How To Deploy Capital in a Crisis (w/ Raoul Pal & James Aitken)
RAOUL PAL: I just want to-- because we've been chatting for a lot, and there's a lot we've covered, which is fantastic. What I'd love to get you talk about some opportunities, where are you seeing the opportunities here because it's very difficult for most people to get their heads around what's shit and what is gold within this. You're getting through this, so we have to know what you're doing. JAMES AITKEN: One way of thinking about it, for sure, but I think there are-- yeah, there are plenty of opportunities for patient capital. To provide a metaphor, one consistent observation across all the largest pools of global capital, who I advise, is that they've all been nibbling in this selloff. No one's trying to pick a bottom, no one's trying to predict the bottom. They're deploying capital into very specific assets and sectors based entirely on valuation. I think that's important for all of us, because we can read every COVID model we like. I don't think that's going to give us much insight into how to deploy capital. It might make us informed, but it's not going to tell us how to value a security that might be on sale at an enormous discount. I think that metaphor, nibbling and to be very precise, there is capital being deployed at the top of the US credit markets, so AAA CLOs. Just an anecdote, and I keep saying just an anecdote, but I'm trying to make it tangible for your subscribers. There was a strange Bloomberg story last week, and I think it was ill advised if true, that Citigroup had made 100 million dollars by buying a AAA CLO trash from potential investments. Now, that's a very strange transaction, because first, why would [indiscernible] of all people given they're fully funded need to sell a bulletproof and they are bulletproof AAA CLO tranche in the low 90 range? It doesn't make any sense, and yet Citigroup had the balance sheet to take the other side. The reason I share that is because I think it reminds us how different this is to 2008 because in 2008, it would have been Citigroup spraying stuff everywhere to the buy side. Now, Citigroup that has the liquidity to allow the buyer side to sell, and it tells you where a lot of this risk is held, hopefully in a sensible way. There is capital being deployed, very specifically senior secured credit for those who have read their prospectus, AAA CLOs. Obviously, this money that's dribbling into US credit up in the bulletproof tranches is not nearly enough to offset the potential supply and destruction to come, level out and offset anything people might need to distribute in high yield. Now, this is a very important technical point when we think about opportunity and solvency. On March 24th , ICE BAML indices said that they were going to take a raincheck on rebalancing their credit and fixed income indices at the end of last month. Now, that's very interesting. Then the other index providers, including Bloomberg to a degree, followed on and that actually gave the credit markets a lot of breathing room because if the rebalancings had gone ahead as planned, Raoul, there would have been a tremendous amount of liquidation in all sorts of credit, which the market would not have absorbed. It would have been particularly problematic for the Vanguards of this world and all the passive quant funds. They've postponed that to April 30th . The point I'm flagging here is there will be plenty more opportunities in credit for the professional credit investor, and the long only credit investor because they're able to name their price and they're able to hold on rather than picking a bottom in all this other stuff. We could talk about credit, more data afterwards, but I want to come back to equities as well. I think we all need to be very careful here, especially now, given the uncertainty to try to stay within our circle of competence. To be very frank with your subscribers, some of my friends would argue-- I'd even argue whether energy more at the broadest level is within my circle of competence. Although you and I know many very, very smart energy investors who have done phenomenally well in all sorts of market conditions. Now, let's think about numbers. Potentially over the next week, there may be some agreement between major energy producers that takes 10 million barrels a day of supply off market, perhaps by May. On the other hand, if you look at what traffic Buru and other leading oil firms are saying, demand action right now, as a result of the things we've been discussing in the energy markets, is running somewhere around 30 to 35 million barrels a day, a day. Let's take 10 million barrels of capacity off market, the frank answer is so what? Why should we care? If I go down another layer, and I turn on the Bloomberg and I look at all those products and spread products and all down the energy food chain, it roughly comes out with a market clearing price of oil, let's just call it broadly oil, somewhere in the low teens. You think to yourself, uh-oh, there's a lot more reckoning to come. It is however striking then in the context of that which every oil professional knows that some of the better shale, the large cap energy stocks have stopped going down, because eventually they discount the worst case scenario. We need to sharpen our pencils here, but we're in the process of what you might call the shale reckoning, or the shale restructuring that was postponed in 2016. On the front edge of that, there will be consolidation, people will need to tie their balance sheets to the ground, but there will be winners, and at some point that despite this supply dispute, despite the demand destruction today, we will need the oil and we will need these companies no matter as a sidebar, whatever people tell us about ESG. If we're going to restart the global economy, we need these companies and we need the shale companies in particular. If I dare to think about what's not in the price, I look at what, again, to use that metaphor. Our friends down in Texas, the really sharp guys are doing, and I say, okay, I'm watching what they're doing. I'm doing my own homework about the liquidity on the balance sheet, and the funding and the hedging, of course, and the breakevens of some of these companies that I imagined might last, so it might be the Devon Energies, the EOGs, the WPX, those sorts of things, passive energy, and then of course, I'm thinking about Chevron, Exxon and Hess. Then I might be thinking about what side of Australia. It really depends, but the point is, I am very carefully-- I don't trade, but I'm very carefully deploying some of my liquidity buffer which I've had for a long time into some of these companies. RAOUL PAL: Equity or bond? JAMES AITKEN: Equity. I'm doing so knowing that the demand destruction is staring at me in the face. I do so knowing that I'm very likely to be punched in the face again if I missed the market, but I'm prepared to absorb that because I think to myself there's long term value in these particular companies. RAOUL PAL: Do you think that the shale credit market has priced much of this in as well? Look, it's not going to be completely correctly priced, but everyone knows it's all going bankrupt and somewhere within that, you're going to find some real gems as exactly as you say. Do you think it's all priced in, or do you think there's bit more ugliness still to come? JAMES AITKEN: Put it this way, if I'm a sharp reducer, and I couldn't refinance at the end of 2019, which was the greatest credit liquidity bubble of all time, I'm dead. I think it's CUSIP by CUSIP. Mr. Market is identifying it company by company. There's a long way to go yet.