Panic in the Bond Disco

new or is it just a false dawn? And as always, will end the episode with our tradition the Craziest Thing I Saw in Markets this week? Sarah, I presume you're prepared for that second. I am prepared, but I have a feeling that you have a very special one I got. I have a very special edition of the Craziest Thing I Saw in Markets this week. But let's get right to it. I mean, sort of a crazy week in

the bond market. We're seen a really notable back up in yields, and luckily, by happenstance, we happen to have the perfect guest to help us break it down. From p G I am, we have Robert Tip, who is the chief investment strategist at p G. I am Robert, Welcome to the show. Thank you, good to be here. And it's good to have a Jersey guy. I would say to at least do you work in Jersey and Newark? If if my notes are credit, well I'm quite diverse.

I commute from a Westchester so I drive through you know, quite a range of geography that's very regional. Yeah, that's a nightmare of a community I imagined. No comment, Well it's not, you know, at least it's not the most common commonly trodden path. And also joining us this week, commuting all the way from Greenwich Village, we have Chris ag, the executive editor of Markets at Bloomberg. Chris, welcome back to the show. Thanks for having me, Mike, thanks for

identifying where I live. That's true. Anyone looking for Chris you can find pretty big, right. Well, you've got people looking for you, Chris, based on some of our Trump stories. Yes, so Trump fans and debt collectors can find Chris Navy. Robert, I gotta sort of pat you on the back, pat your team on the back. So I was looking at some of the returns on the funds this year, especially the p g i AM Total Return bond Fund up ten year to date. Wow. But not only that, it's

it's uh performance compared to peers is really impressive. A one year basis, according to our date, it's in the ninety percentile. Five years, it's in the eighty nine percentile. What's going right? I mean, obviously we've had this ferocious rally and bonds, but what are you guys doing especially

right to have these really great numbers? Sure, well, thanks, you know, we're taking a long term approach, So we're looking at the overall backdrop the macro economy, policy, monetary, fiscal not just in the US, but globally and so much so these days what happens in the bond market

is really a global phenomena. The balance of borrowing and lending is really driven almost more so by the amount of savings coming out of foreign countries than what's going on here just domestically in the US that would impact

you know, a general intermediate bond fund. And so when we look at the big picture, even just in the US, the markets quite sensitive to interest rates, and when they've been up well north of two percent, the economy has really kind of bogged down a bit, especially the interest rate sensitive sector, and give you the message that the equilibrium interest rate here is lower than most people think. And when we look abroad, the money is pouring across

the trance and most places have negative rates. People are paying to park their money in these countries, or if they're buying long dated securities, they might be zero yield um long term, zero coupon bonds, you know, that have an asymmetric looking risk we term profile. And so the money has come over here as well, even if on a hedge basis, when they eliminate currency risk, they end up with a negative UH yield on a standstill basis, but at least over here yields are well north of zero.

Maybe you have some upside as well as downside, and so I think you know, that's driven us to a secular view that rates would be declining, and we've positioned for that. Is there anything in this so often the bond market this week that sort of changes your your stance on on all of that. Is is it a turning point or is this just sort of a little bit of a correction in a very much an overbought

treasury market. Well, I wish I could give you the answer, UM, But you know what, what we've seen over the years in the secular bowle market that we've had in bonds for forty years, At any given point in time, you may have a cyclical upturn and expectations and views of economies around the world have become pretty morose, and uh so you can get a backup in the bond market

driven by technical conditions. And I think to a large extent, what we've seen so far is kind of an equal and opposite reaction to the panic by that we saw

not too long ago. And we'll have to see if the fundamentals follow through, um, but our base case would be that the range safe for the tenure treasury is maybe one and a half to two and a half, but probably more likely something more like one to two, and that we're going to see these fundamentals reassert themselves and cause rates to stabilize or maybe even fall again.

So we did see a pretty major backup and yield this week, the tenure once again approaching two percent, which is a level we hadn't seen in at least a couple of months. Because when you think about your lower for longer thesis. Much of that does have to do with where yields are overseas. Does that just mean that there is a cap on where US treasury yield can go going forward, because no matter what, as long as they're higher than yields overseas, you're always going to have

some sort of demand. I think creates a friction. And so what we've seen in the sell off is the treasuries have sold off less than foreign bonds. And in these UH that the key global markets j g B s, buons, UH, European bonds, Japanese bonds, there has been a sell off and UH, you know, there there's a whiff of change

in the air. And both of these places. In Japan they've been trying to steep in their yield curve, push up long term yields to lead more on the table for insurers, for banks UH and in Europe you have a change of of of leadership at the e c B. So people you know, questioning will there be this unflinching commitment to incredibly low rates and quee going forward. And so I think the level of yields is spread being at at you know, your nine type percentile of multidecade

levels relative to much higher than these four yields. That creates a cushion, but it doesn't create a lid. I wanted to dig in a little bit on the I was looking at the p G I am Total Return bond Fund. I think it's one of your big gets straight about fifty billion in assets, UM. And I was looking at sort of the allocations and the holdings. Now, this is our data is at the as of the end of August, so not necessarily current, but a couple

of things really caught my eye. Uh, mortgages corporate about eighteen percent government. But looking at the individual top holdings, there were a few US D euro swaps uh usd uh British pounds swap, so walk us through UM and I think those were all about like four or five of the allocation, so pretty big positions. UM. Now, I'm a stock guy, so I don't necessarily know what's going on with these, but my guess is these are these are basically bets on rate spreads, yield spreads narrowing between

the US and Europe. Is that is that the safe way to describe it. Our risk or principally domestic and a currency risk, foreign interest rate risk, is going to be very limited, and so uh, notes of of swaps that will be used in the fund will be issues selection driven. So we may find that a US issue are issues and euros maybe at a wider spread than in the US. We buy that bond and we hedge

it back to the US. Now we have had, um, you know, at different points in time, uh, you know, small positions and for an interest rate risk or even fcs on for on the foreign currency side, but those tend to be very small, not not as large as as that magnitude generally, Right, Chris, come in here and give us the equity view, because it's not only yields that have been rising this week. I mean stocks have

been rising and pretty forcefully to it that. Yeah, um, I feel like stocks are happy to see yields go up. I mean the big equity perspective on that is that something going on with bonds and yields in the curve means recessions coming. So anything that kind of undoes that argument.

Now you're saying that just as big an issue would be fields getting too high at this point kind of reminds me of a saying we have on the desk, which is whatever the hell happens, it's bad, But I guess we shouldn't get too comfortable with the relief for feeling over seeing a little bit of unwinding in the curve and all of these uh, you know, sort of

unbelievably reliable recession indicators. What is true that you know, the the good news that's that's boosting the equity market, whether it was less worse than feared earnings or some optimism on the trade front, that that's it's bad for yields until yields get too hind they begin to choke

off what's going in the equity market. But so far we're in the sweet spot where you have some concerns on the right side, but rising risk appetite and not economic optimism to outweigh, you know, the rising discount rates.

So is the last few weeks in markets? How much would you attribute it to, uh, the trade optimism and how much would you attribute it to the FED apparently being on hold but yet still uh, sort of doing what it can to keep the repo market, uh, in order with with this short term treasury purchases, I mean, how big of a deal is to FED at least in the rates market right now. Yeah, I mean I think those are those are excellent points. I think that the risk on makes people wonder, you know, g is

it really over for bond? Should I have more equities? And on the retail side there have been a lot of outflows from equities, so there's some of that. I think though we have shifted in market environment from one

where central banks had wound down their quantitative purchases. There their quei buys, and that was bad for risk I mean what we saw, for example in two thousand nine, in these previous instances of aggressive quei is it dampened equity volatility, It pushed up stock markets, it pushed down volatility, and we had moved away from that. Last year was a very volatile year where risk product had a hard time going anywhere and there was much less liquidity coming

into the system. So now we've gone back into bill buying, you know, UH and a rising FED balance sheet. The e CB is back in buying. Bank of Japan is is slowing their purchases, but at a very slow rate, and at the same time they are in a way remodeling their policy because they feel they will be incredibly accommodative for even longer than anticipated. So I think the accommodation, the aquidity liquidity injection has tended to bear steep in the curve a little bit, and we're seeing some of

that here. At the same time, you look at the data that's come in so far for the fourth quarter and kind of distill it down to these UH now casts that the FED does. The Atlanta FEDS GDP now model, I think is that like zero point nine percent growth for the fourth quarter. The New York FEDS one is even lower. I think it's like zero point eight. So, you know, some of the lowest growth potentially we've seen in the cycle. Albeit you know models that tend to

jump around a lot. There's still a lot of data to come in UH for the quarter, but our markets getting a little bit ahead of themselves on the optimism here this week, well, I think so, I mean, our base case of a one to two percent range would suggest you're getting near the top of the range. And as as you're highlighting this week, the news has not been really positive on the fundamental side in terms of what really matters for rates markets, which in some um

some extent is really the real economy. Do people need to borrow a lot of money to invest durable goods. Big picture, those numbers are very flat. We had this week another poor industrial production figure coming from the European side, and so basically, you know, that would suggest that more likely than not, there was some exuberance when the rates were rallying, and then some people are asking themselves what were we doing? Uh? And and a little bit of

panic selling here, Chris. So it seems as that the stock market is maybe getting a bit ahead of itself too. I mean, you just look at where we're seeing the output formans lately, and energy stocks are really on a tear this week. You look at other cyclical areas of the market. Is it possible that this is just beta chasing? Um? In a in a way, yes, I I feel like what's going on in the in the equity market reflects uh,

this sort of standard word is rotation going on? That does a lot of people have been caught short by this routy And let's face it, if the if the if the markets stopped dead right here basically a year to date, no one would be no one would have

any reason to complain. I'm sure they would complain in fact, um yeah, um, but uh, if you're a fund manager who's watched this happen and has been wedded to defensive shares or bond proxies, and now the bond markets rolling or some degree rolling over, and you're stuck with all of that stuff and you're watching everything take off. I mean, it's a sort of a self fulfilling prophecy. You're gonna you're gonna need to dive back in and grab some beta.

It reminds me of a story your team had out this week about the percentage of active equity mutual fund managers who are beating they're getting killed. It was getting the benchmarker. I mean, they're they're always getting killed, but they're getting killed a little worse right now for some of these reasons. And it's a bad year I think

probably to look bad. I mean everyone's gonna I mean, to the degree people care about performance, I feel like everyone should look at their returns in their foreign k and say, man, I made this year. But that's not how the professional class will look at it. And this is sort of the big sort of melt up thesis right now that there's going to be a lot of people diving back into the market in the next two months try to make those numbers. And it's like, lookout above.

If that starts to happen, what do you think the chances that are. I mean, we're obviously seeing it to some degree. Does it continue through the t the end of the year. Walking in here, I probably would have said pretty good. As I listened to our guests and some of the signals coming from the boom market, I think that's ultimately the determined if the economy doesn't go anywhere.

And what I know about is the economy is earnings, and earnings in the fourth quarter look like they're gonna suck, so uh, they're The ultimate determinant will be whether or not the macro picture is good enough for stocks. And you know, the supply demand and chasing beta things are a factor for a little while, but they won't they won't call the ultimate tune. Much of this reversal has been predicated on the idea that we are seeing a stabilization and growth. We could see a nice rebound in

And I did do my homework, Robert. I dug up something that you said on Bloomberg Television last week and after the employment report, you said, this is a picture perfect soft lanning. It's what they're on track for talking about the federal reserve. Is that actually what we're seeing And if so, wouldn't that bode very well then for

risk assets? I think so. And I think the comment I made was that he Powell has been criticized, you know, for how he's handled the press conferences, and I think they did a pretty flat footed last hike last year, you know, one too many, but I think in a way they kind of wanted to stick their finger in the eye of the President who had been badgering them, and so they managed to do that without doing too

much damage. They've whipped around, they've cut three times, which was you know, going every meeting every six weeks, as opposed to when they were hiking, which you know, they were only moving once a quarter. So that quickly cut and they may be there for the soft landing. And so our hypothesis, Frank, for some time is that although this is a moribund economic backdrop, it is not as

much growth as people would want to see. It is not a feel good economy for people that in the markets, you have a declining equilibrium interest rate, you have a very long business cycle. Because these central banks have prevented uh, really big financial accesses from building up, and they have not jumped in and crushed the economy with rate hikes, which is typically what kills it. So I think what's what's shocking to people is you are having a very

extended cycle. They're on track to continue this, and so as a result, your eights are likely remain low, your period of spread sector outperformance continues, and your equity market continues to look quite competitive in terms of earnings, yields, and valuations relative to a bond market with yields this low. I feel like that there's a point to be made here about the stock market being an economic input onto itself.

That's sort of a lucky break that they get here, that the one thing that could not the one that obviously, the consumer remains strong. One of the reasons the consumer remains storming. You saw this after the fourth quarter of last year when market tank some of the uh animal spirits kind of get beaten out. But right now a lot of people are sitting with a lot of money thanks to stock market. That's part of the big Eco

bowl case. I'm glad you brought the consumer, Chris, that that brings me back to looking at the p g I total return return bond fund mortgages. Um, is it safe to say that you know a lot of what we've heard people talk about and seeing ourselves this year is Yeah, certain parts of the economy are very week. You have you have manufacturings week, the consumers still remain strong. Um, what are you looking at in the housing market? Is

it just blue skies ahead? Uh? In the housing market, is there you know and is there still yield there? Considering Uh, you know some people are still looking at that market with a jaundiced eye after the financial crisis. Well, I think that in terms of the agency passed through market, we're seeing a little bit of value there after the FED has been rolling off and people have been scared out of that market a little bit. We're we're stabilizing at at attractive levels and and so we have you know,

some intermittent exposure there. But most of what you're seeing in the mortgage categories is structured product that is actually

away from residential. So you're gonna be looking at a good amount of commercial mortgage backed where those asset prices have been firmer, but also where we tend to be Uh, in the top position in the capital structure or in one of at any rate, one of the very highly rated ones unless uh, you know, in some exceptional cases there could be a single asset type situation that's that's mid rated, but there's much less of that, so predominantly

high quality commercial and then a fair amount of collateralized loan obligation clos and uh, this is a sector where you are collateralized by below investment grade loans. So uh, an area that is not one of the best looking areas right here. That's an area that was technically very well supported because they're floating rate assets during the period of FED rate hikes, and now the FED is on hold and so retail money is going out of those funds.

Loan prices are under pressure, and their concerns on asset.

The underwriting was most aggressive there. But for diligent investors, I think, who can you know forge through the different managers what exactly is in these deals and then go right to the top of the capital structure, not in the middle, not at the bottom, that they are spreads available that are very competitive with intermediate and long term corporate bonds that are much lower rated than a triple a c L o U and have very competitive spreads the c L so I think it's a fair amount

of that, uh where we're looking to get some some lower risk, lower beta spread at this point in the cycle. Do you see any product offerings out there that do make cause for concern for those who maybe aren't doing their due diligence we work, Yeah, Well, I think the loan area is one where you've had some uh you know changes. I mean there's almost a terminology misplacement at this point where a lot of those deals they don't

go through banks at all. So at one point that market in its genesis, if you had an LBO, or you had a lower rated company, they may have a range of different financing options. They may go to the high yield market, they may borrow collateralized in the bank loan market and then that would be syndicated out, but that paper would be going through a major bank that

would have a certain kind of underwriting process. Now, with the really large private equity pools out there and a lot of capital looking for deals, a lot of the loans are not going through a bank intermediary at all. There are a lot of very small deals, uh, and

um um much wider range of credit quality. And so you know, as the economy is moderated a little bit, and you alluded to the stats on the economic side, you are seeing rising um UH a number of companies that are missing their earnings forecast and seeing their bonds drop ten points UH. And that's more so on the loan side, for sure, than than in the high yield area. I'm curious to know to get back to that one percent to two percent range on the tenure yield that

you see. UH. Is there an expiration date on that if say we wake up next week and that Phase one trade deal is signed, um, or is it you think we'll stay in that range regardless of what happens with trade. You can never say for sure. And we're investors, were not forecasters. So if that situation changes, I have to change. I have to get on the right side

of it. Um. But my a priori is that the world has changed in a massive way after the financial crisis, and it is in some respects just begun that the workforces in China uh, and in Europe we're growing until you got to the financial crisis, and now they have rolled over it. They're actually shrinking, And so you're left in a world where debt is not rising at an

astronomical rate fueling growth, fueling profit growth, fueling spending, fueling investment. Uh, and where you have a growing population that needs a growing stock of goods, cars, housing, and so on. You on the far side of that. And even in in China, your car sales have rolled over your retail square footage being put in place. This is a global phenomena where your growth rates are you gonna be much more modest. You're borrowing again for the real economy, much more modest.

And so that one and a half percent central tendency basically does not have a shelf life. I would think it's going to be there until we see some major change on the horizon that's going to take us too much faster or slower plane of growth. Regardless of the supply of treasuries coming into the market. I mean, we're looking at what trillion dollars. That's another good point I

should differentiate too. So when I look at the curve, now, I will look at treasuries, but I really need to look at o I S. SO o I S or overnight index swaps are based on the Fed funds rate, that is the rate that the Fed is controlling. The treasuries are really trading at big spreads relative to O I S because of the massive issuance. I don't think it's necessarily credit concerns, although at this pace the US over time will click down in ratings as debt to

GDP rises and so on. When you look at the the O I S curve, it's perfectly flat and about the effective Fed funds rate right now. Uh. And but your treasury yields make you know very around that depending on what what happens with the deficit. Chris, last question before we get to the craziest things that we will all share.

How much do you think it's possible that this resumption is such a risk on fuel has to do with timing, that we're getting closer to we're less than a year away from the election, and that President Trump and the administration just can't screw up this US China deal. Well, yeah, if you take part of his motive as being the beginning of that kind of a campaign, then yes, timing

could be part of it. Of Course, the election itself hold all ends of volatility potential that we shouldn't under undercount. It's not like that's just unanimously good tidings coming down over the horizon. But um, there's that there's a general tendency for stocks to go up at the end of the year for all kinds of sort of window dressing

as reasons, and you know, uh, just the end. If this thing has been going on for so long, and if you know there's some if there's ever really there really isn't reason to believe that it's permanently settled at any level. We shouldn't kid ourselves. But to the degree that, uh, it's it's getting weight as far as what when Trump can roll it back and sort of sort of get the economy, get the stock market, the economy and these sort of sentiment proxies and under control timing could be

a factor for sure. Speaking of timing, it's that time, Sarah, what is the craziest thing you saw in markets this week? So I'm going to go back to I believe something we've spoken about before on the show, which is the Popeye's Chicken sandwich because it's pair an owner which is Restaurant Brands International Canadian company. They also Aarned Burger King. They also owned Tim Horton's. There's been a lot of

hype over this Popeye's chicken sandwich. Um, and they're trying to kind of gain competition and gain traction from Chick fil A. Well, what happened was when they first came out with the sandwich, they did not have the manpower for it, so they had to hire more people at Popeyes, and Popeyes actually just had an unbelievable quarter in sales. Um. But what's crazy? And it's pretty unbelievable and also a

little bit sad, I must say. Um, there was so much demand this one Popeye's location that a fight broke out over a chicken sandwich in line and it actually ended in a fatality, which is yeah, um, unbelievable that you get to that point. But it just shows you what they're trying to do to gain competition gain traction is leading to other issues for the company. Um. In the long hall, Robert, did they tell you about our gimmick here? The craziest thing in markets that we've seen?

You know, I did hear about it, but I don't have any content for you, Okay, that's all right, that's all right, I mean for me every day, wake up. Look at the markets. I'm totally shocked and have to figure it out from there. Would you say seventeen basis points swing in ten years on Thursday was pretty crazy. I think the swings that that we're seeing and U market swings and sentiment on on trade and I'm positioning

and fixing them, they have been a little shocking. Chris As, I think you possibly are our first five time or guest here. Yeah, like the Paul Simon you are. Yeah, we're gonna get you the smoking jacket. Anything. Have you witnessed anything crazy and market? I would say, there's this thing that happened this week, so I wrote it up. This guy Cliff Fastness, who loves he adores our coverage of the start read. He can say enough good things about it. You got to get him on sometimes man

who um. But anyway, he put out a note where he said that this he's he runs Qure Capital Management, big hitch fund, big hitch fund that runs equity factors, which means that they and things like high dividend stocks and low valuation stocks, value stocks, and his whole thing

is to basically program his computers and step back. It's kind of like really like advanced calculus passive investing, and they're incredibly rich and successful and huge and really is one of the smartest guys really on Earth and um. But so he came up with a note saying, so his big thing is you don't you don't jump in and out of markets. You sit and let the computers

do their work with the factors run. He when I when up with a note saying, now might be a time value stock cheap stocks have gotten so cheap that it might be a time to sort of try to market time to take sort of opportunity opportunistic stabs at them, which for him, I mean, it's hard to describe. It's so outside of his usual worldview and philosophy for him to come in and say act like he's not saying, act like a day trader. But you could translate that.

He probably expect us to translate that into one of our stories. Um. But given some of the wars he's had on Twitter and in public about trying to time factors with another guy guy we had on this show, Rob are not they've really gotten into up in each other's face about it. But now Cliff is saying, you know, factor's values so cheap that maybe in this limited instance, it's okay. He says, modest overweight might be the same

as I don't want to Cliff. If you're listening, you can call to what goes up hotline and correct whatever Chris got wrong in that description, which is nothing. Obviously. All right, time for mine. I think I got I think I hate to pat myself on the back, but I think I think I got the best one here. So we've all heard about this price war in the

retail brokerage industry, Charles Schwab cutting commissions to zero. Well, the firm that really got it started Robin Hood a few years ago, the first to offer commission free trading. Now they're one upping everyone by offering quote unquote infinite offering. There is a glitch in the system, in the system, and of all places, it came out on Reddit. Someone someone basically out of them for this on Yeah, I

guess I have to read Reddit now. But basically, if I get it right, what happens is you you take out a marginal loan, you buy a bunch of stock, then you sell a bunch of covered calls based on that position. The one do you collect from the selling the covered calls, you buy more stock. With more leverage, you sell calls on them, and on and on it goes Robert, if you had infinite leverage, what would you buy? Oh my god, I'm listening. You know, after your description

of of Ascetic, I'm just a bond guy. You know, if they didn't have a tap performing fund, I would have a complete complex. But we don't go to the infinite leverage only Robin Hood. With that said, though, I think Mike you you did when it this time. It was pretty unbelievable saying that story this week. But Robert Tip, Chris nag thank you so much for joining the show this week. Thanks, thank you. What goes up? We'll be

back next week. Until then, you can find us on the Bloomberg Terminal website and app, or wherever you get your podcasts. We'd love it if you took the time to rate interview the show on Apple podcast so more listeners can find us. And you can find us on Twitter follow me at Sara pont Sec, Mike is afre Anonymous, and Chris Nagi is at Chris nag One. You can also follow Bloomberg Podcast at podcast and don't Forget. You can also give us a call at our very own

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