Category: Uncategorized

Short one today as I woke up late (relatively speaking), due to sleeping late, due to a book that is too exciting and entertaining for night reading. If curious the book is called Undermoney, and it is a fiction novel involving finance, warlords, and the military – what is not to like? It’s written by Jay Newman, who I previously mentioned, the guy who seized Argentina’s naval vessel while fighting the government for better sovereign bond recoveries on his Argentine debt. Who would have thought a hedge fund guy could write fiction but it’s shockingly detailed and a decent read.

Anyways, housing is unwinding, at least from it’s blow off top. Phoenix, ground zero for the prior housing bust and perhaps also ground zero for the most cap rate compression over the ensuing decade, is headed back to normalcy. Listings are back to 2018 levels, which mind you, was still a hot time for housing. According to the guy below there are 2 months of supply on the market. Things are bad when it’s closer to a year.

I don’t really care about San Francisco real estate but I also do really care, because as a human I want our choice to sell our condo to be an unequivocally good decision in hindsight. I am human, after all.

San Francisco inventory is heading north, but nothing like the 07-11 timeframe. We’ll see how things shake out.

I’m not a credit guy. In a different world I fancy myself a lender extraordinare but alas here we are.

A Twitter compadre flagged some bonds to me today (hat tip) which seem downright interesting. They are part of the debt package backing the Blackstone Private Credit Fund (BCRED) and have traded down materially as rates have risen and fears around default rates in private credit are abound:

For investment grade credit, the yield to maturity on these bonds seems pretty enticing. Given BCRED equity is at roughly 40% LTV, and has 1.0x leverage roughly speaking, that puts the last dollar of debt around a 20% LTV. I’m not sure what the implied default / recovery rate on the portfolio has to be to wipe the equity and start debt impairment but finger in the air it seems like a draconian scenario. Else I think that this credit is probably one that pulls to par over time.

Locking in a 7%+ pretax return on investment grade credit doesn’t seem so bad (if it does indeed pull to par). Alas it isn’t quite for us (and individual credits are above my competence), but this market is serving up interesting opportunities in many different parts of the market

Disclosure: We do not own BCRED debt or equity, this is not investment advice. Do your own work.

I had previously noted when Sri Lanka defaulted on its debt in April. Yesterday the Presidential palace was stormed by thousands of people and the PM + President finally resigned.

The whole situation is unfortunate, and while was borne of many of its own actions (the heads of state specifically), it was exacerbated by global inflation of commodity products. According to Vox, the simplified series of events included borrowing heavily (via China’s Belt and Road Initiative, or simply, its global debt for influence plan), massive corruption in use of funds from debt rather than building promised core infrastructure, reductions in taxes driving lower debt service capacity, bans of imports in core inputs (such as fertilizer) driving desperate core food inventories, and the final blow being inflated commodities (there is no fish as people can’t afford diesel to run the boats; lentils which are a core staple in Sri Lankan diets are unaffordable). I may have pieces of that wrong but check the Vox explainer article for a better version.

Overall I mentioned this because, as I mentioned before, we visited Sri Lanka in 2018 and had a wonderful experience in the country. It seemed peaceful, friendly, and rich in culture. The following terrorism incidents and national meltdown touch a bit closer to home, especially given the hotel we stayed at in Colombo was the center of a bomb blast.

Alas there is not a whole lot to say from the perspective on an investor. Jay Newman, the man who went up against Argentina as a part of Elliot Management’s bid to pry reasonable recoveries from Argentine bonds, has commented vociferously of the bad state of emerging market debt, specifically that the IMF and others have loosened credit metrics and covenants such that emerging market nations’ access to credit is far in excess of what they can rsponsibly service.

One can hope that a new leaf is turned in the country.

Maybe we are headed in the right direction?

A quick look on where we sit just a bit over halfway through the year.

Global Equities:

Notable to me is Brazil being near flat.

Short ends of these rate curves, notably US / CA / AU vs the rest is interesting. Also note the US 2Y yield eclipsing the US 10YR yield.

US and EU high yield spreads:

I’ve been looking at the US HY spread in prior writing, and think a lot points to this being a good time to add exposure to that slice of risk. Oaktree Capital, a premier opportunistic debt investment manager, specifically indicated:

“In roughly six months, the average yield spread in the [HY] asset class has widened by more than 200 basis points to reach nearly 550 bps. With yield spreads at this level, we think investors are well compensated for default risk.”

Oaktree Capital

And economic numbers, with the US printing negative QoQ GDP growth:

Also note negative policy rates in Europe versus their high single digit CPI numbers. Yikes!

Politicians on both sides of the aisle make me want to blow my brains out. Mostly because of the dual nature of stupidity and the need to feed rabid members on the extreme sides of each.

For July 4th, Nikki Haley had a nice tweet proving she indeed does not know basic math despite a degree in accounting:

For the holiday weekend, Joe Biden placed blame for high gas prices on the mom and pop owners of gas stations and “price setters” of a global commodity whose price is set by global supply and demand:

In more reasonable pieces of the world, and rooted in data, here is what financial markets are pricing in for inflation for the average of the next 5 years:

The market is betting that inflation will be tamed roughly speaking, though 2.6% is above the 2% target. For fun, here’s the same expectation measure on a 10 year view:

You never know when markets have bottomed. Financial media is rife with stories with proof of multi-year downturns along with “Was [the prior day] was the bottom” headlines.

For the most part, especially as measured by sentiment indicators, people both professionals and retail are bearish right now. One ex-GS credit trader I follow on Twitter (@sidprabhu) has been hinting that maybe the inflation scare is starting to peak. Yesterday he tweeted a number of headlines in succession:

• Biden may soon ease Chinese Tariffs (WSJ)
• Chip boom loses steam on slowing PC sales, Crypto rout (WSJ)
• Falling commodity prices raises hopes that inflation has peaked (WSJ)
• Glut of goods at Target, Walmart is boon for liquidators (WSJ)

Perhaps the air is coming out of this boom to the extent that price growth starts slowing. Quietly, the 10yr treasury has dipped back below 3% after shooting up near 3.5%. Remember, financial markets often bottom far in advance of the real economy.

The high yield spread (average yield of high yield bonds versus corresponding treasury security) has ticked in at 5.84% over treasuries, increasing borrowing costs for lower credit companies materially. The HY spreads up materially from the 4% long term average¹. However it isn’t up at crisis levels of the past.

Verdad capital’s research indicates that:

Usually, high-yield spreads continue to rise after they hit 6.5%, peaking a few months later. This is also when the impacted equities stock prices are most precipitously affected, representing the optimal time to buy.

Verdad Capital

Note that Verdad indicated that 6.5% wasn’t an absolute line, and 6% or 6.25% would yield similar statistical results, just that 6.5% represented 1 standard deviation from the 4% mean.

Given that the current HY spread is near 6%, are we near a “financial accelerator” in which spreads continue to rise or are they peaking? One interesting comment:

Levered loan defaults have been at near historic lows, and one could expect that they start to rise as high yield markets telegraph that defaults are to rise. But in today’s somewhat unprecedented environment, in which the average B rated fixed coupon is below the current treasury yield, levered loans are an interesting niche.

We own select levered loan portfolios and continue to add modestly as market stress increases.

1 – https://static1.squarespace.com/static/5db0a1cf5426707c71b54450/t/5e57b290304a016161c46d62/1582805651161/Crisis+Investing+-+Verdad+Advisers+Ebook.pdf

Miller Value, Bill Miller’s outfit, is out with a new newsletter. The theme is, based on historical precedent, that there is no prior scenario in which the forward returns are negative over the next five years (given the drawdown to date).

They argue that near term forward returns may be painfully negative, but the mid / long term returns tend to be good. That said, that is on freshly invested capital. Here’s what it takes to get “even”:

It’ll take some time for markets to decide whether it has priced in the right amount of earnings degradation / multiple derating (due to interest rates), as earnings haven’t yet started their march down en-masse:

Investing for current income (aka dividend investing), a style of investing that has gone the way of the dodo due to shifting investor and business appetite to reinvesting into growth runways (and eliminating any dividend), is one that is dangerous at first blush.

It’s easy to oversimplify by looking at the yield of a security and get tunnel vision that the yield will continue into perpetuity. Want to make more money? One’s eyes immediately go to the highest yielding securities, albeit the ones that are largely the most junky securities on the market.

Cigarettes have been a yield stalwart for decades. There is no shortage of total return charts, articles, and more about how cigs have been one of the better performing stocks for decades because they consistently raise price more than the drop in cigs sold, and buy back stock that trades relatively cheaply. Investors most often look backward to predict the future rather than ignoring the past and thinking solely about the future.

Enter Phillip Morris (now called Altria), which was annihilated over the past week as the government indicated it was going to reduce the nicotine content in cigs and ban certain vape instruments:

Life comes at you fast:

While I have no opinion on the future of cigarette companies, I think it’s a good example of a company that people buy for yield ignoring the future outlook and risks. I often find that it makes sense to buy companies that yield much less, but have far better future outlooks. To each their own.