this pandemic. Well, we got a sloom of economic data this morning. GDP number thirty three percent increase in the quarter, off setting the prior quarter thirty or partially offsetting the prior quarters declined jobs claims came in a little bit better than expected, but still stubbornly high. Let's dig into some of the meat of those numbers.

We can do that with Constance Hunter, chief economists for KPMG based in New York City. Constants, thanks so much for joining us here. Let's start with the GDP number. Obviously a big print, but we're no, we're not back to where we were pre pandemic by any stretch, are we. Yeah, Paul, that's a great point. We are two thirds below the pre pandemic level of GDP. And and just to put this in contact, on a per capita GDP basis, we're

back at Q four levels, right. So I think it's important when you see such a bifurcation and the impact of who the impacts to think about not just the GDP level, but the per capita GDP. And then of course on a year of a year basis, we're still down two point nine percent. So Um, we're not back. And more importantly, what this data says about the future

growth rate is very interesting. When we look at that bifurcation between goods consumption and services consumption constants built up on that place, What does that say about the future of goods versus services. Well, so, first of all, normally in a recession, we don't see services consumption fall that much. And the reason is because people still go to the dentist and they still get their hair cut even during

a recession. Right. So um, that fell dramatically um services as a percentage GDP in part because of lockdowns and in part because of reduced capacity. Um nobody bought World Series tickets, for example, So um, there was a lot of services consumption that just didn't occur. And then when we compound this with people spending more time at home,

people are buying goods right there. They're buying fire pits, they're buying you know, outdoors, uh, you know, like Lawan furniture, and they're buying pelotons and things like that, right And and there's only so many pelotons you're going to buy. Right, So that goods consumption while it rose dramatically, and it's up five point five per cent Q over q UM. It is not going to continue at that pace right now. The and so the hope is that services continues to rise.

It only rose at two point eight percent q over q and and and that as we continue to reopen services consumption is going to resume. The concern, of course, is that the virus is surging in a number of parts of the country and and actually growing in some parts of the country where it was not growing previously. And the concern here is this is going to hold back conservices comes option. So we're not going to see

a repeat of the goods consumption. And unless services consumptions grow, we're conservices consumption grows, we're going to see a pull back in the pace of growth of GDP pretty significantly. Cons Where are you were you kind of coming out at KPMG in terms of your GDP look for the remainder this year. But more importantly, yeah, so in UM, we're so our base forecast at the moment does not

have additional stimulus. And and let me just say that I think that's going to end up well, yes, and no, I was gonna say I think that's going to end up being incorrect because, um, if the president wins reelection, he will try to put forth a stimulus plan. If Biden wins, he will try to put forth a stimulus plan. And the sign of that stimulus plan depends in large part on whether the same party that holds the White

House holds the Senate. Right, So if you have a different party holding the White House and holding the Senate, the stimulus who is going to be smaller. If you have the same party, the stimulus is going to be bigger. And it honestly, both the Republicans and the Democrats, if they are in control, are going to put forth similar sizes of stimulus. The focus on where those stimulus stellars goes, of course, will be very very different, depending upon whether

it is a Republican or Democratic resident constants. Just give us a sense of how big the spread is in your estimates for the economy if we get a fiscal support bill or if we don't. Yeah, so it's it's pretty significant, I mean um, and where where it really comes down as in personal income, So we'll see personal income decline um in one. If we don't get stimulus, um,

we will see it rise. And this sort of this sort of makes the difference between like a five percent rebound in GDP and like a six and a half percent rebound in GDP. Wow, that's huge, Constance Hunter, thank you so much for being with us and for all of your research. Constance Hunter as chief economistic KPMG joining

us on those GDP figures. We didn't even get to the jobless claims figures that we got today, which were better than expected, but still a very hefty amount nearly eight hundred thousand new claims coming in and a number of people shifting to permanent unemployment. This is the sticking point to meet at. Paul and I think about this all the time. What is the structural scarring that we are experiencing at this point? People who are not going

to get back into the workforce for years. That's exactly right. And you know, the longer this goes on, at least the expectation is, you know, the more permanent some of those job losses will in fact become. And we saw that with the financial crisis in two thousand and eight and two thousand nine. You know, many of those jobs took several years uh to kind of get refilled and get back to a stronger employment situation, and the concern

is we may have something like that this time around. Yeah, with the added emphasis and this idea that there's an increasing focus on tech. So what jobs are going to be required. I don't know whose idea this was to have Alphabet, Amazon, Apple, on Facebook, and Twitter all reporting

earnings after the bow on October twenty nine. But here we are, and we are going to be trying to pass through all of these earnings reports today, even though they account for a significant chunk of the entire equity market of the United States, not to mention the world economy, joining us to help us focus on what the most

important aspects of these earnings reports will be. As David Garretty, chief market strategist for laid Law and Company and partner at bat Block, David, what were they thinking all coming out in the same day? I gotta start there, well, Lisa, it reminds me a lot of UH. I used to work from the more of the Japanese bank back around two thousand and it used to be the Japanese companies, all the banks would all schedule the release date for the same day. So I don't really want to say

it here, but you know, the tech Big Five. Are they turning Japanese? Uh? Very good. I saw what you did there, all right, David, So let's step back here. We've gotta you know, some real bell weathers for the technology economy, for the consumer economy, um, for the advertising economy.

What are you going to be looking for as you kind of read across some of these big names the section in Yeah, certainly, I mean probably starting off at the top with Apple, I mean, clearly, what's gonna be happening in terms of sell through or at least three orders for the latest iPhone is going to be most significant. Also, at the same time, looking at what continued demand there

is for hardware. We've certainly seen from data sources such as mp D that you know, laptop shipments are up substantially year over year, seeing some of their strongest years in decades. Uh So, certainly we expect Apple to be participating in that, um, you know, clearly looking for Amazon, um, you know, people continue to be staying home. Obviously Amazon is feeling more and more of their needs. Amazon also,

at the same time, the movements of the cloud. We saw the strength and Microsoft's numbers earlier this week, Amazon's leader in that sector. We would also say that Amazon has been moving more in terms of online advertising. So clearly, you know, Amazon has a lot of weapons to work with and we expect to see them deploy them all. Uh, if we're looking at Alphabet, you know, even though you had a lot of heat being put on the CEO last week from yesterday from the Senate Commerce Committee, Uh,

we do expect online advertising continues to do well. Uh. There may be some drags that we see in terms of some of their startup ventures, but you know, from that standpoint, we still think that their market to remain strong and they are clearly a significant player. Even though Apple has been looking at moving off Google as being the main search engine on its bones. But still we

think Google's alphabet's position remains quite strong looking. You know, Facebook also the subject of the Commerce here in Commerce Committee hearings yesterday in the Senate UM. You know, certainly Facebook also benefiting as well also with the run up into the election next week. All the social media companies Facebook, Twitter, Snap to some extent have all been beneficiaries of influx in terms of more campaign driven spending. But that's something

that's cyclical phenomenon. But elections look have only become more expensive over time, So we're seeing a nice uptick here from two thousand and sixteen levels as far as spending is concerned. And then you know, uh, let's see. I think that I think we got to you got through a lot of it. I don't know, just home in

on one. In particular, Amazon, I'm particularly curious about the costs that they have incurred to operate in this environment, to pay their employees enough to keep them coming back to work, to provide the right pps and whatever else to keep their workers from getting sick. Do you think that they will be able to deliver the margins that are being priced into their share prices after the run

up that we've seen this year. I think that while you may have costs in their online e commerce business, specifically related to worker protection, you know, remain high as they were back during the second quarter, I think that the uptick that you see in terms of profitability on the cloud as well on online advertising could help to offset some of that margin pressure. So I think the

mix of Amazon continues to improve favorably. And I think obviously we're sitting here in front of the year end holiday shopping season, which given all the news about COVID. People are not gonna be going at the stores to do shopping. So where are they going to go? I guess it's Amazon? So you know, you don't want to sell the stock here in front of the strongest seasonal quarter of the year, David. Uh. That hearing we had yesterday were some of the you know, the Microsoft Uh.

You know, we had some of the big CEO s there is that. What do you make of that? Is that important risk for some of the big tech companies? UM? I mean what's been interesting to look at here, Paul, is the fact that you know, the tech companies have been ramping up their lobbying spending. Actually the tech company's Amazon being one, and are actually spending more on lobbying than Boeing or a lock Keed Martin, who you would

think of as the DC lobbying giants. Historically. Clearly, these spending levels are indications of what kind of regulatory risk these companies perceive around their businesses. And all we really saw last yesterday, I hate to say it was the fact that just a lot of grandstanding, you know, the GOP coming down in these companies because of where their headquarters are geographically or what kind of contributions from a

political standpoint their employees make. I mean, good, Lord Paul, I mean the next thing you're gonna hear is that they're gonna start criticizing these companies because of the religions of their employees or the color of their skin. Come on, this is ridiculous. I think that Maria Senator Cantwell from Washington I basically did the right thing and basically stepped in on the democratic side and said, look, there's a freedom of speech in this country that needs to be protected.

And these companies in the testimony came out and talked about what they're doing to try and safeguard social media as difficult as it is is from being manipulated by outside sources. Right, we'll have to say that's going to play out over the long term, certainly. David Garretty, Chief Market strategis, thanks so much for joining us. He's a laid long company also a partner at bt block giving

his tech rundown. Well as companies and governments around the world race forward in look in search of therapeutics and vaccines for this virus. That's probably we're taking a look at Operation warp Speed. That's the US government's effort to accelerate development of a vaccine. We can do that with Stephanie Baker, financial investigation senior writer for Bloomberg News. She joins us on the phone from London and she has a Bloomberg Business Week story. I think it's just fascinating here.

Operation Warp Speed could shape up to be an eighteen billion dollar bargain. Stephanie, thanks so much for joining us here.

What's your key takeaway with the status of Operation Warp Speed. Wait? UM, you know, given that Trump has not UM pursuit a strategy of trying to contain virus in the US, Warp Speed is really the most visible tangible response of the Trump administration to the COVID pandemic, and it's it is a unique initiative public private partnership where they've given out billions of dollars to pharmaceutical companies to try to fast track a COVID vaccine and UM utilize the expertise, the

logistics expertise of the Department of Defense to try to help on the manufacturing side, to try to help, you know, fast track everything from you know, the manufacturing of you know, syringes to vials. UM and other uh parts of the vaccine manufacturing process to make sure that once a vaccine is approved, there are doses ready. So obviously there's no point in having an approved vaccine unless there are doses

um waiting and ready to go into people's arms. So we're just to set it to take a closer look. Is it working? You know, how are these companies interacting with the federal government, What help exactly are they getting from the U. S. Military? And it was kind of a fascinating look behind scenes to try to figure out exactly what is happening. It does seem like it is

moving forward. It's still an open question of course, is to you know, will we get enough doses, will there be a vaccine that will be approved, and if so when they're quite bullish in terms of when we might get one that operation work speed Um folks are saying that they think they'll have more than a hundred million doses by the end of the year. So do you get a sense that the government is paying the appropriate amount for the development of these items, that they're overpaying,

that they're getting a bargain. You know, I went into this thinking, actually is this you know, there are a lot of questions about lack of transparency UM. And you know whether or not the pharmaceutical companies were profiting off this, And there's no doubt that there's some pharmacutical pharmaceutical bodies that are doing quite well off of this, and their stock prices have rallied on the back of these government contracts.

But if you step back and look at it, and you look at the cost to the economy, trillions of dollars, I mean huge economic fallout, eighteen billion is nothing, and you could argue that they should be throwing even more money at this UM given the scale of the economic fallout. So Stephanie, is you know at this stage it might

be too early. Do most people within the industry, the healthcare industry, the pharmaceutical industry, did they feel like Operation warp Speed is, for lack of a better term, working helping the process? I think they are. I mean, you know there are Operation warp speed is back to six

companies developing vaccines, at least publicly. There are a couple of others that they are looking at backing UM and five of those are basically using Operation warp Speed how either to run trials or to help on on the manufacturing side. Um Fizer, which is developing a vaccine together with Germany's BioNTech UM decided to go different route and they are paying for the cost of the clinical trials and manufacturing will recoup its investment UM when it sells

and and approved vaccine to the government. UM. You know, so I think it would be hard for these companies to be able to do this completely on their own without the government stepping in. And for instance, that used the Defense Production Act pretty extensively actually to prioritize um UH suppliers. Who are you know, providing key materials to either the vaccine manufacturing process or you know Corning, which is another big company that is making glass files and

what have you. And I think that as that has helped, I think there would be delayed if that had not happened. Stephanie, just twenty seconds here. How much do you expect us to be talking about government funded medical infrastructure the way that we had in this extraordinary setting in a more ordinary setting. You know, it's a really interesting question. How will this change the way the government UH interacts, you know,

with healthcare provision going forward? I mean, I think the expectation is down the line um that the government will step out once we have in a vaccine and we have it and you know, in sufficient supply, that the government will no longer be involved. But I think it does raise the question of we need to be investing more in things like vaccine and rapid technology technology to

rapidly make vaccines to emerging pathogens. Stephanie Baker, thank you so much for being with us and for the tremendous story. Stephanie Baker, senior writer for Bloomberg. Talking about that story, Operation Warp Speed could shape up to be an eighteen billion dollar bargain. I mean, I'll just want to bring you this headline crossing the Bloomberg terminal x on mobile is going to cut nine hundred jobs, mostly at US management offices. Has comes, of course, as the price of

crude SAgs to the lowest since May. Uh. This is going to be through voluntary and involuntary programs, and they have kept their dividend despite the oil route trying to attract investors and Lisa bram Boyd's filling in for Vonnie Quinn alongside Paul Sweeney. This is Bloomberg. Thanks for listening to Bloomberg Markets podcast. You can subscribe and listen to interviews at Apple Podcasts or whatever podcast platform you prefer. I'm Bonnie Quinn, I'm on Twitter at Bonnie Quinn. And

Paul Sweeney I'm on Twitter at pt Sweeney. Before the podcast, you can always catch us worldwide at Bloomberg Radio