Hello and welcome. This is The Michelle Hussein Show. I'm Michelle Hussein.
I speak with people like Elon Musk. I think I've done enough.
And Shonda Rhimes. That's so cute.
This will be a place where every weekend you can count on one essential conversation
to help make sense of the world. So please join me. Listen and subscribe
to The Michelle Hussein Show from Bloomberg Weekend, wherever you get your podcast.
You certainly ask interesting questions.
Hello and welcome to the Credit Edge Weekly Markets podcast.
My name is James Cromby. I'm a senior editor at Bloomberg.
And I'm Rob Schiffman, a senior analyst covering tech at Bloomberg Intelligence
and co-head of our US high-grade and high-yield research teams.
This week, we're very pleased to welcome Robert Kahn, the director of global developed credit at
DoubleLine, the employee-owned money management firm. How you doing today, Robert?
Doing well. Thank you. Happy to be here.
Awesome. Great. For those of you who don't know, Robert, he joined DoubleLine in 2012
and is a portfolio manager and the director of the GDC Group.
He's also a permanent member of the Fixed Income Asset Allocation Committee.
The firm manages around $100 billion in client assets and is among the most
followed thought leaders on the street with a preeminent Fixed Income Franchise.
We are pumped to hear your views on credit markets and to get some first-hand insight
into what the smart money is doing. So, James, why don't you kick us off?
Yes. Credit markets have brushed off a recent bout of distress and are seeing a barrage of
debt issuance, mostly from tech companies looking to fund a gigantic build out of AI
and associated infrastructure. Big tech has a lot of cash on hand,
but they're still concerned about how this massive increase in spending will hit earnings.
Meta, the Facebook and Instagram provider, saw its stock price tank by more than 10% last week,
chopping off about $200 billion in market cap, but that didn't stop investors placing $125 billion
in orders for a $30 billion fundraise on the same day, setting the record for the biggest
order book ever for a corporate bond deal. Investors just can't get enough tech bonds at the
moment, it seems, and there's a lot more to come in both public and private markets.
But anytime we see such massive demand for bonds or debt, alarm bells do ring, the FOMO,
the buy now, ask questions later. Robert, is this a positive market signal? Are you joining
the Gold Rush into AI or should we be a bit more cautious here?
I think we're supposed to be cautious. So, you zoom out a little bit when a sector of the credit
markets is small or non-existent, and then this becomes more frequent and then becomes large,
which it's not yet, but when it gets momentum, you're supposed to be cautious.
These transactions, particularly in investment grade, are novel in terms of the way they're
structured, the features in terms of being off balance sheet, and I think you're supposed to
be careful. Of course, we don't know yet it's unknowable at the moment whether these capital
projects will actually be profitable, and we also don't know how many are ultimately will be built.
You can think of it as, if you think of it more simply, it's really, they're building capacity,
and when you build capacity and fixed assets, sometimes you build too much or not enough because
these projects take time, they take years to put together. By the time they come online, there might
be, I don't know, there could be a hundred more projects coming online that could be sufficient
or insufficient, it's really unknown. I think you have to have a level of skepticism. Speaking
about the investment grade companies, they clearly have rock solid balance sheets, and so they can
handle whatever comes of these projects if they build too much. Certainly, I don't think it would
be a material impairment for these, for the MAG7, so-called MAG7, these very large companies,
but for the projects themselves, it could be a problem. And of course, there's a spillout over
into other areas of the economy. So these data centers use power, they consume materials,
they use chemicals. Who knows what the spillover will be if the music stops? So I think you have
to be not only cautious about the tech sector, but the tangential related sectors that are
providing support for these new projects. Yeah, I think there's a ton we're going to dig into
details more into this AI tech trade. But just, I'd love to just get a little bit of a sense from
you, Annette. This is such an industry driven by short-term results, and we're obviously seeing
markets still rally. How do you maintain a long-term investment horizon in your decision-making
when so many people are focused on how you're outperforming today and tomorrow?
Well, you can't focus on short-term results. It's a simple proposition that's hard to stick to.
When markets get rich in valuation, you're supposed to be cautious. That could lead to
underperformance for a short period of time. Or maybe not, it depends on the situation. But
sticking to investment discipline is the only tool in the toolkit, really. When the opportunities
are light, then you have to be stepping back. I think it's important to communicate to your
investors and tell them what you're doing. And when will you outperform and when will you underperform?
I think in this current environment, double on telling investors that we see the things that
everyone else sees. We're thinking about them and we're cautious. I think that that helps our cause.
Luckily, our performance is good now. But as valuations get higher and higher,
as cred spreads get tighter and tighter, performance will be harder and harder to come
by if we want to have a level of risk management that's important. So, I guess I'll leave it there.
Let's set a baseline then, because I've heard you say cautious now twice. So,
where do you think fair value is right now for IG and High Yield? And what are those one or two
things that you're cautious about that you think that the market is missing?
Well, I think when you talk about spread level, you're kind of missing what's happening underneath
the hood. So, I think it's more interesting to talk about the fact that there's, at least in below
investment grade, a significant amount of dispersion. And so, I think it's all about credit
selection really more than anything else. Fair value at the index level. I don't really think
about it that way. I think about fair value building up from our portfolio name by name
and does it do the credits we own make sense. So, when I talk about high dispersion, what that means
is if you take High Yield, the single B index spread is about 280 or so. It's about where the
index is. The index, High Yield index spread is about 286. The spread on the single B index is
about the same, but there's a lot of dispersion, meaning that there are many credits that are
much tighter than 280 and there are many credits that are much wider than 280. There are some
credits that are in the low 200s. There are some credits that are 1,000 over. And according to some
research, I see the dispersion, that difference between the names that are higher than the index
spread and lower than the index spread is now the 86th percentile. So, it's only 14% of the time
is the variation between spreads higher. The loan index is similar. I think it's in the 70s. So,
the difference between the tightest spread and the widest spread is still usually lower than it is
now. So, only 25% of the time, the difference is higher. So, fair value. I think you have to look
at it on a credit-by-credit basis. If I'm looking at a chemical company with deteriorating financials
and uncertain outlook and it has a tight spread to the High Yield index, that seems pretty rich.
If I'm looking at a very stable, let's say, insurance business that's been growing
and has stable earnings and cash flows and is on index or maybe a little tight to the index,
that seems reasonable to me. So, what the market is doing is they're paying for quality.
So, the tight spread credits are inside the index and the credits that have uncertainty
are wide of the index where they're talking about High Yield, bank loans or investment
grade for that matter. In the investment grade space, for example, BDCs have widened out because
there's great concerns about BDCs. The stocks have been repriced over the last few months,
worries about quite simply rates. Falling interest rates don't help BDCs because they're
floating rate, but then credit concerns with the headlines of first brands and so on.
And so, if you put that all together, it's hard at the index level, let's say,
80 base points on the investment grade index as a whole. Is that the right price or is 286 on the
High Yield index seem fair? I'd say they both seem very tight and leave little room for mistake,
as I guess the way I would characterize it. I could say maybe something that would be
quite fair value in a stable growing economy would be a little wider.
Exactly how wide? I think even more from the bottom up, as I mentioned before.
And when you go back to tech and look at that, Robert, the deal we talked about Metta,
they came out with initial price talk on that new deal quite a bit wider than where they priced,
just because of the massive demand for those bonds, despite the fact that the stock price
was tanking on the same day. What are you doing that situation? Do you just not participate?
I mean, you're kind of forced to, right? Well, we're not forced to. I think if you are an active
manager, which we are, we're not forced to buy anything. So, if there's a position that we don't
like, a credit we don't like, then we don't need to own it. If there's something we like a lot,
then we do own it. I also point out, most of the money we manage is multi-sector. And so,
the pitch for that is if the corporate credit market gets a little too nutty, then we can allocate
to other areas of the fixed income market. So, we can stick true to that discipline because we
have the flexibility to say no and move money around if necessary. So, I think active management
is very important now. I think another theme that maybe people don't talk about as much is
since the financial crisis. Active management hasn't been as important when rates are taken to
zero because it's all sort of liquidity trade where the worst credits actually perform the
best and the most unprofitable companies and the equity markets outperform. In an environment
where we're no longer in QE and we have higher base rates, credits need to live on their own
performance. And I think credit selection has been very important 2025 and will continue into
2026. So, I don't think you have to own anything. I think you have to be very careful of credit
selection. And I think credit selection will be rewarded. It was rewarded this year. The year's
not over yet, but I think it will continue to be rewarded next year. There's a lot of layers to
this credit selection even inside of credit. So, for something like Metta, one is they should
bond as far out as with 50-year maturities. Interesting to get your thoughts on how people
should evaluate tech names 50 years out and how you value that. But more specifically,
companies like this are now issuing somewhat liquid private deals. And I'm wondering how
you're discerning between am I supposed to be owning a more liquid public deal or something
that's giving me a little bit more yield through an SPV that might not be as liquid. How are you
determining fair value of public versus private within the same name?
Well, to answer your second question first, it depends on where you're putting it. So,
people often pay for liquidity when they don't need it. And so, in a strategy that does not need as
much liquidity, maybe it's some sort of SMA or private fund that we're managing where liquidity
is not a primary concern, then we should get paid for that illiquidity. And we're happy to
do that, all else being equal, credit neutral, rates neutral, if it's just less liquid and we're
putting in a place where it's appropriate, then that's totally fine. We have other funds at our
firm that have daily liquidity demands. And so, if we are accepting illiquidity, we have to determine
whether that's the right place. So, that's just a simple question of, are you putting in the right
place? And then the question is, does that SPV have substantially more credit risk because of the
nature of the structure than the parent company? Of course, it does. And then you have to evaluate
that credit risk. I think that these are generally structured, I'm speaking more broadly now, in a
way that the credit risk is pretty well buttoned up. So, you're taking illiquidity risk. I think
you're taking some extension risk, depending on how these projects unfold. And so, those are
acceptable and putting them in the right place is fine. In terms of 30-year, we're not super excited
here at the firm about long-duration assets anyways, because we're worried about steepening
curve. And then, of course, when you layer credit risk on top of that, it's not our favorite trade.
So, that's not something that we're super excited about, like long-duration interest rate exposure
to begin with and then add long-duration tech exposure on top of that. That wouldn't be our cup
of tea, as people say. So, not for us. But, keeping it on the shorter end, private versus public,
taking additional illiquidity risk, I think that's totally fine as long as you're putting the right
place. And what was your view on the bignet deal? Did you think that was fairly valued?
It's one of these transactions that broke 10 points higher than were priced. How does that
suit you? I wasn't super excited about it, to be honest. I think it's neither fish nor fowl.
It's not really a standard investment grade deal. And I think there's a lot to look at in the high
yield space, where you can replicate a similar type of yield profile. So, I thought it was fine.
I didn't think it was something you had to buy. I'd say that. I think if you bought it, if you got
it at new issue, where it was originally priced, that was interesting. But then where it's trading
in the market, I don't think it represents anything really unique. Again, because you have
to get paid for the illiquidity, for the extension risk, you price all that in. The uniqueness of
the structure, that's worth something. And so, is it cheap? I didn't think it was particularly
cheap, but maybe it's fair value, but it wasn't some kind of unique opportunity.
And you've got better insight than most into what the supply looks like over the next
few months. So, I think the market was a little bit surprised by the size of meta's deals. Now,
we're sort of hearing whispers of $38 billion coming out of Oracle. Alphabet does more in
dollars in euros than I think people would have anticipated based upon what their cash flow looks
like. What does the calendar look like to you? What are you seeing in terms of people lining up
private deals, people lining up public deals? Are we going to see now a standard sort of $25
billion at the new size of the jumbo deal for the next 6, 12, 24 months, or are these aberrations?
Well, it's hard to predict exactly the size and timing, but I'd stay from a higher level.
We have been below a trend in terms of issuance and M&A transactions. These aren't M&A transactions,
but in terms of just overall corporate issuance has been down since the pandemic. So,
corporate debt as a percentage of GDP since 2020 has been going down. That's unusual
when you're not in a recession. So, I would expect corporate issuance to go up,
but putting aside AA for a second, just because M&A normalizes and you get a more normal M&A
calendar, you get above-trend M&A. And then, of course, you have these projects, these AI data
center infrastructure build-out projects. I think we have substantial growth issuance.
The exact size is a little bit hard to pin down, partly because of timing. There's a calendar
effect as we get to the end of the year. We probably have a couple of weeks. People don't
want to price during Thanksgiving. They don't want to price during Christmas. So,
what does the rest of the year hold? I don't know, but let's say over the next six months,
I would expect a very strong calendar. There is very strong demand. We know that the credit
markets overall are undersupplied. And so, investors are happy to receive more paper. You
can see how these deals are subscribed, how they trade on the break. Those are the indications
that the market is happy to see those. And then, in the below Investing Green side,
we haven't seen any LBOs really. We've seen the one Electronic Arts deal.
We've seen that BASF is selling their coatings business to Carl Isle. We're going to start
to see things more of those types of transactions as well. So, I think it's going to be busy both
from the investment grade and below investment grade side into 2026. I think that will be the
story for 2026, new issue. How much is Double Line participating in this AI
new issue story right now? Are you buying everything as it comes out?
Yeah, we're definitely not buying everything as it comes out.
Salesmen like to hear that you're buying everything as it comes out. I mean, I would be
every salesman's best friend if I said, "Yeah, we buy everything," but no, absolutely not.
I don't know. We had a count on the number of times I use cautious. But when you have an emerging
sector of the credit market, I think that you have to be, maybe use a different word, careful.
And mitigate how much exposure you have to these areas.
There's a technical perspective where people pile in and then all of a sudden,
they decide they don't want as much as they bought in the first place.
These credits need to season. These structures need to season because they're somewhat novel.
So, we're certainly not buying every deal. We're actually buying a, well, I should say holding.
Sometimes we buy and then we trade, but the overall exposure, I'd say, is modest.
And in terms of expressing that caution, are you buying CDS? I mean, the Oracle CDS popped up,
and I think Meta's going to come out with CDS because there's demand for it, but
are you hedging yourself through the swaps?
We can do that, but we would do that more as a strategic position as opposed to
a risk management perspective if we own too much of something, we're in a position where we can just
sell that exposure in the cash market. So, we can use CDS really more for strategic purposes if we
think that there's a way to buy something cheap that way, but we really use CDS as a risk management
tool, I'd say quite lightly. That's just the way our firm operates. We tend to be managing on a
cash basis. We like to buy and hold exposure that we can manage and move in and out of. So,
we don't like to own so much of something that we're stuck in it and have to use
synthetic tools to mitigate risk. That's just our style. So, that's how we operate.
The market has shifted somewhat from banking syndicates to buy side syndicates.
Are you guys approaching companies on private deals as anchor tenants or
syndicated transactions for names or projects that you like? And is that a real opportunity where,
again, you can get in at much better levels than where something ultimately trades when there's
liquidity? I'd say broadly, no. There are specific situations where we know a credit well.
I'd say I have to zoom back and say our philosophy here is that there are credits that we have
covered here for a very long time. We know the companies. We know the management team. We know
how they operate in good times and bad. And we're happy to provide them capital either in a direct
way or indirect way as the opportunities come. But we're not what you would consider a private
credit firm overall. So, we don't have a bunch of bankers knocking on doors to help finance their
businesses. We're more passive in our orientation where we generally speaking are looking with the
market gives us and we decide what to buy or sell based on what's out there in the market.
And it's a select few opportunities where we think that there's a specific situation where
we have a relationship where we lean into. Let's say that's the minority as opposed to the majority
of what we do. And we've just, we've been vocal about our views on private credit, which I can
get into for a minute. I mean, private credit in 2020 was an outstanding opportunity. And we
participated in ways we could to provide capital when the capital markets were frozen.
And those were epic opportunities where you had double digit yields with amount of security that
made the risk of impairment de minimis in my estimation. That turned out to be true the way
those seasoned fast forward to today. I don't think there's any also in private credit. I put out a
video in 2023 that believe is posted on the double line website where I thought that the returns
of private credit and public credit would converge to effectively be no benefit to being in private
credit. There has to be a yield benefit. Otherwise, you're not getting compensated for the liquidity,
for the concentration risk, for the credit risk. To me, if I think about private credit today,
it's just a riskier cohort of credits. It's not bad or worse. It's just a different positioning.
They're mostly B3B minus. They tend to be more concentrated, holding larger positions often
with a software tilt to it. So that's a different trade. You could say whether you like it or not,
but it's different than investing in the high yield index or the bank loan index. Those are
broadly diversified. They're higher in credit quality. And of course, they're liquid. You can
trade, depending on the strategy, be in a daily liquidity fund where you can get in and out every
day. So it's a completely different trade. And because those spreads have compressed and the
returns have compressed, I don't think there's a big opportunity there, frankly. And some of the
private credit managers have gone publicly and said that expect lower returns. I believe Blackstone,
the Blackstone CEO, John Gray, was in the press somewhere saying expect lower returns.
So if you're going to get mid to high single-digit returns in private credit, well, that's what
high yield index is doing near-to-date so far. So where's the advantage? That would be my question.
And that goes to your question about chasing companies directly. If you're trying to finance
a company right now directly, you're competing on fees and terms. And I don't think it's... We don't
want to get into that environment where we're winning by the tightest spread in the loosest
terms. I don't think that's something we want to be doing. So we don't think we have a competitive
advantage in terms of anything else, in terms of providing financing to someone with a set of
terms. And so it's not something we're really super excited about now. Although in 2020, we were
very excited about it because if we're one of very few people providing capital, then we get
pricing and we get terms. We get the structure we want. Then that's quite exciting. Then we want
to lean into it. Definitely. It's a really interesting debate you've hit on. We've discussed this for
some time. I remember this time last year we were talking with PIMCO about the advantage in public
and private. They said at that time, I think that there was about a 100 basis points advantage to
going private and sacrificing liquidity. Then we... Come May, we were talking to a dimensional,
which had a very academic approach. And they actually found over a long term that public
eye yield did better than private. And then switched back to a couple of weeks ago and we
had Blackstone on this show talking about a 200 basis points premium on private IG over public
IG. And then we got into the whole area of bespoke financing and you're tailoring it to your exact
needs, all that stuff. So people are kind of all over the place in terms of where they think
private might shake out. And also I would add that your colleague Jeff Gundlach at our event
in the summer compared private credit to CDOs, which obviously blew up the financial
world and the rest of the world in 2008. So there's so much divergence. Don't you find though
that your end users, your customers want private because that's what's hot at the moment?
I actually know, I think that there's been such a boom in private credit that I think our clients
are actually asking questions with a level of skepticism. They know that they're called constantly
from private credit managers with the newest fund. They've committed a lot of capital.
I think in some cases, the returns have been good. In some cases, the returns have not been so good.
And they're not clamoring for more of it. If anything, they're interested in alternatives,
ways to diversify their exposure away from private credit. And those are the types of
solutions we're providing. You mentioned how people have been quoting how there's a yield
advantage in private versus public, different managers mentioning different yields.
I point out that yields are not returns. So there could be credits that have a higher yield,
but ultimately become impaired and the returns are lower or at least get marked down for some
period of time. So you can, I mean, in the public market, you can see that bank loans versus high
yield. Bank loans yield more and I have a total return that is lower than the high yield market.
So I think it's very important to point out that yields are not returns.
But no, back to what I was saying before, if anything, we're getting more clients asking
questions about private credit. And the number of questions seem to be increasing in frequency,
whereas more of a trickle. Now it seems like, I don't know, several times a week people want to
know, what do we think about private credit? What do we think about the credit markets overall?
And how do we put this all together? So again, I'm just hearing hints of caution.
And I'm trying to squeeze out now how you convert those yields out there to return.
So where do you see the best opportunities? What are the sectors? What's the duration?
What are the ratings? How do we hone in on how to outsmart this market?
Yeah, well, I can tell you what we're doing. Maybe that's the easiest way to do it. And we
have strategies that have a variety of different risk profiles. So I can start more general and
we can get specific if you want. But we have been, as a firm, trimming credit risk. I feel like
maybe for 18 months, we do it very gradually. So a credit we liked, that was a 9% bond,
gets refied into a 6% bond. We don't think it should be 6%. We just let it go. We're worried
about sectors in the corporate credit market. We've been worried about some of the cyclical
stuff like chemicals. We're worried about the housing market because the housing market has
been languishing because of high rates. And so our housing exposure goes down.
And then you go and so on and so retail other sectors. So as we raise cash in these sectors,
then we have to do something with it. We've been moving it in some cases last year when spreads
were tight, move it to treasury and agency mortgages, which worked out fabulously when we
had the taper 10, not the taper 10, that was a long time ago, the tariff, the liberation day.
So when liberation day happened and we were sitting with higher exposures to treasuries
and agency mortgages, that looked great. And of course, there was a great buying opportunity
that lasted for a moment and then spread snap right back. So now if you look today, it looks
the same as it did at the beginning of the year. What are we doing now? The same concerns that I
just mentioned, rotating out of some of the cyclical names, cyclical sectors. We like other
sectors of the fixed income market better. We like CMBS. Why? Because sectors that get beaten up,
CMBS got really walloped during the pandemic. Those tend to have the tightest underwriting
standards. And CMBS assets have been repriced. So if they were marked at 100 and now they're
marked down to 30, well, if the 30 is probably more realistic, particularly if it actually traded,
but traded hands at 30, you know that the value is 30, not 100. And so it's easier to lend when
you have that sort of mark to market. And the underwriting standards are tight. And so if I can
get, you know, high yield, high yield corporates are in high sixes. If I can get high sixes in a
CMBS structure that has more conservative lending, a more conservative structure in terms of lending
standards. And I now know what the asset is worth. Those are interesting. And CMBS, of course, is
not just office space. It's industrials and hospitals and all sorts of things mixed in there,
residential. And so it's a mix of assets. And you can construct a portfolio that has the right
risk profile, non-agency residential mortgage backed securities. Most housing activity has been
anemic. But what that means is most borrowers have a very large cushion in terms of equity cushion.
And so if you have a 30, 40% equity cushion, then the risk of impairment, if something bad
happens, the real estate market is low. And just like CMBS, underwriting standards have been
very tight. So you could argue that underwriting standards in corporate credit are loose.
In that market, they're tight. So we've been moving out, we've been allocating more money
away from corporate credit over, I don't know, the last year or so. And so if you look back in time,
maybe in 2022, 23, 24, 2022, we had spread wide now a lot. And I thought at the time that corporate
credit was quite cheap. I thought that we should be overweight corporate credit, which we were at
the time. So we had more corporate credit than some of the other things I just mentioned.
RMBS might have been a very small allocation at the time. But then as we move forward in time and
credit spreads tightened, then we had to reallocate. And so we've moved from being maybe
more corporate focused to now more focused on some of these securitized sectors.
That's how we're solving the puzzle right now.
Not all of that has done well, though. There have been some blow ups even on the triple A's
in some of those. I mean, they maybe are idiosyncratic, but do you have to do more credit work now to
analyze those structures? Well, I think the blow ups are the opportunity in a way, because I said
sectors that are under stress, once they come through that stress, tend to be quite clean
for the next few years. In the corporate credit market, the analogous sector would be energy.
Energy, there is a wave of shale financing in the high yield space in, I don't know, was that 2013,
2014, something like that. And then oil went from 100 to 30. And there was a wave of defaults.
Many of those companies were wiped out. Some still limped along. And then we had the pandemic
where famously oil went negative in May of 2020. And then we had another wave of defaults.
Now you look at high yield energy. It's very clean. The companies are self-funding.
They have low leverage. They generate cash flow. And so it was the most dangerous part of the credit
markets, or the high yield corporate market, I should say. Energy is now one of the safest.
And so we're applying that same sort of logic with CNBS, what was quite dangerous in 2020
and has gone through this period of stress, we think is actually one of the areas that's most
safe because investors become shell-shocked from it and don't want to touch it. Well,
when that happens, that's actually a great environment to invest in. So that's why we
think that that's very interesting right now. Right. When you look at the returns of this year,
it's kind of interesting that the investment grade debt has done better than the junk.
Triple Bs have way outperformed triple Cs, possibly because of the fear around cockroaches
and all this stuff at the bottom end of the market. But it doesn't often happen that in a
very risk-on year, like Trump gets reelected and everyone's risk-on again. But what's happened
to junk bonds? Are you really long IG and then short high yield as a result? And are you worried
at all about potential re-leveraging because of M&A, potential slowdown in earnings? The economy
might start to sputter. Is there risk in IG at the moment? Well, I think I'd first say that
if you look at the returns where investment grade is outperforming high yield, a lot of that is
duration. So if you look at excess returns, looking at it right now, double Bs have actually
outperformed on an excess return or yield or return over treasuries more than triple Bs.
Double Bs are up on an excess basis. Around 2.5%, triple Bs only 128%. So on an excess basis,
you'd be better off in high yield. On a total return basis, the duration has helped investment
grade credit. I think if you look where we are now, we are in a carry environment that
spreads could tighten a little bit more. I can't say that this is the end. We could certainly go
tighter. But let's just say there's a lot more room to widen than tighten. It's quite asymmetric.
So in a carry year, if you're in an environment where credit spreads are very tight and it's all
about carry, then again, you want to think about credit risk. And up in quality is certainly a
mantra that we have been saying a double line for a while. We tell our clients, when we tell them
what we're doing with their portfolios, we are moving up in quality. So yes, that's more investment
grade than high yield. In terms of duration, that's a little different. So we are inside the
index in terms of duration. The investment grade index is what, the duration of six or so.
We've been focusing on 10 years in in basically to keep it simple. So we think that the long
end has risk of steepening further. And so we don't want to be exposed there. And we want to
be up in quality in terms of credit quality. So I think that the trend of investment grade being
competitive, I don't know if it's going to outperform, but certainly competitive with
high yield next year, I think that that's definitely in the cards. I thought that investment grade
would be competitive with high yield this year. I didn't necessarily predict as much of a duration
rally as what occurred. So it turned out to actually outperform, but I thought it would
perform well because of the phenomenon of weaker credit deterioration and the dispersion that I
talked about earlier. I think that story continues into next year where the dispersion continues.
Dispersion usually it results itself one of two ways. You get a tightening of all this so that
the single B triple C's that are wide join the tight market where you get a tight where everything
is tight or you get widening. Now, we already had the tight market that was last year where
everything was spreads were all compressed within one range depending on rating.
And then we've been slowly decompressing. I think that decompression continues over time.
It usually starts with a sector. So we've been worried about real estate for a while
because of high rates. Then you add chemicals. Then you add retail. People are worried about the
consumer. When you are adding things to the list, that growing list tends to keep going. You keep
adding things to the list and all of a sudden spreads widen a little bit and then they widen
a little bit more. But this could take some time. So this isn't something that all of a sudden the
economy falls apart on January 1st. I don't think that. I think that this could take a couple of
years to play out. I think the liquidity in the market, the AI spending, the Fed lowering rates,
deregulation coming, fiscal spending, all that. We've got I don't know how much stimulus is coming.
There's a lot of it. And so betting against all that stimulative impulse into the economy is that
would be a strong position to take. I'm not taking that. I think what's more likely to happen
is that we continue with the trend we're going where we have some simmering stress under the hood.
But the market keeps roaring with these big mega deals, big mega AI deals. The below investment
grade market ramps up LDO activity. And I actually think we are likely to have a leg up in risk.
The equity markets find new highs next year. Multiples expand. Credit spreads stay very tight.
And instead of a decline in corporate credit as a percent of GDP, we start to see a resurgence,
a growth in corporate credit as the percentage of GDP. And we see growth in the overall
number of issuers in the investment grade in high-yield market. And that would set the table
for instead of caution, maybe concern. We go from caution to concern under that scenario.
And I'm waiting for that. I think that that's probably at least a year away. It could be two
years. The timing is very difficult to predict. So that's where I think we're going.
Well, you started to list out a wall of worry. I think that's our life as
fixed income analysts is that's all we do is worry. But what actually has to get us to that
next leg? It sounds like you're also describing a little bit of a Goldilocks scenario where
spreads are tight, but the fundamentals are fine. And from a fiscal policy standpoint,
it's also positive. What has to happen, like we've seen a couple of these one-off blow-ups,
what has to happen for this market to go significantly wider for people to lose confidence
for everyone to say, "Wow, we knew this was way too tight for too long,
and we're just waiting for this event." What is that black tail? What is the black swan event?
The immediate term would be a growth scare that the market has misperceived the amount
of growth in the economy, which I don't think is a high risk. I think that we're going to have
good enough growth into next year that I don't see that as sort of a shock that causes
a repricing of risk, but that would be one. I think the other one that you have to worry about is
that the AI bubble pops. That certainly could be something. That seems very, very early for that.
We see these headlines constantly, and they grab attention, but there hasn't been that many
transactions. We could list them all. I don't know. We could use maybe we need all 10 fingers,
but we don't need our toes. There's been a handful of investment-grade transactions.
There's been another handful of high yield deals, but by no way is it a significant amount of the
corporate credit market or the economy as a whole. It looks like it's going to be as time
rolls on with the trillions of dollars being spent. We roll a year forward, two years forward. It's
going to be a pretty significant percentage of the credit markets and the equity market. Then,
at some point, it's going to have to be proven that these projects are profitable or not. If
they're profitable, I think things will keep humming along. If we find that most of them are not,
then there's going to be a severe reaction. I kind of think about it as people like to talk about
the dot-com era and the dot-com bust. Cisco in 1990 was growing faster than NVIDIA. People
forget that. It was the darling of the era. It grew through all the '90s. I don't recall the
multiples of earnings, but it was, I believe, higher than NVIDIA is now. In 2020, I forget
it was a 2020 or 2021, the earnings kept growing. All of a sudden, they had a negative net income
year. The stock dropped 75%. The music stopped because these fiber-optic build-out projects,
we built too many of them. Many of them didn't make sense. They were never actually lit,
and the whole market collapsed. Cisco was a fine company. It's still around today,
so the strong will survive. I could see something like that happening in a few years,
maybe, maybe not, where we realize the profitability of all this AI spending,
some of it's going to be great, some of it's going to be terrible, and there could be a washout from
that. I think that's going to take some time. That is not happening anytime soon in the next
six months. I think that would take years to happen. If we use that dot-com analogy,
maybe we're in 1992, '34. We're not in '99, 2000, 2001. It's going to take some time for us to get
built out. Well, I think the big difference between dot-com and today is dot-com created their own
valuation multiples. They didn't actually have revenues or cash flows being valued on eyeballs
or clicks versus today, you're actually seeing revenues pass through the system. I think that's
why the level of confidence is so much higher, as well as it's really the ones with the biggest
balance sheets that are performing the best as well. It creates a lot less concern.
That's true to some extent, but on their hand, it's maybe not true, because
the big companies have rock solid balance sheets. You could argue stronger than US
government in some ways. Some people try to make that comparison, but back then we had very strong
companies. Cisco that I mentioned, Dell, Microsoft, those are very strong companies,
but then we had some silly ones. We have plenty of unprofitable tech now that's trading on multiple
of earnings that should be coming in five years. You can list off the companies that are trading
at 200 times earnings or even times sales. I think there was a Bloomberg story this morning about
I forgot who it was, trading at 200 times sales. You're trading on earnings and cash flows that
are coming many, many years in the future. If those earnings don't appear, those stocks can
certainly drop 50, 60, 70%. That's the phenomenon still true, not with Google, Alphabet, Microsoft,
Meta, and so on. I don't think they're likely to drop like that, but these unprofitable tech
companies certainly could surprise in a really horrible way and drop 75%. That will have a very
negative effect on the equity markets. We'll spill into everything else.
When it comes to fundraising, what's the appetite you think from foreign investors to buy US corporate
credit right now? Well, I think what's really hot right now for us, I can only speak for where
we're being successful, is multi-sector credit. For the reasons we've spoken about, I think the
pitch of being able to rotate to safe income, people find that very attractive. If you can get
the same income with less risk, that's the holy grail. We find that people are resonating with
that very strongly because they see the same things we see and they're trying to mitigate risk
as the economy heats up. I think that's an area that we find a lot of demand. I think overall
credit as a whole is in demand. As long as the yield is there, the demand will be there. I expect
overall credit markets to be very strong for 2026.
Great stuff. Robert Cohen with Double Line. It's been a great pleasure having you on the
credit edge. Many thanks. Thank you. Glad to be here. Lots of fun.
Excellent. And to Robert Schiffman with Bloomberg Intelligence. Thank you so much for joining us
today. Thanks, James.
For even more analysis, read all of Rob's great work on the Bloomberg terminal. Tech is his life.
Call him. Bloomberg Intelligence is part of our research department with 500 analysts and
strategists working across all markets. Coverage includes over 2,000 equities and credits and
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keep on listening. I'm James Crombie. It's been a great pleasure having you.
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