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“I’ve been hearing about investors losing money” sitting in cash, and that cash is garbage as long as I’ve been in this industry,” she said on this week’s episode of “What Goes Up.” But the reality is, if you’ve been in cash for the past five years, you’ve essentially In general, the Bloomberg Aggregate Index has outperformed the Bloomberg Aggregate Index on a year-on-year, one-year, three-year and day-to-day basis, yes, even. five years.”
Below are lightly edited and condensed highlights of the conversation.
widening spreads in credit market hint to you? Is it as clear as the recession is on its way or is it more nuanced?
I’m going to zoom out and express a little doubt about the bond market’s ability to have that kind of predictive power. Because if that were the case, yields have been lower and lower and at new all-time lows in all these years, which indicates a recession, I think, if we really believe in indicators or predictive function of the bond market. . This, of course, didn’t materialize – or we had a very dramatic dip around the pandemic, but it was a very puzzling event. Plus, we haven’t really seen the kind of slowdown that the bond market would have been predicting each year at these record-low returns. This, of course, has to do with massive interference by central banks. This, clearly, has distorted the ability of the bond market to be a predictive or predictive mechanism.
Having said that, we see inflation expectations flattening out. The 10-year breakevens are stuck in the middle of the 2nd, but you see them climbing higher – with respect to the 2-year and 5-year breakevens – so inflation expectations are either staying bullish or staying elevated. We still don’t have a positive, real return on the 2-year portion of the curve. Well, that’s something Powell and the Fed are focusing heavily on.
But let’s take a step away from that for a second to talk about spreads – yes, we’ve seen some spreads widening. But to put that in perspective, the last time we had a hiking cycle and a little bit of inflation was 2015, 2018 hiking cycle. We barely had inflation above 2%, the unemployment rate was high and the hiking cycle was incredibly benign. We still see high-yield spreads going into the mid-5s. With inflation at a four-decade high, we are now barely crossing that threshold. No one can really tell if it’s really moderating, or it’ll keep ticking.
The unemployment rate is also far below where we were during the last more gentle hiking cycle. So I think calling it an investment opportunity, calling it a bargain from a broader perspective, I think we’re far from it. At this point, all of the carnage we’ve seen in bond markets, whether in the interest-rate-sensitive part or the low-interest-rate sensitive part like high yields, is all interest-rate driven. Very little of it is actually spread or credit-risk driven. To start talking about opportunities we have to look at that punch.
We’ve talked about moving to cash in the past, but in a 10%-inflation environment, you’re losing money on that cash. So what do you do?
I’ve been hearing about investors losing money sitting in cash and for as long as I’ve been in this industry, cash is garbage. But the reality is that if you’ve been in cash for the past five years, you’ve essentially changed the Bloomberg Aggregate Index on a year-to-date, one-year, three-year, and day-to-day basis. Outperformed five. years. And for three years, that’s a positive return versus a negative return. So I think we have to stay away from these absolutes.
It’s one of the weirdest things to me, frankly, how our industries work, because in fixed income, you have absolutely recognizable tops. When the 10-year was at 50 basis points, it had nowhere else to go. So why aren’t widespread alarm bells sounding about this? Do you remember hearing this? No. The rhetoric was the same – cash is garbage and you should be invested, and because anything else yields higher than Treasury, you should buy it, even if the valuation there is equally high.
So instead of resorting to these absolutes, we have to really think about what it’s worth. We just have to think about inflation, it’s a serious problem, and yes, you’re earning 8% in high yield versus still significantly less cash. But what is your value addition, or what is your capital preservation potential? And which of them is most important to you? Again, for us as full-return investors, we focus on capital preservation first.
Given all the push-back forces in the markets today, we see this and we say that we think the risks are downside biased. That’s why we prefer to have a lot of liquidity in our portfolio because right now it essentially acts as a free option on any asset class in the world. We think the SET opportunity will continue to improve on balance, as in the full six months of this year. We have been hearing about people investing in January, February, March and April and it keeps getting better. And we think the spread will continue to be widespread.
For us right now, again, as full-return investors who are trying to manage cash and outperform, regardless of whether the regime is a lenient one for bonds, we’re going to look at market-risk-driven benchmarks versus Not investing. We are investing versus conserving capital. We believe that the focus on capital protection continues, and we prefer to be in very liquid structures at this point in combination with liquidity, high quality floating rate — we continue to like that business. Actually for us, it’s still a capital-conserving part of the cycle, although I think we’re closer to the end of it than we were a few months ago.
We’re probably going to transition into the start-to-get-aggressive, start-to-go-after-the-returns part of the cycle, probably over the next month or two, as we Let’s see the widens and some of these more bearish expectations are reflected in the price. But at this point we think that capital preservation is still the name of the game.
Why not delve into investment grade, very cheap bonds with very high ratings?
We have no problem with anyone doing this. Generally, right now, a laddered portfolio is an approach that we don’t really have a problem with. I think where investors are going to struggle is, frankly, mutual funds because mutual funds have a permanent maturity. Unlike a physical bond that you have, there is no maturity that you should mature up or down. You are stuck on that price until the market gives you a better price. This is why the loss that mutual fund investors have suffered is a real loss. If they had gone and tried to sell now, they would have turned those paper losses into actual losses.
But we don’t have a problem with someone buying heavily discounted bonds and putting them in a laddered portfolio at the moment. We think it’s fine. Deeply discounted stuff, there really isn’t a ton of it at the moment. If something has a huge discount right now, there is usually a very good reason why it is trading at that price. Some of the market segments that we are seeing that we think are starting to look more ripe for investing are around the edge of fixed income and have more equity-correlated risk. So things like convertible, closed-end funds — both of which track equity risk more closely and have a higher beta for equities. We’re seeing significant discounts there. This is probably going to be at the top of our shopping list in the near future. But we’ll see how the rest of this market plays out.
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