Speaker 1Today's Animal Spirits Talk, your book, is brought to you by J.P. Morgan. Go to jpmorganassetmanagement.com to learn more about the J.P. Morgan Strategic Income Opportunities Fund, J-S-O-S-X. That's jpmorganassetmanagement.com to learn more.
Speaker 2Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.
Speaker 1Welcome to Animal Spirits with Michael and Ben. Michael, the AI trade has now hopped from the risk was initially the stock market to the economy to the bond market because these companies are finally issuing debt. Should we be worried that tech companies, these tech companies, and these tech leaders have actually never really dealt with debt before? This is a totally new thing for them. Has Mark Zuckerberg ever dealt with issuing corporate debt before?
Speaker 3Well, I don't think he's personally doing it. I think he's got some people there.
Speaker 1Should we be worried that they're issuing debt? The historical playbook would tell us, yes, we should be worried. So we talked to Bill Egan, who is the head of Absolute Return and Opportunistic Fixed Income team at J.P. Morgan. He's the portfolio manager. He's the CEO of J.P. Morgan. He's the founder of J.P. Morgan. The portfolio manager on the Strategic Income Opportunities Fund, which is an absolute return fund, meaning we don't want to lose money. And it's really interesting. Before we talked to him, you sent me a chart of their returns. And it's a line that doesn't move at all. They've been heavily invested in cash. Because a lot of it is in cash. And it's funny because it felt like for years, cash is going to be trash again once the Fed lowers rates. But the Fed hasn't done that. In fact, they lowered a little bit, but now they've raised them again. And cash is actually still yielding something. It's not bad.
Speaker 3You know what? Our investors are always complaining. Of course. Yes. The answer is yes, they are. Interest rates at 1% were no good. And now interest rates at 5% are no good because X, Y, and Z. And I'm not sweeping those concerns under the rug. I choose to see this as a glass half full story. And I understand that part of the reason that rates are rising is fiscal irresponsibility. I understand that inflation is stickier.
Speaker 1That's not it. Come on, that's not it. What do you mean? It's inflation and growth. How do you know? Because we had a fiscal surplus in the 1990s and that interest rates were 6%.
Speaker 3That doesn't disprove that yields are moving higher because people are worried about deficits.
Speaker 1Yeah. You also can't prove it though. I'm just saying, I think it's more to do with economic
Speaker 3growth. The onus is on you, sir. You seem to be pretty emphatic.
Speaker 1Yeah. I think it's more about economic growth and inflation than anything. And that's what investors are dealing with. It really is an interesting market because as yields rise, people are so worried about inflation. But if yields keep rising, eventually that's going to cause yields to fall. It's kind of like higher prices are the solution to higher prices. Same thing, higher yields are the solution to higher yields.
Speaker 3The 10-year can't possibly go above 5.3%.
Speaker 1Right. And then it does. And I don't know. It's interesting to think about what that means. Eventually, if the Fed kept hiking, they'd hike and they'd slow the economy down and then rates would fall and that's good for bonds. And it's a weird. Anyway, we talked about all this with Billy Egan. I like the way he thought about the world and fixed income. Many fixed income managers are naturally pessimistic. I think from a marketing perspective, kind of like hedge fund managers, you almost have to be a little bit pessimistic. Every time a fixed income manager goes on CNBC, they're pretty bearish about the general state of the world. Because guess what? Being bearish means, hey, come to the loving arms of bonds. But Bill said, no, no, no. I have to make money for my investors. I'm not tied to some benchmark. It's a go anywhere, provide us income, don't lose money. And I think that's an interesting way to think about not having a benchmark and a way to manage this kind of mandate. So anyway, fun conversation. Here's our talk with Billy Egan from
Speaker 3J.P. Morgan. Bill, welcome to the show. Thanks for having me on. Looking forward to this. All right. It has been an exciting environment for bond investors. Today, we're going to be talking about the J.P. Morgan Strategic Income Opportunities Fund, which I believe you've ran since inception in 2008? Yes. Yeah, 18 years. All right. So before we get into what today looks like in terms of the market opportunities, what is the purpose of the J.P. Morgan Strategic Income Opportunities Fund? What is the purpose of this fund inside an investor's portfolio? What's the mandate here?
Speaker 4J.P. Morgan Strategic Income Opportunities Fund has always been and was designed as what's known as an absolute return fixed income fund. Very, very different from traditional fixed income funds. As you guys know, traditional fixed income funds have a benchmark that's typically pretty sensitive to things like interest rates and risk premiums. They typically allocate around that benchmark. As a result, the bulk of fixed income funds out there, like it or not like it, kind of move up and down. With interest rates, right? So that's why, you know, over the last five years of interest rates have risen, a lot of these funds have negative returns because interest rate, rising interest rates are terrible for fixed income investors who own traditional funds because it erodes the value of their investments. Absolute return investing, on the other hand, it's not just a long only fund. In other words, I can go long, I can go short, I can put on relative value trades, I can use traditional securities, I can use synthetics like credit default swaps, I can hold unlimited amounts of cash. In fact, just to give you a brief overview, I've held as much as 90% of this fund in cash at one time and as little as 10%. So it really depends on what the opportunity set looks like. Absolute return investing involves reacting to the opportunity set in fixed income, which in turn is driven by mathematics. In other words, I can never tell you when equities are going to crash exactly or when they're going to go straight up, right? But what I can tell you with a pretty good degree of certainty is when interest rates are low enough or risk premiums are tight enough, you run out of room to make money in fixed income. And that's something that people have been unwilling to accept for quite some time, because I think what happened is you had a 40-year cycle running from the late 70s until around 2020. Interest rates did nothing but fall, right? So it made heroes of a lot of people who got into fixed income during that period, right? Because it just goes up every year for 40 straight years. It gets very easy to confuse brains with a bull mark in that environment. But the last five years have been the real test where rates went to zero, basically, right? At which point you're guaranteed to lose money in fixed income. And yet fixed income was never more popular than it was when rates were at zero. And so I think it's a really good example of how you can because people kept looking at trailing returns and thinking that they were repeatable. They're just not.
Speaker 1Very unlike equities. It's interesting, the cash piece, because if you look back, it seems like it was really easy to hedge bonds. It was like, well, just go to T-bills because you don't have the interest rate risk. But when you were supposed to hedge, though, T-bills still didn't yield much. Like it took for the Fed, the Fed had to jack rates up a bunch of times to get there. So I'm just curious how that felt, because when you hedged, you had no yield, right? The mathematics of it. Now there was yield. I'm curious how you navigated period of 2022 and then how you avoid being just totally seduced by cash all the time and being like, no, it's so easy. There's no volatility. How do you get out of that mindset?
Speaker 4At the time, I'm not going to say it was easy. I was literally in 2021, I was holding 80 to 90% cash just saying, listen, I'm not going to give this government my money and lend it to them for 10 years at 50 basis points. All you need is for rates to go to 1%. You're sitting on a huge loss. I'd rather get nothing, like just a few basis points on my cash than to buy longer term treasuries just to look like the index when I know I'm going to lose money there. Why would I knowingly buy something that I know with almost complete certainty is going to lose money? That's the problem with fixed income. That's the problem with active management and fixing them in general. It traditionally revolves around getting along a benchmark like the Barclays Aggregate Index and maybe overweighting corporates, sprinkling in some high yield, overweighting agencies, anything with a spread, right? But when those spreads are really tight, it doesn't really make a difference. Like right now, whether you own investment grade corporates or whether you own treasuries of the much in either one, because there's no spread, right? Spreads are near all time tights. In fact, spreads are tighter in high yield investment grade mortgages than they have been 96% of the time over the last two decades. So you're not getting compensated for taking the risk, particularly given all the risks that are in the market right now, some of which are starting to get priced very recently. And when markets are like that, and I got to say, hey, listen, I got to put up a positive return no matter what. I don't have any excuses. Like for instance, in 2022, your bond fund was down 13, 14%, right? Because rates fired higher. We were up, you know, a little less than 1% that year. And I still didn't think that was very good because we trailed cash. But for some reason, you know, everyone looks at us, oh, you guys are heroes. You know, you had a positive return when the market really tanked. And I'm like, no, that's what we're supposed to do, right? I mean, I don't, I can't point to a benchmark that's down 13% and I'm down 12 in a fixed income fund and say, I did a good job, right? That's like, there's something wrong with that. Because when someone gives you fixed income, it's supposed to be a do no harm asset class, right? And yet the five-year return on the Barclays Aggregate Index, which is the S&P 500
Speaker 1negative. I was just looking at this. It's the worst five-year return ever for the ag, right? Or close to it. Right. And it's no surprise though, because it came off zero.
Speaker 4Frustrating for me as a manager during that time, people were questioning my position in 2021 constantly.
Speaker 1Like just, you know, we got to make money. Things are different now. And I like how you, I like how you talked about bonds being about math. Cause that's the way that Michael and I explain it to our clients. The yields are higher. The future forward expected returns are also higher. How much more excited are you about the asset class now versus back then?
Speaker 4I'm getting pretty excited about the front end treasuries at around five or pricing and too much Fed tightening now, because the Fed can only tighten so far before they're going to tip us into recession. Because so much of this economy right now is being supported by a very narrow set of factors like, you know, hyperscalers, AI, spending capex. Starts to reverse, which I think it will, or slow down. In fact, the second derivative is already slowing down. That's going to pull a stool out from under the, you know, the three-legged stool of the economy. If the Fed wants to tighten into that, it's going to bring that about quicker in my mind. I think all the Fed's doing right now is they realize they never should ease as much as did when inflation never even came close to hitting their target. So I think they're just kind of taking some of that away, you know, some of the easing that they did. But I don't think they can go too far with it just because, in my personal view, this economy is pretty fragile. I mean, I own a number of small businesses in addition to what I do on the money management front. And every single one of them is kind of telling me that we're in a kind of a fragile state here, especially when you consider like AI CapEx accounted for almost half the GDP growth last quarter. That disappears. You have a real problem.
Speaker 3Bill, let me ask you the question that I'm sure you're getting asked every day at this point. Why are rates going up so fast and what does it mean?
Speaker 4One is inflation. The last person you should ask for their opinion on interest rates is someone who's long interest rates all the time. Like a typical bond manager. I'm not. I can be long. I can be short. I can do whatever I want. So I'm going to be objective here. The single biggest problem you have is inflation. The second is fiscal. I'll get into both. Inflation is not slowing down. In fact, it's getting worse. Whether you look at inputs to the manufacturing process, everything, you know, whether copper, aluminum, rebar, anything to put up a building is getting ridiculously expensive. I know that because I'm putting up a building. You know, food costs. I mean, you've got to take a home equity loan these days just to come out of Costco with a cart full. It's not slowing down, unfortunately. It's just getting worse. The Fed recognizes that. And they're like, we have an inflation problem. We never should have said we think inflation is going to go right down to our 2% target. It never even got close to that. Now it's going decidedly the other way. I mean, diesel is $6.50 a gallon. The implications of that is pretty big. Whether it's, you know, filling up your construction equipment, whether it's, you know, 18 wheelers, you name it, diesel goes into everything. So that's going to be a problem for some time. And the other thing is that it doesn't get talked that often about, which is huge to me. Because, you know, the thing I've been saying lately is this government has shown me that they don't care about the long end of the yield curve. So why should I? Right. You look at the complete lack of fiscal discipline. You look at $40 trillion in debt. You look at a $2 trillion deficit. They're just getting worse and worse. You know, you look at 125% debt to GDP, which used to be like, you know, 50, you know, only 15 years ago. We just keep printing and printing and printing. And we keep, you know, the revenue side's coming down because of tax cuts. The cost side's going up. Entitlements keep going up. Defense spending's through the roof. And most importantly, interest on the U.S. debt is hockey sticking straight up. So the cost side's getting a lot worse. The revenue side's coming down. The deficit's getting bigger. And I think that's part of the reason why when you look around the world, a lot of countries are second guessing their treasury exposure, right? You're seeing some countries divest a portion of their treasuries, whether it's China, Japan, Europe. And that's not good for the technical flow, obviously. So I have a hard time like in the long end, even here at five and a half on 30s, 5% on a two. I think that's worth doing. I don't think it's high risk because it rolls very quickly. You're getting a pretty healthy premium over cash to own that. I don't think the Fed's going to get the 5%. You're basically pricing at a 5% there and they're only at four. And I don't think they can go a heck of a lot more. I think they're going to try. They'll try to go one, two more. But I think by that point, unfortunately to me, the only way you make money in the long end is via a nasty recession, which takes rates down with it. That's the thing. As an absolute return manager, you can never exclude a scenario. Like every time I put an investment in the fund, I'm like, okay, what if I'm wrong? Even if I'm wrong, the fund itself will still be able to produce a positive return. It's the key difference. When I was running long only money, and I ran long only money for a lot of years at Fidelity, the reason I got out of it was because I didn't like being held hostage to single factors like interest rates. I just couldn't stand it. An absolute return manager, you have to be able to control the outcome. You have to be able to put up a positive return no matter what. And for 18 years, we always have 2008, 2009, 2013, 15, all positive. We've never had a negative return. We've never had a negative return in the fund ever in a calendar year. Over every 12-month period, I think we've had two drawdowns, the worst of which was like around 2% over a non-calendar year period. But that was subsequently followed by a double-digit return. Because typically, the only time we'll have a drawdown is when things start to go pear-shaped and the building catches on fire. And I'll be one of the guys running into that building that's on fire. And I'm not necessarily going to be right on time. But once risk premiums get to the point where I'm getting paid enough to take on that risk on behalf
Speaker 1of my investors, I'll go in. Bill, I agree with you. I agree with you that if the Fed keeps pushing, eventually what they're going to do is kind of tip the economy into something. I don't know if that's a recession or a slowdown or whatever. So I feel like those fears are a bit overblown. But there are people who think, no, no, no, inflation is just going to stay sticky high. We're going to run the economy hot. And so some people would say it can interest you in tips potentially because tips yields were also horrible back in 2020 and 2021. They were negative on a nominal basis. You were paying for those as well. Now we're looking at five-year tips yields of 2.7%. And we're recording this, I don't know what today, today, 28th, September 28th. 10 years, almost 3%. 20 years, 3.3%. At what point do you become interested in these tips yields where you're getting pretty good real returns here in tips?
Speaker 4I'd like them a lot better if the CPI that tips reset off of was the same formula they used to use in the 70s and 80s. Because it would be literally two to three times the level it is now. And those would offer tremendous value at that pace. You got to remember tips reset off the unadjusted CPI, which is, you know, yeah, it's running in the threes. You know, like you said, a 2.7 plus three, you know, you can get, you can get in the sixes, you can get, you know, around six. You know, you'd get 555 on a 30-year right now if you want to go that without, you know, without the risk of inflation actually at CPI unadjusted coming down and then actually taking that, you know, taking your yield lower. I guess what I'm saying is the spread between tips and, and nominals is not enough for me to really get interested yet. If that spread were much higher, I could be interested. Now, I do think tips will outperform traditional treasuries, but still they have duration. That's the thing people have to remember. Tips have duration and, you know, rates go up enough. You're going to, you know, you're going to get hit on tips much like you did in 2022 if rates keep going up, but they certainly will outperform treasuries. But again, if I can get, if I can sit on cash at 4%, right, with, with, with no worries and I can actually, you know, investor grade floaters, very highly rated investor grade floaters can get you even a little bit more than that. I don't feel the need to reach out 10 to 30%. To be, to be honest with you, I just, I just don't want duration risk here. I just don't, I haven't wanted it for the last five years. That's been the right call. If you think about it, if you just did nothing, when you look at all the, you know, the fixed income categories that Morningstar has and others have, you'd be shocked at how much, if you just look over the last five years, cash has pretty much outperformed every one of those categories. Just holding cash, doing nothing, you've done better than most forms of actively managed fixed income. The only one that outperformed cash by a little bit over the last five years. There's high yield, which is more akin to equity type risk, as you guys know, than, than fixed income risk and spreads can easily jump out there and wipe out your returns in a heartbeat. In fact, even today, high yield is getting hit, has been getting hit a little with equities.
Speaker 3Bill, but even still, high yield has outperformed the ag year to date. It's an obviously interesting and exciting and unusual macro environment. A lot of the fears that you're talking about, fiscal and inflation, you're not the only person saying that. There's a lot of people that are hyper. It seems like every day we're talking about these worries and yet I know this is much shorter term, but like the VIX is super low and credit spreads are super tight. The lowest rung is starting to blow out a little bit, but yes, triple C's are doing terrible. They're up to 1200, by the way. Yes, which is bad. So there's a lot of movement there. Is there something in the composition of the high yield index getting maybe more higher quality as private credit has stepped in? Is there something in the index itself that is maybe we're using an outdated plan?
Speaker 4Playbook? Yes. Let's get into that for a minute. First of all, private credit has its own issues. I've been talking about this for two years. So much private credit sits in affiliated insurance companies that are owned by private equity firms, which tend to really overload these general accounts with private credit. I started in the insurance industry, believe it or not. My first two years out of school, I actually worked for a very large insurance company helping to manage a general account, which in turn had annuities and guaranteed investment contracts, etc. So I grew up learning the general accounts. And I learned that the general accounts are precious. They're supposed to be duration-matched. This will be all IG. It's supposed to be liquid. No, you buy sports teams.
Speaker 1Yeah, Bill, you could have bought the Lakers if you would have stayed there.
Speaker 4You know where I'm going. Yeah, now your average affiliated insurer has something like 40-plus percent in private credit. I mean, if you have an annuity run from one of these companies, you're going to have a big problem on your hands, right? Because you can't level three assets dominate the allocations now, not treasuries, investment grade, or even high yield. And at the same time, private credit is going through its own issue. I mean, you guys know about BDC performance. Average discount up like 25%, 28%. But most importantly, the amount of bad payment in kind paper in the marketplace is hockey sticking higher, right? Redemptions continue at a very high pace. You know, there's more gates up around private credit funds than during a COVID lockdown, right? I mean, it's just crazy what's happening right now. So go and get their money out. And a lot of them were sold something that they thought was kind of liquid and now finding out that it's not at all. And, you know, now you just can't leave. You know where I'm going with this. And high yield at the same time. Like you pointed out very accurately, record tight spreads. But the most disturbing thing that's going on in high yield right now, which I have not seen since 2016, this has been an 11-year credit cycle we've had going on here. Longest one in history. Credit cycles always end in the shadows, right? The first warning signal was kind of private credit BDC performance, right? Which is still terrible. The next step is it starts to carry over into the public markets. Now, right now, triple Cs are screaming at you, be careful what you're doing in high yield. Because the lowest run of high yield is starting to blow out, right? It's gone from like 600 over to 1,200 over. It's going to be out again today.
Speaker 3Pretty good amount. Sorry to interrupt, but wasn't the 600 stupid? Like, weren't spreads too tight? Doesn't this reflect more of reality with the default rates what they are?
Speaker 4Yeah. You know what's terrifying, though? The all-in high yield spread at the index level is still at absolute tights, despite triple Cs blowing out. That's because double Bs and Bs have tightened even more further in to beyond record tights. You're getting about 150 bips to own double B rated paper. Doesn't this tell you a lot about how much liquidity is in the system today? It does, but that liquidity can be fleeting. Like, I've been here before. Totally. through so many of these cycles, you can give back five years of gains in high yield in five months. Totally. Yeah. Just like that. And that's the thing people don't want to realize about some sets of the fixed income asset class, that that can happen. And it will happen again. We are so overdue for a credit cycle. I mean, there's so much speculative paper out there. Underwriting standards really went downhill right up until about six months ago. And pretty much anyone could get a debt deal done. And now if you even have AI related in your name, you can still get a debt deal done. Not as good a price as you could three months ago, but you can still get it done. And that's going to come back to hurt. I mean, right now you're looking at $2.3 trillion in off balance sheet obligations for the AI related trade. You're looking at $2 trillion in RPOs owed to companies like Oracle, Microsoft, Amazon, Meta.
Speaker 3Do you think that this is crowding out treasury investors or otherwise would be treasury investors? To an extent it is because
Speaker 4you've had just a ton of long-term issuance from the hyperscalers. These are guys who never really took on debt before. And now not only are they taking on debt, they're taking on tens of billions of dollars of debt all at once. And that's going to come not to mention again, the off balance sheet obligations, which is a whole nother, we could do a whole podcast about that. It's scary to me as a guy who's been doing this a long time, like I haven't seen this type of behavior, not even in 2015, 16, that was the last time spreads in the high yield market blew out to a thousand, which they'd done like seven times, I think. This is more kind of a combination of like the massive tech speculation you saw in 2000, coupled with financing issues that came from 2008. Because I view data center construction is kind of similar in a way to the housing bubble of, oh, wait, like a lot of these data centers aren't going to get built. You saw what Oracle did last week with the force majeure, or they're already scared, might not be able to pay the bills down the road for some of this stuff. And it's, and there's just been so many trillions, not billions, trillions of dollars of obligations written on this stuff. It's just a guy like me has been doing this 30 plus years. I look at this, I'm like, wow, like I haven't. And the fact that I can walk into 7-Eleven and the guy behind the counter is giving me semiconductor stock tips is not very comforting to me either.
Speaker 3Which stocks? I want to know. All of what you're saying is actually reflected in your portfolio. About half of the, about half of the assets, give or take, are in cash, a little bit less. Yeah. Yeah. So you are, you are probably not to put trades in your, in your mouth, but you're probably very anxiously licking your lips for this to go a little bit sideways.
Speaker 4Well, I love providing liquidity into a marketplace that has to have it. Like I'm, I'm the guy, I don't buy hurricane insurance when the hurricanes in the process of ripping my roof off. Like everyone else does. I buy hurricane insurance. I buy hurricane insurance when the weather forecast is saying there's no chance of a hurricane forever. Like you're never going to have one. And, and insurance against credit protection is literally the cheapest it's ever been. It's not anymore. Like a couple of weeks ago it was and we kept adding. So not only am I holding a lot of cash, I'm also for every dollar I'm long, I'm roughly, you know, 30 cents short combination of credit default swaps on the investment grade indices, the high yield indices, and then actually a couple of, you know, and I say some individual names as well that I think are very, you know, very vulnerable here.
Speaker 3Oh, let me ask you about this. So speaking of credit default swaps, I'm curious if you look at some of the credit default swaps on hyperscalers, obviously Oracle is sort of in its own thing because it's so exposed. Are people buying that because they really think that there is an X percent chance that met a default on the debt, or is this just a way to express a trade that you think that you're just going to make money on
Speaker 4this? It's a combination of things. When I look at like a meta, do I really think there's a high likelihood that they're not going to be able to pay their bills? Prob, probably not. And same with Microsoft, certainly not. Amazon, you know, all good companies. But what all these companies have done is they've taken on tens of billions of dollars, in some cases, hundreds of billions of debt obligations, off balance sheet obligations, and their cashflow, as you know, their operating cashflow numbers have just crumpled to nothing. You know, and in the case of Oracle, it's obviously you got negative cashflow numbers coming out of them and also spending 100% of the revenue on CapEx. That's just not sustainable. This is something that I never even saw in 99 to 2000. I mean, it's not sustainable. It's not sustainable. It's not when I thought I saw everything. I mean, I sat across the table, you know, back in 99 when I was at Fidelity from the global crossings of the world, the Quest Communications, the GDS uniphases, Nortel networks, all of them telling me there's this insatiable demand for fiber network equipment that's never going to go away and silly you for even questioning us. You're dumb. You're short-sighted. You know, you have no idea. You don't know what you're talking about. That's the same thing I hear now when I bring up the fact that, you know, I think, you know, this data center craziness is not going to end well. You know, no one wants to hear it.
Speaker 1Interesting to think about the fact that many of these tech leaders have never really dealt with debt of this size before, obviously. But what would you put the probability of if you're looking at this in terms of baselines, what is the probability that they do thread the needle here and they get some fantastic ROI on all this build out that they're getting and it works out okay? Like what probability would you give that that you're wrong? This is going to end badly. Like what would that look like to you?
Speaker 4I mean, if you asked me that question six months ago, my answer would be different. But what I've seen over the, I'd say, well, I don't really know. But now there's been so issues, so much, so many off balance sheet obligations, so many RPOs. I don't see how these AI labs who are unprofitable can even pay back next year's RPOs unless they raise an absolute ton of money. In the past, you didn't buy a hyperscaler to watch them spend tens or hundreds of billions of dollars and take on a ton of debt in the hopes that, you know, this AI craze is correct and that all these data centers will get lit and approved. And, you know, all the chips that have been bought, many of which, you know, haven't been put to work yet, obviously, are put to work. And that by the time these data centers get built, that the chips that are supposed to go inside them aren't obsolete already. The big question here is, I think I have a high probability of being right here simply because of the sheer amount of money that's been spent and the ROI that's going to be demanded of these data centers. And I don't see how, even if a data center puts out a gross margin of 30%, how that's going to cover it, right? And, you know, I think increasingly more and more people are coming around to that. To me, it's pretty obvious that there's going to be winners and losers here. Right now, everyone wants to treat everyone like a winner, right? Like when you look at the NEO clouds, I mean, these guys are completely reliant on the AI labs to fund them, right? And to pay their bills. What happens when that stops? I never get answers to this stuff. When I ask someone who's an expert, give me the ROI on a data center, I don't get a straight answer. So Bill is very bullish, obviously.
Speaker 3I'm just realistic. That's the thing. I'm not making a call on equities here. I'm teasing. So let's fast forward a year. And I liked what you said earlier, not taking any risk, but taking a step back and saying, hey, if you were to be given the headlines, some of the economic data, certainly where the housing market is, you would probably not. In fact, I definitely would not. And I'm pretty sure you wouldn't either predict that the S&P would be within 2% of its all-time highs. You wouldn't predict where spreads would be. You would obviously think it's much worse. What would have to happen for this to not go badly? You'd have to have a hell of a lot more
Speaker 4money pour in, you know, pour into this market via, you know, VC investments, secondaries, IPOs, et cetera. You know, I think it's interesting that some of the big, you know, well, one of the biggest IPOs that was supposed to go months ago keeps putting it off, putting it off, putting it off, right? And now it's into next year. And that's never a good sign, by the way. You know, they say history doesn't repeat, but man does. It reminds me very much of other scenarios I've seen like this, the most recent of which was, you know, was 07 and also 99. And again, I'm not saying this is going to be exactly like that, but history can rhyme quite proficiently. The thing I'm nervous about is just so much speculative behavior going on right now. Every time I've asked me last year, like during the Trump tariff meltdown, you remember the tariff tantrum back in April, 2025, we actually went in and bought a lot of stuff during that because at that time, the economy was doing okay. Inflation was actually in a nice range. The speculative behavior hadn't gone crazy yet. And I personally back then bought semiconductors because I thought they were, that was 400% ago, by the way. It was like April, 2025. And we added risk to the fund. We bought a bunch of high yield. We added a number of bullish positions, and that worked out for us, the balance of the year, and then took them all off because everything went right back to the tights again. That was the last time high yield even blew out even a little bit. It went up to like 500 over and then came right back in again. When high yield goes this time, I don't think it's going to stop at 500. I think it's going to kick because then the default cycle is really going to start to kick in. You got a lot of companies hanging by a thread right now, both in private and public credit. And again, you can see it in the stats, whether it's percentage of the market that's gone payment in kind, actual default rates starting to creep up. Fundamentals, coverage ratios deteriorating, et cetera. The numbers are there. So that's why this time, unlike 2025, I'm like, I'm the most defensively I've been positioned since 07 in my fund right now.
Speaker 1If your baseline happens where we get this AI slowdown because they've taken on too much debt, the cash flows can't cover it, or they're just not getting the ROI, is there any scenario you see where we don't at least get a minor economic slowdown that turns into a recession? Like the 2001 recession, which was very, I don't think people realize how small of a recession that was. Is AI big enough to at least cause some sort of minor recession like that? It has to be, right?
Speaker 4Yes. Yes, 100%. And again, if you asked me that question last year this time, I would say no. But now I say yes, just because of the sheer amount of money that's gone. Past year has been amazing to me. The amount of money I've seen spent, the amount of debt I've seen raised, the amount of off-balance sheet obligations I've seen produced, it's unlike anything I've ever seen. And so by default, a fixed income guy like me who's got to protect capital, I get nervous when I see stuff like that, because that behavior that I know is going to end badly at some point. And that's a big bonus to me, because again, I have a saying. I said, the bank of Egan's always open. You're just going to hate the price, right? Because I'll give up my liquidity when I can see the whites of the market's eyes and guys are desperate to have it. And then guess what? I'm going to downbid you another two points at 359, and I want to get filled at 4 o'clock. So I can't wait for those days, because I'm actually the most calm when the hurricane is ripping off the roof of the house. That's when we really go to work. And that's why if you look at the history of this fund, every time it's done a double-digit return or a high single digit return, it's right after a tumultuous time in the markets where we went in, we had boring returns like 3% to 5%. Then all of a sudden, we've got a 10% or a 12%, and then we go boring again because we take advantage of those fall situations. And like you guys pointed out very accurately, right now, what's crazy is you've got all these things going on underneath the surface of the market, whether it's in private credit, whether it's in triple Cs, whether it's in BDCs that are telling you things aren't right. And yet, when you just look at generic market statistics like the VIX or high yield spreads, they would tell you everything's perfect, right? Everything is just perfect. I've never seen a cycle end where that wasn't the case, where things weren't going, things underneath the surface were very, you know, didn't look too good, but on the surface, it looked fine. But that's when you find out who's been naked.
Speaker 3Bill, that's a very, we're going to go out on a high point. For people that want to learn more about the fund that you've managed through dull times, through great bear markets and everything. Yeah. So the main ticker for the symbol is JSOSX.
Speaker 4It's a daily valid mutual fund. And that's one nice thing. It's liquid. What a concept. It's funny to me. I mean, I do this now because I love it, right? Because I built this fund brick by brick after doing long-only investing for a long time. This was a hedge fund prior to turning into a mutual fund. I actually ran a hedge fund at Hybridge Capital and turned it into a mutual fund at J.P. Morgan in 2008. And the rest is history. All right.
Speaker 3Very good. Thanks, Bill.
Speaker 4Awesome. Great talking to you guys. I'll talk to
Speaker 1you again. Okay. Thank you to Bill. Remember, check out jpmorganassetmanagement.com to learn more about the J.P. That's JSOSX. Email us, animalspirits at thecompoundnews.com. And we'll see you next time. Bye-bye.
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