00:00I want to go big picture first because PIMCO put out an interesting note warning that the credit loss cycle
00:05has begun. We have a
00:06quote on it. They said that the default cycle is reasserting itself and we expect significantly higher losses and lower
00:13quality
00:13credit such as leveraged and private direct lending. It says the tight spreads investment grade and high yield clashes with
00:21an
00:21uncertain macro backdrop. And they see this as a sign of complacency. What do you think. So there's a lot
00:27to unpack there. I did
00:28read that article on Bloomberg and it was an interesting read. I think there's a piece of it with which
00:33I agree which is dispersion in credit
00:36markets. So I think if you look right now and actually I'm going to take a step back and talk
00:40about equity markets. So you see the
00:42returns that we've got in the equity market 10 whatever it is right now. Historically high yield is put up
00:4750 to 60 percent of those
00:49returns. And actually high yields only yielding or only returned year to date a little over a percent a percent
00:54and a half. Whereas
00:55historically it would be up more like five or six percent at this point. But if you look underneath high
01:00yield what you're
01:01actually seeing is significant dispersion. And what you're seeing is underperformance and lower rated credits. So I think that's a
01:08really
01:08noteworthy trend. So that's the first piece of it. So I think I'm going to agree. I expect an environment
01:13in which we have greater
01:14dispersion and security selection is going to be more important. The piece that I think is a little bit more
01:20difficult and a little bit more
01:21nuanced is they're talking about difficult conditions coming. But if you look at first quarter earnings if we look at
01:29the
01:29investment grade universe you saw you know 5.7 percent revenue growth 6 percent EBITDA growth. And if I look
01:37on an S&P 500 type
01:39level you've seen 29 percent earnings growth for the rest of the year. That's not really an environment that suggests
01:45a credit
01:46cycle or distress. So let's pick up on that dispersion point. We have a chart that shows how investors now
01:52require 6.4 percentage
01:53points of extra yield to own triple C credit over higher rated junk. That is actually the largest premium in
02:0014 months. You talk about
02:01how it's all about selection security selection. Which sectors does that opportunity show up in. So I think the first
02:09thing to remember is
02:10that it's less about a particular sector and more about the individual credits. So when you think about really doing
02:16your
02:16whole market. Well when you think about the high yield market it's much more similar to the equity market in
02:22that it's a
02:23particular credit that could be performing. I mean it's like there's no such thing as a bad bond or a
02:28bad credit. It's how much
02:29leverage you're putting on it and what the expectations are for cash flow. So I think that's the first thing.
02:34And actually when we look at
02:36sectors we see different markets in investment grade versus high yield. So in the investment grade market for example we've
02:42seen
02:42opportunities across our strategies. As a reminder I run our core core plus along with the team. So we see
02:47opportunities
02:48investment grade in financials. That's not an area that we find particularly attractive attractive in high yield because it's a
02:54lot of
02:55leverage to put on it. The other piece I think to remember in terms of dispersion and it picks up
03:00on one of the points that I think it was
03:02John you had on there was saying was that we've had a lot of issuance in the market this year
03:06in investment grade. I think
03:08we've had a trillion dollars worth of issuance before we hit the end of May. That's a record or near
03:13record amounts of
03:14issuance. And in high yield issuance hasn't been as robust as the investment grade market. But it's been particularly
03:22concentrated. You've seen sort of the hyperscaler related capex or those types of issuers take it from zero percent of
03:30the high yield
03:31benchmark to north of three percent. And that ties back I think to the original point which is individual security
03:38selection credit analysis really what's most important. You mentioned that high yield has been trailing equities when it comes to
03:45performance. Is high yield is credit leading equities. It's a great question. And I'm not sure I know the answer
03:53right now.
03:53It's felt like equities have been leading. And what's been interesting in the equity market is as as much appreciation
04:01as we've seen in
04:02equities and multiples where they are multiples have actually contracted or improved because earnings have appreciated more than the
04:09stocks have appreciated. So what we've seen in the equity market is kind of an exponential growth. So you asked
04:16me about sectors pick a sector like
04:18semiconductors tech hardware type thing. You've seen those stocks appreciate in an exponential level. You don't see that level of
04:25appreciation in credits. You've got companies that have solid balance sheets. You know we're at two and a half times
04:30levered in
04:31investment grade pretty stable four and a half times levered in high yield. Again pretty stable level of debt issuance.
04:38And the cash flow story is
04:39good. But there's not some ability for an exponential return in that. But that gets us gets us back to
04:46why people buy bonds for the
04:48yield. Those yields are attractive and credit fundamentals as I mentioned from earnings or if you look at you know
04:54net debts only up
04:55like one percent. It's a pretty benign environment. So I'm not sure which is leading which to answer your original
05:02question. And I think
05:03it's been more credit dependent and sector dependent. So the exit exit is from private credit is not over yet.
05:10We're just talking about this
05:11with James Crombie. Business development corporations. BDCs will continue to face a rough ride. Does that mean good news for
05:18public
05:19credit. What kind of contrast is that set up with private with public credit. I think it's important to take
05:23a step back and remember
05:25think about how we got to where we are. So if you go back to the origins of the boom
05:30in private credit which has gone from essentially
05:33zero or was on bank balance sheets to now off balance sheets in the type of vehicles that you mentioned.
05:38It's now larger than the broadly
05:41syndicated loan market and larger than the high yield bond market. So that's a pretty significant growth that we've seen.
05:47But the
05:47origin of that growth was two things. Firstly it was regulatory in that it was less attractive for banks to
05:53keep this on balance
05:54sheet. Right. So you saw this funding opportunity. And then the second one is is really there's all this demand
06:02for private credit. But it
06:04was it was because yields were so low. You go back yields you know 2022 yields are at a half
06:10a percent in 10 year treasuries. So
06:12people were really searching for yield. And one of the ways that people stretch for yield is they're willing to
06:18give up a
06:18premium. They're willing to pay a premium or to accept that for illiquidity. And I think if it 10 year
06:26treasuries yielding 50 basis points you're
06:28willing to take that illiquidity in exchange for a higher yield. And I'm going to agree with James Crombie in
06:34the point that he made
06:35when you've got five six seven percent yields in traditional fixed income with relatively low fees. That's now an attractive
06:42alternative for
06:43people. And I think that's that that's the trend that you're seeing is this movement into public credit markets. I
06:49don't have to reach for
06:50yield to go down in quality. I don't have to reach for yield by giving up liquidity. And I think
06:55that's what you've seen.
06:56When Bloomberg held its global credit forum this month attendees said that stagflation would be the biggest risk to credit
07:02markets
07:03right now. Do you agree with them. And how do you think that would play out. So I agree that
07:07stagflation general. I mean stagflation is the
07:09worst thing that can happen to bonds. So I agree with that. We're not seeing stagflation. Instead what we're seeing
07:14right now is two
07:15things. The first is very strong underlying growth in earnings that we mentioned a few minutes ago. The second we
07:22absolutely have seen
07:23inflation although the prints this week have been in line or maybe even a touch softer than what it wasn't
07:29anticipated. And what
07:30we're seeing this from. And I hesitate to use this word because it's fairly maligned from the Fed's use of
07:36it a couple of years
07:37ago. How did you guess. Scarlett. But transitory. In this case this is very much a supply driven shock. We've
07:43got a war in Iran.
07:44We've had energy prices increasing due to that supply. Yeah. What is it. We used to get seven you know
07:5011 million whatever number of
07:51barrels we were getting there. That's very much supply driven. So we're not seeing a stag lift stagflationary environment. But
07:57should that
07:57happen. You're absolutely right. That would be a difficult environment.
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