PGIM Plans to Reduce Credit Risk In This Year’s Rallies (Podcast)

Today we get a job's report that on many accounts blew all expectations out of the water and port trade. A very strong US economy, So go figure try to square those two. I know that Mike Collins is trying to do that, and he's joining us here in our Bloombergetter Active Broker studio as Mike Collins, of course, senior investment Officer and senior portfolio manager at PGIM Fixed Income, which oversees about seven hundred and thirty billion dollars of assets. Mike,

thank you so much for being here with us. What does today's blockbuster jobs number mean for the Federal Reserve? Yeah, good morning at Lisa and Paul it's uh, in our mind not to get too esoteric right off the start, but it's a it's a curve flattener, right because it blew out expectations in terms of the number of jobs, but the wage gains were more muted than expect and

that continues to be the trend. Not to sound like Larry Cardlow, but it sounds like we're getting growth without the inflation, which is kind of panacea for the Federal Reserve. It means that they can continue to be patient um and they can continue to um stay on hold, probably indefinitely until either the economic data really picks up again

or the markets continue to take off, right. I mean, if the stock markets up another ten percent and spreads are snapping tighter, and the Fed is meeting in March, uh, they're gonna have to deal with the financial stability issues. And I wouldn't be surprised to see them do another one eight or start pivoting at some point later this year and talking again about maybe trying to get another hike or two off before the end of the year.

And that's not priced in it at all right now. Alright, So, given the devish FED, given the good numbers we saw today. Does that just give the markets the flashing green light to take on risk? Yeah, and that and that's the problem, right. I think the Fed has unwittingly given the market this this green light by saying we are on hold uh indefinitely right now. And they're even talking about, you know, slowing the pace of their balance sheet reduction and maybe

ending you know, by the end of this year. So that's kind of a second green light. And that's something that UM worried us several years ago when they kept monetary policy really easy for a long time, we saw

some of the speculative excess is starting to build. The leverage in the system was building, UM, the construction markets were maybe getting overheated in some areas, and and we worry that, you know, and maybe six or twelve months you could be back in that mode, and then the Fed's going to have to have to focus on the financial stability mandate uh to try to try to nip that in the bud. But now we're now, it's not

six months from now, and we're long term investors. Okay, well, but here's my question, So your long term investors, what do you do in response to this? So, so what we're doing is we are trying to focus on the long term outlook, which is really for probably slowing growth over the next two or three years. We really think growth is going to go from three to two and a half to two to probably one and a half over the next few years in the U S. That's

just the natural trend, I think. Um, so focus on that, but take advantage of near term opportunities. So right now that the technicals are really good in the credit markets, the reach for yield is back in vogue, right with the with the ECB and the pank of Japan sitting on their hands and and a relatively benign fed people are there's a food fight right now for bonds again.

So we're riding that. We're overweight credit risk, taking advantage of those trends, taking advantage of the reasonably robust economy. Um Uh, pairing back risk on rallies are our m O here is to sell credit risk down on these big rallies. And we've seen retracement in the high shield Uh index. Okay, I'm sorry, my my head's my head's kind of spinning a little bit. So uh build go long credit exposure and sell it when it rallies. So

I guess, uh what, Yes, selling to strength selling. I think selling to strength has been our our mode, right. But but then when there's any bit of a weakness build up more, you know, I mean we took advantage of it late last year. I think that was an overreaction. Uh. In credit, you saw some dislocations, You saw a lot of outflows from places like the bank loan market. There was an opportunity to add risk on the margin at

that time. But I think a lot of that um rally, the markets move really fast, right, The markets always moved faster than you think. And it feels like the markets are pricing in now a fed on hold indefinitely. Um So, So if you continue to see spreads tighten in here, our our next move would be to cut credit risk alright. So it sounds a little bit like a trading mentality in this context of Prudential being one of the longest

term investors I can think of. But have you, maybe even just in December, or are you generally rotating some of your portfolio out of investment grade into high yield for example? So, so the big trade we've done over the last year or two is already upgrade the quality of the portfolio significantly. All Right, again taking that, putting that long term hat on, and knowing that, you know, I don't know if it's in a year or five years, but you're gonna have a slowdown the economy and you're

gonna have an increase in default rates. The leverage that has built up in the in the corporate sector, investment grade high yield to some extent the bank loan markets is disconcerting and that will come home to roost and result in more defaults. We know that. So what we've done is we've we've reduced our high yeld exposure, reduced pretty significantly our exposure investment grade industrials, investment grade corporate

bonds globally, and moved up in the capital structure. We have a big position in very high quality, mostly triple A rated asset back securities, which gives you as much spread as you get in the corporate market without any of that idiosyncratic UH credit risk or event risk or default risk. And that's a really great opportunistic REALTI value trade that we've we've had on for a while now.

All Right, so I'm going to hand you a crystal ball and I want you to look into it and tell us in two years or three years or whatever you see the next downturn, how bad will it be. It's not going to be bad. I mean, that's that's the other challenge here, right, This is never easy our base case because this cycle has been a lot different. Right. The regulatory response to the financial crisis was such that a lot of the normal relevering that you see hasn't happened. Right.

The banks have delevered aggressively. Right. The banks are in the best financial condition they've been in our lives, and I was a bank analyst many years ago. They've never had so much capital and liquidity. Consumers on average in good shape, small business on average have not relevered. Right, So, so this is not going to be a big downturn. If we get when you're probably asset price correction, maybe growth slows to one percent or kind of bounces between

zero and two percent for a few years um. But it's it's hard to really envision a big collapse in economic activity, at least in the US. Interesting. So I guess if I were to just summarize where you guys are, that's it's a and when I think a potential you guys are monstrous and you're thinking about long term your your policy holders. You're using this rally here to kind of just trade up in quality get position for what could be a software two or three year view. Is

that a fair assessment? That that's fair? I mean the markets are actually giving us the opportunity right now, which is very unusual, to buy really high quality defensive assets like senior debt of banks and like these triple A asset BacT securities at really attractive spreads. So the markets are mispricing the limited amount of credit risk in those securities. Um and there there's probably overpricing or underpricing the credit

risk in the corporate sector. So so you don't have to give up yield today to actually do this up in quality rotation. So that's a that's that trade is gonna work in the near term and in the term. Michael Collins, thank you very much for joining us. I think I learned a lot here about and if I were a prudential policy holder, I think I'd be feeling

pretty comfortable. Mike Collins is a senior investment officer and senior portfolio manager at p G I M fixed income well over at Deutsche Bank, Christians saving the CEO chairman has very few options, it seems, for turning around Deutsche Bank. After an eighth straight quarter of declining revenue, reaction from investors and analysts suggested that the cost cutting at the heart of the CEO strategy won't be enough to keep

markets at bay. To help us kind of dive a little bit deeper into this once Beheamoth of Global Banking is Jonathan Tyson. Jonathan is a senior banks analyst at Bloomberg Intelligence. He's on the phone with us from London. So Jonathan, thanks very much for joys. What do you think is the future of Deutsche Bank? Can it survive as a standalone entity? Um morning, not in his current form. No.

I mean to put this very simply. If you go back a year, let's say um Consensus was expecting about thirty billion of revenue for the bank in twenties and about twenty billion of costs. Consensus is now expecting the same for costs, but twenty six billion of revenue. UM. The bank is targeting a returnal equity of four percent next year, and for that it is acknowledged that it's actually hoping that client activity picks up the market gets

a bit better. So it's just unsustainable in the current form. And unfortunately, the damage to the franchise and the revenue outlook the more you cut costs and the growth in things like customer and all of the investment and expenses for things like anti money laundering means that there's very

very little they can do in the current form. Okay, So give and that given the fact that Deutsche Bank probably will not remain independent according to your assessment, what's the likelihood that Commerce Bank is the likely merger candidate here? And is that a good thing? Well, when you look at Europe, I mean, it's understandable why European Commission, the ECB um, they're saying we need some champions over here, sort of supernational to take on the JP, Morgan's, etcetera.

But just putting a Deutsch amount together with I don't know what Barclays or a new credit in itself doesn't really solve anything. So to start with, you do need to write size, you do need to get efficiencies, and for that reason you are looking at further domestic consolidation in Germany. So the reason that people keep coming out of the commerce Bank is again that's trading at points three times tangible. Just like Deutsche. They need to take an awful of cost base and out close more branches,

get more synergies. So yes, I think the reason we keep arriving at the same conclusion is there's nothing that either bank can do top line. They've done it all that they can independently. So you need to create the bad will. Deutsch is the acquirer. They need to raise some capitals to do a deal. Then you need, for example,

another couple of billion of synergies. When you put the two together, bear in mind that they're already targeting nine million for folding their domestic mortgage banks together would past bank in Deutsche. So yes, Unfortunately you've got to start domestically and then you can then have a sensible conversation about creating a big international merger. So where elsked Jonathan, would you expect to see consolidation besides Germany? Is it

required in France for example, or the UK? What is just kind of the overall m and a outlook and consolidation outlook for European banking. Well, in the UK we've had a few of the smaller Challenger Banks UM coming together, CYBG and Metro's in trouble at the moment, so I think we'll see a little bit more over here in the UK. Italy you'll definitely see further consolidation, and a

little bit more in Spain. But to to be honest, Germany is a pretty special market because it has a lot of spark Caster and Lander's Bank unlisted banks, and the reason that it's so unprofitable in Germany is because of these banks. So there can be there will be more consolidation in names that you've probably never heard of UM. And I think overall we will we have one or two big deals within the next eighteen months. Yes, I mean for us things like UNI credit to see at

L makes an awful lot of sense. Maybe a bar plays and something like a BMP that could make sense as well. But I don't think, um, we're going to see anything big quite yet. But I do think over the next two to three years, in the absence of anything that's sort of exciting top line for these banks and they can't keep cutting costs, you need the mergers to create proper synergies. So here's a question, and this

is kind of in the weeds a little bit. But one thing that I do when I look at Deutsche Bank's future is I look at their contingent capital bonds are convertible capital bonds, basically their tier one capital that is dead until they don't have enough capital raised to meet with regulations. So then all of a sudden they could potentially not pay interest on these bonds, or even these bonds could get wiped out in a worst case scenario. They're kind of all over the place today. Some are up,

some are down. That is surprising to me. I would think that they would be plunging given the fact that Deutsche Bank got bad results essentially and that there's talk that it will not be existing as they standalone bank within the next three months. Can you explain the two things they're one, don't forget that a lot of these

things are trading in a fair discounter face. And also if you go back to early two thousands and sixteen, that's when the eight ones plunged to about seventy something sent in in the euro Uh, it's all about your MDA, your maximum just description of the amount and can you honor coupons, can you pay um your bonuses et cetera. They talked about that on the care They've got a

little bit of headroom. So I don't think anybody thinks because capital is still about thirteen and these things aren't going to get triggered um and at the moment because they've pretty much got a handle on cost now, I think we've got enough visibility that they can honor the coupons.

It isn't really an issue. I mean, a lot of the European at ones are trading at a discount now, and we're seeing clients talking to us saying, well, why don't we just go short the equity along the eighty one because we know that we're going to get paid. I would sort of be in that camp in so much as I think the Deutsche and a lot of other banks will pay the coupon. We have seen one bank, a Greek bank, so that it's not paying the coupon this Yeah, but that's Greece, all right. Jonathan Tyson, thank

you so much, really interesting analysis. Jonathan Tyes, senior banks analysts for Bloomberg Intelligence, joining us from London. Meanwhile, a big wild card for markets is also the price of oil, which plunged in the last three months of last year by forty percent by my measure, and has had an amazing rally so far year to date. What is going on? How much more does there is there for this uh, this commodity to rally? John Kilduff joining US now founding

partner of Again Capital based in New York. John, you have been prescient when it comes to the price of oil. Where are we in this crude rally? Does it have more upside? Or is this basically the peak for a while?

You guys are too kind with that. I have to say, um, at this point, if given the really the lack of a rally on the chaos that's going on in Venezuela here, and you know the continued uh negative data points coming out of Asia in particular in terms of the economy, it is my sense that prices appear to be peaking here. So peaking oil? What so? What is really so you're supplying demand? Are you suggesting there that generally in balance

here at the moment. I think the Saudi Arabian particular is struggling and working hard to try to get it into balance. But we got a data point out of the US government yesterday. Now it's backward looking it's it's from November, but US production in November hit eleven point nine million barrels a day, a record. I have to believe we got higher than that in December, and it will be even higher number here for January when it finally gets uh tallied up. So the wave of oil

keeps coming at this market. Uh. You saw x on Mobiles earnings this morning reference their own increase UH in production, and that's a trend that's going to continue this. The saddis really have their work cut out for them. It's really becoming harder for them with the slowdown that we're seeing in China. Well, John, I guess that. Then it raises a question if oil prices are peaking here, are they kind of kind of remain range bound or we

headed for another oil plunge. I remind myself that in the bond market, the guys and gals keep always say don't fight the FED, and in the oil market you have to say, don't fight Saudi Arabia because they do have a lot of hefft still and power. So I do think we're gonna be uh somewhat range bound. But it returned back down to sub fifty dollar a barrel oil, Uh, you know isn't out of the question. And another interesting point that x On made today is that they're profitable

in their Permian operations. That at thirty five dollars a barrel is remarkable revelation by them. So it shows you how sticky that that production is going to be. So that's part of the problem here for the for the oil market. So, John, you mentioned earnings Royal Dutch Shell reported last night. Uh, x On mobile this morning, Chevron this morning. Anything in those numbers that really stood out for you as it relates to your call for kind of you know, range bound oil, Well, I need that

they did remarkably well. Um, I think surprised most folks because the headline, of course was that oil rightly crashed during the quarter. But the fact of the matter is oil prices actually you know, maintain themselves above fifty dollars a barrel right up until mid December. They were above sixty bucks of barrel through October, and we're you know,

pushing sixty bucks through most of November. So it was a pretty good quarter price wise for the majors on that basis, and particularly the exposure a lot of them have to the international market and attack another ten dollars on top of that for the for the Brent uh mark or the international marker. So I think what I've been talking about when I've been on with you guys previously,

you should get an exposure to these companies. Make sure there's an international aspect to them, because the relative tightness in the market and other issues that don't affect um them is that obviously in the U s there's a surfeed of production, there's bottlenecks, there's there's localized downward pressure on prices. You don't have that internationally, So you want to have that portfolio. UH Refining did great demand all quarter for refined products, jet fuel, diesel fuel, gasoline here

United States remarkably strong. So they all seem to capitalize on that. The big guys that is, so we're talking about the big guys, let's talk about some of the little guys. Yesterday, Blackstones g s O unit reported a really poor earning, particularly tied to some distressed companies in the oil patch. And I'm wondering, if we do get sub fifty dollar oil for any sort of prolonged period, do you expect the insolvencies to sort of return in

that industry. I do they for the most part, despite what Exambo said about thirty five dollar barrel oil, uh, the oil in costs for most of these companies, they start to struggle when we're under fifty dollars um. The banks, you know, the last go around on this, the banks didn't necessarily force a lot of them as many of them out of business as I thought they would. That sort of pretend and extent type of uh you know

actions went on. I think this time, though, the gig be up and you will see a lot of consolidation. The thing to remember is that though that that oil production and that infrastructure doesn't go away, it just gets sold to somebody at a at a firesale price. So um. What what interesting thing I saw is that for Excen Mobile, the CEO will be on the earnings call for the

first time in fifteen years. What's going on there? I think they've had a real wake up call there at Exon Mobile, you know, for so long, you know, they were considered sort of the you know class of the industry, and they stumbled. They brought a natural gas company at the heights of the natural gas uh you know, price structure. Um. And you know, they've been criticized for a lot of

other different things and they're finally getting their act together. Um. And it's could finally be I think, returning to the kind of company that we all admired and it was so fantastic and still is to a large degree, don't get me wrong, but I think they realized that they can't hide in the shell anymore and they have to be more uh out there and and pressing their case. I mean, I saw a couple of interviews with the gentleman already this morning, and he was fantastic. It was

shed a lot of light on the operations. Wasn't cag like they had been historically. It's it's a new company and I think there it's worth a look at this point for sure for investors. John Kildoff, thanks so much. John killed Off as a founding partner of Again Capital, joining us on the phone here in our bloombog leven three oh studios. Boy, we are right smack in the

middle of tech earnings. We had blowout numbers from Google, but last night we had some numbers coming out of Amazon that were a little weaker than expected, particularly as it relates to their forward growth. So let's dig into some tech here today. As we like to do that, we always like to turn to our good friend Shira

overy day. Shira is a technology calmness for Boomberg Opinion, and she joins us once again in our Bloomberg Interactive studio and shere came out with a really cool column today entitled Amazon Mystery, Where did all the growth go higher? Margins are great, but it's not exactly what investors have been paying for, which is I think a great take

on what's happening at Amazon. It appears to be that after years and years and years and years of no profit and just focusing on top line revenue growth, Jeff Bezos company is actually starting to provide some significant profits. Pretty interesting. It is pretty interesting, you're right, Although I think the thing that really freaked out investors was that Amazon said this year nineteen would be another year of

significant investment, at least compared to eighteen. We're spending growth kind of slowed, and as a result you saw profit margins getting um plumper, at least by Amazon's relatively modest standards. But the issue, of course is the top line appears to be the top line growth seems to be slowing considerably. And it's a little bit confounding how that's happening, honestly, because it does seem like US retail sales are going great. The US economy, where Amazon generates the vast majority of

its revenue, is going great. Amazon seems to be gaining share, and yet the growth is slowing there. This is sort of the conundrum that you and I have talked about for years, which is that nobody looks at the profit margins of the Amazon. They never have. Is this the beginning of actually looking at the profit margins? I think it is, and I think that story started to change

a year or so ago. And and look, you can see what's happening at Amazon to to grow that bottom line, which is they're getting an increasing share of revenue from businesses that are relatively higher profit margins. So Amazon Web Services, their cloud computing division. The revenue growth there continues at a really significant rate or so in in the quarter that has much higher margins than Amazon's e commerce business, something like thirty compared to five percent in their e

commerce business. So as more of Amazon's overall revenue comes from AWS, you see the total company margins go up. Same for their digital advertising business. Same for Amazon is now selling more than half of the merchandise online is coming not from Amazon itself but from the outside companies that are using Amazon as a sales channel, and those sales are significantly more profitable for Amazon because they're just

kind of taking a commission basically. So the stocks down almost four percent today, and I think that's primarily on the weaker than expected revenue guidance that you highlighted. The company called out in on their call last night that part of the reason for the more cautious revenue outlook was India. That is a big growth driver for them, but apparently there's been some regulatory changes there that are

impacting their business. What's going on there, Yeah, India has been a really significant investment market for Amazon and Walmart two, which bought flip Card, a kind of large e commerce operation in India. India is basically now the new gold rush for a lot of tech companies around the world,

including e commerce companies. But what the Indian government did is it it tightens some regulations that essentially prohibit companies like Amazon and Walmart, foreign companies from us selling goods on their own or having kind of their affiliated companies selling goods on their own as opposed to just being a middleman for sales by by local companies. And so that has meant that both Walmart and Amazon have had to remove a lot of items um from their India websites,

which I think is is worrying investors. I want to shift gears a little bit because we also have been getting other tech earnings and Facebook, really, I gotta say, is the one that stands out the most to me of this hire earning season. Yesterday shares rose eleven percent. Today they're basically flat. I do also want to just give an update because yesterday we spoke about Facebook with David Garrity and he was saying that that that that

Facebook had been removed from some Apple apps. It wasn't entirely accurate the way that we had originally framed it um and a Facebook spokesman just noted that we have our we have had our enterprise certification which enables our internal employee applications restored. We are in the process of getting our internal apps up and running. To be clear, this didn't have an impact on our consumer facing services, so there was never any kind of breach in a

consumer's ability to download Facebook from their Apple products. But I'm just wondering shia in the light of some of the privacy crackdowns from other companies like Apple, etcetera. With Facebook, is Facebook really in the clear the way that the share price seems to suggest, or are they going to face more backlash year? So I think what's going to happen to Facebook is pretty similar to what's happened at

Google over the last decade. So at Google too, that's a company that has faced a lot of regulatory and privacy questions UM for for many years, including if you remember, the Federal Trade Commission in the US UM launched a significant investigation into whether Google was abusing its monopoly on search and eventually came out that said said no. But it was a close call at the FTC, and and

Google's face regulatory headaches in Europe and so on. So I think basically this is the new cost of doing business for for Google for a long time and now for Facebook, that it is just going to be a regular drumbeat of questions and pressure on that company around

data privacy security. The way that they used the enormous databases of data they have on on billions of people, And no, I don't think it's going to affect business, but I think there will be questions for the rest of that company's life about whether they're kind of one regulatory investigation away from having a crippling business impact. So just following up on on Google. The company does report earnings Monday after the closed conference called four thirty Eastern time.

What are you looking for in the results? So one thing I'm looking for is we saw this week from the big tech earnings that they're now significant questions around growth UM. And we started to see that last year, and I think all of the big tech companies now to a different degree have questions about where is the growth going to come from? And and Google faces that as well. So I think I'm going to focus a

lot on the top line. UM. Google has made a lot of investments all over its business trying to find the next big business beyond digital advertising, and uh, it hasn't yet founded. But boy, you know, if you're gonna be a one trick pony, that is a really good pony. But their devices there's old, not kind of no, I mean for the basically everything Google invests in is just kind of a drop in the ocean compared to their

core advertising business. But the good thing is that the core advertising business is so successful and remains successful and growing fast that they have a long leash to figure out whatever might come next. Shara Overday, thank you so much for being with us and taking time out of this incredibly busy week for you. Shara Oviday is technology columnist for US at Bloomberg Opinion. 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. Paul Sweeney, I'm on Twitter at pt Sweeney. I'm Lisa abram Woyds. I'm on Twitter at Lisa A. Bramwoit's one before the podcast. You can always catch us worldwide. I'm Bloomberg Radio.